In commercial real estate, we are always looking forward. Where are trends leading the market? What lies ahead in the coming year? While some of these things are important to understand, the key is to know what is worth your time and attention and what is not. It’s easy to get distracted.
CRE is a long-cycle proposition. The smartest investors are those who are able to stay focused and ignore what is outside of their control. As we look ahead in 2023, with a volatile economy and the lingering possibility of a recession, it’s important to stay focused and tune out the noise.
Our company has built a multi-million dollar commercial real estate portfolio by sticking to fundamental, time-tested principles and practices designed to sustain income, value and growth through nearly any transient market conditions.
So, is a recession coming? My advice is to be prepared. Here are five guideposts for 2023—and potential challenges—that are top-of-mind:
1. Demand In The South And West
While the migration to the southern United States continues, pay close attention to local economies and trend indicators. In some areas of rapid growth, supply simply can’t keep up with demand. The development boom is sometimes met with pushback from local communities and government, and the infrastructure for basic services can be lagging. Investment in these regions remains strong, but be aware that the corresponding growing pains often drive costs higher for CRE.
2. Adoptive Reuse And Redevelopment
Lifestyle changes brought on by Covid-19 have impacted the market value of once-premium real estate, especially shopping malls and downtown office buildings. Over the past three years, I’ve liquidated most of our office holdings and focused instead on small to midsized industrial/warehouse space and small-bay retail. I expect to see more properties being repurposed and redeveloped, such as urban industrial space converted to retail and office space converted to multifamily properties.
3. Long-Term Exits
With most recessions lasting two to four years on average, I wouldn’t get into a project right now with an exit plan in less than four years. I also wouldn’t get into any debt that matures in less than four years. Even if you have willing buyers lined up, securing reasonable financing could be extremely difficult for them in the event of a downturn. Be prepared to hold assets over an extended period, especially now. It is, after all, the best way to build wealth and grow net worth.
4. Historical Values
Use only past and current market performance as a baseline for valuation. Pro formas can be misleading, and shifts in the financial markets such as rising interest rates must be considered. These challenges, however, can motivate you to become a better negotiator and a more disciplined investor. Limited financing options will force you to explore non-traditional strategies such as my preferred alternative: seller financing. In short, be realistic with your projections and know your numbers inside and out.
5. Debt Vs. Cash Reserves
Too much debt and not enough cash reserves are the two main reasons companies fail in a downturn. I recommend having no more than 50% leverage and enough cash in reserve for one to two years of debt service. If you need to sell half of your assets to pay off the debt on the other half, do it. You may miss the chance to sell at the top, but you can sell near the top. In the event of a recession, cash will be critical as bank financing dries up. Being prepared beats a liquidation sale every time.
Focusing on long-term goals, sticking to the fundamentals and maintaining a conservative financial position can help you preserve the value and performance of your portfolio, especially during periods of unpredictability. I’ve seen firsthand how, over time, commercial real estate investments can produce some of the best return on investment of any asset class. With the right strategies in place, yours can, too.