Economists can't seem to agree on whether the US is indeed entering a recession. But, on the other hand, job creation has been strong this year, with an average of 488,000 new employment positions created each month.
Unemployment is still low at 3.6%, and wages have been growing at a rapid 5.2% pace. Moreover, despite recent declines in retail sales, they are up nearly 8% over last year. Those are all positive economic indicators indicating a solid growth scenario in the future.
But on the other hand, the economy shrank for two consecutive quarters. Moreover, we have rising interest rates, an exceptionally high 8.5% inflation, a falling stock market, and sinking confidence levels.
So in many ways, there's a fear factor at play that might cause people to curtail their spending and trigger a recession.
For commercial real estate (CRE) investors, the prudent thing to do is to prepare and reassess.
Key indicators suggest that the US economy is on course for a recession, with the Federal Reserve increasing interest rates by 0.75% and more increases anticipated this year to curb inflation.
Aside from all this volatility, record commodity prices, a never-ending war, and a persistent pandemic add to market anxiety.
How do you make your portfolio recession resilient if you're a CRE investor? How can you ready yourself for a market contraction? Here are some tips.
Commercial real estate professionals must balance long-term thinking with the agility to shift positions should quick action be required. This means keeping decent liquidity.
When banks refuse to lend, cash will reign supreme. However, staying liquid doesn't necessarily mean keeping a lot of money.
Ready access to credit lines should suffice. This will allow you to maintain your assets while also having access to cash when needed, allowing you to cover any shortfalls and take advantage of buying possibilities.
If you've been investing in CRE long enough, you already know that when the going gets tough, some close banks' lines of credit for 'risky' clients, even if the account is fully performing and current.
This is why it's essential to have access to non-bank lenders that understand the market.
Don't rely on traditional commercial lending alone. Instead, start building relationships with lenders that offer commercial real estate bridge lenders, commercial hard money lenders, stated income commercial loans, and commercial investment property loans.
This will help you access a credit line when you need it most.
The primary cause of CRE investors losing their assets and even going bankrupt during economic downturns is too much leverage and not enough liquidity.
Selling assets and using the money to pay down debt can be beneficial if you have more debt than assets.
Think of it this way: If you have $100 in assets and $70 of debt (70%), it's often better to sell 50% of your assets and pay down your debt so that you have only $20 of debt (40%) and $50 in assets
.If you do this, your equity position remains at $30. Still, you can keep the leverage to the ideal range of 30% to 40%, which can help you protect leveraged assets from trouble and prevents the loss of assets from lenders calling in covenant defaults.
Given the current state of the economy, it might be wise to consider selling some assets that aren't performing well financially.
Selling a property now may help you save money in the short term. As interest rates fall and market conditions improve, an opportunity to acquire a new investment might open up later.
Constantly monitor market fundamentals, such as property location and construction specialties, while evaluating your portfolio.
When it comes to commercial buildings, those that have more generic features will always be easier to sell or lease.
In contrast, properties with highly specialized or customized features may remain vacant for longer because the pool of potential buyers is smaller.
If you are facing upcoming or maturing debt, it might make sense to refinance now. But, first, review your position and ensure your balloon payments on your debt are at least five—ideally seven to ten years out—so you can weather the storm.
During the next five to seven years, your assets may be left vacant and enter into covenant default as the economy fluctuates.
Ideally, you should refinance any debt with non-recourse debt and negotiate covenant default provisions ahead of time.
Because most lenders don't want to take ownership of property, having no personal guarantees on loan will strengthen your negotiating position and raise the likelihood of reaching more favorable terms with the lender should you get into trouble.
Consider deferring any long-term commitments that are (1) capital-intensive, (2) have an exit strategy over the next two to three years, or (3) have debt that will otherwise mature over the next four years.
Remember: Even fully-performing Class A assets can be lost during recessions if banks suddenly freeze lending activities and owners cannot refinance when the underlying debt matures.
Complete current projects as promptly as possible or pause them if needed.
You don't want to be in the middle of a large-scale CRE construction project in the thick of an economic recession in a few years. Many analysts suggest getting out while there is still time.
The industrial, commercial, and office space industries are shifting. As a result, many of the CRE properties that we once regarded as the gold standard--such as suburban office spaces, indoor malls, etc.--are becoming relics. Don't be a dinosaur. Evolve with the times.
Before investing, do your due diligence to research if the building will soon become obsolete.
Think twice about putting money in CRE properties quickly becoming undesirable, such as mobile home parks, older industrial warehouses with low ceilings, multifamily properties in lower-tier markets, and office spaces with small wall-to-window ratios.
In addition, traditional retail is suffering as e-commerce grows, so it might be wise to avoid big-box retail. Instead, consider focusing on recession-proof assets like medical offices, flex/small bay industrial facilities that cater to the service sector, and some in-line, service-oriented retail or grocery-anchored centers.
Recognize that the broader economic change will influence property valuations and costs when leasing or selling a property.
Although the commercial real estate market is doing well, it's prudent to anticipate a slowdown over the next year.
When making changes or investments in your property to make it more appealing to renters, figure out what is necessary and what can wait. If you're selling, consider what upgrades will provide the most value.
With rising interest rates, access to capital and borrowing has become more complex. Making significant investments to modify a property may not be prudent. Carefully consider any upgrade and be prepared if it doesn't play out in your favor.
CRE investors were hit hard by the shift to working from home during the height of the pandemic. Thankfully, the dust has settled, and people are returning to the office.
But some analysts warn that this may not last because of threats like rising gas prices, increasing crime rates in large metropolitan areas, and inflationary adjustments.
Don't let the pressure of quickly leasing out vacant space cloud your judgment, though. Instead, take time to check each applicant, especially their creditworthiness, thoroughly.
If a new tenant is unable to pay rent in the long term, you are exposing yourself to even more recessionary risks that you're trying to avoid in the first place.
COVID-19 has both beneficial and harmful effects on some sectors and businesses, so it's essential to understand your tenants' financials well.
Protect yourself from high-risk tenants by determining when their business loan terms are up. Pay close attention to letters of credit and insurance provisions to protect you if the rent isn't paid.
Inflation can be a pain, so watch out for it and don't get caught in a bind. While longer leases are traditionally seen as the safer bet in CRE, there's a risk that inflation may outpace rent growth in the next few years. So instead, consider shorter leases, so you increase the rental rates when the market cost rises.
While market downturns are undoubtedly uncomfortable, you can lessen their impact on your CRE investments by taking appropriate precautions. Commercial real estate remains a solid asset class that can be utilized to hedge against inflation.
By staying focused on CRE properties with sound fundamentals and partnering with a full-service CRE investment firm like Capital Investors Direct, you can protect your portfolio in about any market situation.
Disclaimer: The information presented in this blog is not investment or financial advice. Consult with a CRE professional for guidance concerning your specific situation.
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