Although the future of commercial real estate remains murky, current operating conditions are crystal clear: There is very limited capital, extremely tighter underwriting, shrinking net operating incomes, shrinking space demand and declining property values. For companies today, that means leaner and more efficient operations and more focus on tenant retention rather than tenant attraction.
The bigger question may be how long will these current conditions remain in effect. And while they are far different than what conditions were just three years ago, the smart money is starting to act as if it expects the current operating environment will be in effect for some time and is starting to look for opportunities that match the times.
This is the assessment of a wide variety of clients and readers we contacted about what they expect the flip side of the current recession will look like. They said, despite some signs of overall economic stability, commercial real estate is still reeling from the effects of the credit crunch while trying to avoid the recession’s knockout punches. At the same time, they know the cycle will eventually turn will eventually come to an end.
We probably have already experienced the worst, but our economy is still falling, albeit at a slower pace. Several leading indicators suggest that we will likely bottom out before the end of this year. Nonetheless, investors should keep in mind that the economy declining at a slower rate is a lot different from actually beginning to expand. The recovery process could be less robust and take longer than expected.
We believe that there will be more distressed assets coming to the market over the next 12 to 18 months. Investors with cash can cherry pick the best assets in the most desirable markets. Preferred equity, mezz debt, super senior CMBS and ‘loan-to-own’ are also attractive investments during this period. There are very early indications that an end of the recession may be in sight — somewhere in the next several months.
That doesn’t mean the end is next month, but it might mean a continuation of reductions in job losses through the next two or three quarters, which will offer some hope but won’t put a lot of money back in consumer’s hands.
Last night I was talking with Jim Kane the Director at HCR Group, an Employee Benefit and HR consulting firm. He indicated that his work with his clients is growing for them. They offer new hire kits and manage cobra administration. Usually when one is up the other is down. Currently they are flat; companies have moved away from downsizing with employees and are now starting to look toward attracting new talent. Being in a flat position, talent retention is critical. This can be accomplished with a strong work environment (your office and any green practices you have in place) good benefits, and a supportive management team.
That all being said, my clients will be seeking and making worthwhile real estate investments, with an emphasis on low cost basis, low or no leverage, and a lot of patience. It would not be prudent to expect any quick turnarounds in value in the commercial markets, so conservative underwriting and forecasting will drive deals.
What does all of this mean going forward? In my opinion, there will be a continuation of what everyone in the business now recognizes as the norm. First, lenders want more equity in the deals (whether it’s a new loan or a refinance). Second, prices have already dropped in most markets to the point where a lot of properties are under water or close to it, which will continue that downward pressure on prices because lenders will be taking back more properties and selling them at a discount to get them off their books and owners will be selling them at a discount to avoid going back to investors to raise additional capital for a refinance.
We’ll get through it, but it’s going to take some time. I personally think it’s too early to start any buying on a large scale, and you’re going to need a lot of cash to make anything happen. The disconnect between what sellers want and what buyers are willing to pay is clearly pointed out by looking at sales volumes around the country-anemic compared to any “normal” year. I don’t see anything that’s likely to change that any time soon.
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