Let’s face it, for those of us in the business we knew a correction was coming. This hard this fast was beyond the prediction of most if not all of us. We knew the party had to end one day but, the awakening was rude nonetheless
For the past 10 years, Multifamily real estate has been a shining star. Demand had been going up, consistent rent increases, compressing cap rates and price appreciation, tax benefits, and depreciation. In addition, syndication, crowdfunding and ventures became normal. This all accumulated in everyone wanting a piece of the action. But had it gone too far?
From an economists perspective, a good rule of thumb is to compare your real estate investments against the risk free rate of return which is typically Treasuries or 10 year T-Bond. Over the past 20+ years, interest rates have been declining, making real estate investments appear more attractive. But are they really?
The short answer is yes. The longer answer gets us into the difficulties of pricing various risks. In real estate, we have 3 major risks. The first is operational risk, the risk associated with operating the property efficiently, keeping costs in line, vacancy low and income high, management, etc. The 2nd is market risk. Is the property in a market that has good fundamentals for growth? As we can’t “move” the asset to another market, we can be exposed to demographic shifts and legal risks. Rent control laws, higher licensing fees, local taxes or mandates are just a few of the implementations to be aware of. The third is liquidity risk. As we know, we can sell a stock or bond with a mouse click for immediate cash, that’s far from the case with real estate where it can take months longer.
Whether the spread of return between 10 year T-Bonds and Class A, B or C properties was enough can only be identified in a case by case basis. As I’m writing this, we should not be surprised that some sellers deals may already be going south. Buyers are pulling out given the uncertainty, sellers are re-trading lower to get to closing, banks and bridge loan operators are pulling out of deals. Of course some lenders will be still lending, but rest and be assured credit policy will undoubtedly shift as we try to find the new norm and equilibrium in the market place.
Further, operators with large cap-ex may have difficulties meeting their deadlines. With a majority of the travel and service industries shut down, the ripple affects through the rest of the economy will be felt far and wide. Rent collections will undoubtedly be affected. So what can you do?
Action steps
- If you’re in a GP in a syndication, start communicating frequently with your limited partners. Expect and prepare for calls to liquidate as LPs may look to raise liquidity given their situation. What can you do to calm their fears and anxiety that may have?
- Raise liquidity as much as possible to weather the turmoil in the next few months. Cut or re-adjust cap-ex projects to save cash. Offer reduced rents for vacant units or older units not updated. Better to have 75% of the rent than 0% of the rent.
- Communicate with your bank about options available to you. There is greater flexibility in smaller regional banks than larger ones. Seek a rate reduction or interest only payment plan for a short while if possible. In commercial real estate, virtually anything can be negotiated so the stronger your balance sheet and proactive you are, the greater the chance for success.
In these trying times, stay healthy, stay strong and stay safe. I’ll be happy to hear your thoughts.
