Much talk has been made over the past year as to the timing of a potential commercial real estate (CRE) downturn. If there is any certainty in this industry is that the real estate market will make its cycle from recession to recovery and then eventually back to recessionary times. Most investors may not agree to the timing, but all will agree that eventually there will be a downside to this real estate market.
With that said, I don’t believe this next downturn will resemble anything like the years of 2008; 2009 & 2010. However, I do believe that certain markets and property types that are grossly overheated will eventually subside and interest rates will continue climbing back to their historical averages. In addition, when the residential markets begin to cool, the labor shortage commercial real estate is currently experiencing will loosen up.
Then, on top of all of the possible scenarios that could happen, we have a presidential election in 2020. These events could be enough to slow the commercial & investment real estate market and leave buyers sitting on the sidelines, which will eventually bring lower offers.
Currently, the real estate market is still going strong with cheap debt and low cap rates so most sellers for class A properties are still getting premiums for prices while sellers for class B properties are seeing a steady velocity of sales volume.
Based on my experience there are a few proactive measures most investors should do ahead of the eventual CRE downturn. I have narrowed these down to the essential three (3) things. They are strategy; debt and occupancy.
Strategy. The first thing most investors should do is decide if any properties in their portfolio still meet their long-term investment goals. If not, then they should strongly consider selling the property. As with most investors, goals and risk tolerances change over time and because of this real estate projects may not meet the goals and/or investment strategies originally sought when the property was first purchase. My advice is to think about selling while the market still has velocity and there are active buyers. You can do a 1031 Exchange into another property that may be more suitable to your long range goals. This way you can defer all taxes and use your equity to trade into another property.
Debt. You should strongly consider the amount of debt you have on your properties and most importantly, when does your loan term mature. If it is within a 2 to 3 year period, I would suggest going to your lender to see if you can lock in a longer term and/or extend amortization, even if the interest rate might be higher. Trying to re-finance in the middle of a recession brings a lot of problems and is often at a time when banks/lenders are trying to minimize their exposure to commercial real estate. Risk tolerance, which was mentioned above, is something else that should be considered as part of the debt structure. If the property has negative cash flow, do you have enough liquid funds to cover any temporary cash flow issues? If not, then reducing debt or increasing amortization should be strongly considered.
Occupancy. Now is a good time to approach your current tenants and especially renewing tenants to lock in longer term leases. You may even consider making a few capital improvements around the property at the same time to show tenants that you are investing in the property for the long term. Also, I would consider employing a very aggressive leasing strategy which might consider giving free rent upfront to get occupancy levels high enough to sustain the property should the market slow down. Regardless of occupancy though, there will be tenants in your building that will go through hard times should there be a recession or market slowdown.
Overall, the timing of the next CRE downturn is uncertain, but will definitely happen regardless. It is imperative that all investors start thinking about either exit strategies or locking their properties down with longer term debt and solid tenants. Most investors who rode through the last recession unscathed didn’t have loan term issues or experienced minimal occupancy & collection problems. Although the previous recession may have caused some investors temporary cash flow issues or minor tenancy problems, none of these contributed to a forced sale or foreclosure of the property, which was disastrous for a lot of investors.
Brian E. Estes is president and investment adviser with the Estes Group and can be reached at firstname.lastname@example.org.
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