Will there be a recession? Here are five tips for organizations looking to make investments in commercial real estate in 2023.
With political volatility on the rise and the possibility of a recession still looming, it’s important for commercial real estate investors to stay focused and avoid distractions.
In commercial real estate, the key is to focus on your own actions and ignore what is outside of your control. Here are five core guidelines to consider – and potential challenges to prepare for – while staying the course.
- Think demand. Focus on markets where demand is strong but pay close attention to local economies. In recent decades we’ve seen a migration of people and business investment to the sunbelt. However, unprecedented growth in southern and western markets has created challenges. Supply cannot keep up with demand. In addition, the development boom is sometimes met with pushback from local communities and government, and infrastructure such as water, sewer, and public education capacity is often not prepared for a surge in growth. All these factors limit supply, driving costs higher for commercial real estate.
- Think adoptive reuse. The pandemic changed how people live, shop, and work. Properties that used to be considered grade-A assets, such as shopping malls and downtown office buildings, became obsolete. It’s critical to know how local demand for different commercial real estate assets is driving market behavior. With the possibility of a recession in 2023, we’ll see more properties being repurposed in lieu of new development. Industrial space in urban districts being converted to retail and office space converted to multifamily are good examples of redevelopment concepts.
- Think long-term. Historically, most recessions have lasted two to four years. With that in mind, a good strategy is to not get into a project right now with an exit plan in less than four years or get into any debt that matures in less than four years. You might have an exciting project in a prime location and lots of willing buyers for the final product you are developing, but if they are not able to get reasonable financing to buy, then there is little good their “willingness” can do for you. In general, the best way to build wealth is to hold assets over an extended period, especially now.
- Think historical, not speculative. Don’t be swayed by optimistic pro formas. Look only at past and current market performance as a valuation baseline. The lending environment has shifted significantly with rising interest rates and underwriting stringencies. A year ago, it would have been possible to have bought a vacant building and secured an acquisition and construction upfit loan at 75 percent or even 80 percent LTC. Today (Q4 2022), we can’t get a spec project financed. The good news is that these financing challenges will help you become a better negotiator and a more disciplined investor. Limited financing options will force you to explore non-traditional financing strategies, such as my personal favorite – seller financing.
- Think resourcefulness. When companies go bankrupt in an economic downturn it usually boils down to one reason – too much debt and not enough cash reserves. As we are starting a new year, no more than 50 percent leverage is the best recommendation. Have enough cash in reserve for 12-24 months of debt service if cash flow is interrupted or delayed. If you need to sell half of your assets to pay off or adjust the debt on the other half, do it. Yes, you have missed the window to sell at the top, but you can still sell near the top. When institutional financing dries up, cash will be king. So be resourceful while you still can, so you’re not caught on the outside looking in.
Being consumed by fear of the unknown is the surest way to slow progress and make unwise decisions. Sticking to the fundamentals, and focusing on long-term goals will help one preserve the value and performance of their portfolio, even during these turbulent and unpredictable times.
Nikita Zhitov is principal at CityPlat LLC.