Seeing returns

Many people consider the current markets, especially real estate, volatile
and risky. There have been highs and lows, and some regions have a large number
of residential and commercial properties that
have been on the market for months. While
this news may seem discouraging, according
to Michael Mason, senior vice president and
commercial real estate team leader with
FirstMerit Bank, this is not all bad news.

If you are an experienced real estate
investor looking for multi-tenant residential
properties, retail centers or office buildings,
this can be a great time to invest in commercial real estate. There are plenty of properties
for sale at an attractive price and long-term
interest rates are very favorable. Due to the
current condition of the real estate market,
says Mason, it is clearly a buyers market.
However, that does not mean an investor
should simply buy and manage a property.

The most successful real estate investors
will make ongoing improvements to a property, particularly during an economic downturn. Ongoing reinvestment in a property will
typically assure maximized occupancy and
rental rates, and a maximized future selling
price during an economic recovery. The key
is to know how to successfully purchase and
manage the property that will provide the
investor with the desired return on investment. Given the current market conditions,
this is not the time for the highly leveraged
novice to make real estate investments.

Smart Business spoke with Mason about
what the current market means for real
estate investors and how investors can prepare for future swings in the market.

There has been a lot of bad news in real
estate. Is there light at the end of the tunnel?

There is light. Actually, for long-term
investors, now is a good time to invest in the
real estate market since property values and
interest rates are relatively low and certain
properties may be eligible for historic tax
credits. The truth is, investors will not realize
immediate profit, but if an investor is willing
to invest time and money into a property,
there will be profits in the long-run. Many
economists believe that long term commercial real estate investments will continue to
outperform the stock market.

What is the status of long-term interest rates,
and what does it mean for investors?

The general consensus among experts is
that interest rates will remain flat or decline
slightly in 2008. Keep in mind that 2008 is an
election year and politicians will do everything in their power to keep interest rates low
during an election year. Long-term rates will
also continue to be impacted by the issues
surrounding the sub-prime lending market.
As a result, investors will benefit from near
historic low long-term interest rates.

Are there new factors the lending industry is
abiding by for real estate buyers?

Investors should be prepared for more
stringent underwriting standards as financial
institutions are going back to a more traditional lending model. Financial institutions
will continue to be competitive and creative
with loan structure, however, there will likely be more reliance on the experience of the
investor, the ‘global’ performance of an
investor’s entire real estate portfolio, and the
quality of the tenants. In particular, a diversified tenant mix and the sustainability of their
income streams are important factors for
lenders. High-quality investors that are willing to inject equity into a property to sustain
future slumps in the market are looked upon ery favorably. The greater the investor’s
equity position, the more aggressive a lender
can be in providing financing.

What should investors be looking for when
selecting properties in which to invest?

Location and diversification are the keys.
Understanding the quality of the other properties near your investment is important.
Investors need to clearly understand the
rents and cash flow streams associated with
that property and how they compare to current market conditions. A diversified tenant
mix and a clear understanding of the credit-worthiness of the tenants are important. For
example, a 10-year lease to a weak tenant
means nothing once that tenant goes bankrupt. Also, make sure the tenants represent
diverse segments of the economy. A downturn in one specific industry segment could
cause a large vacancy in your property.

What can investors do to protect themselves
against similar slumps in future markets?

Don’t over-leverage the property and keep a
reserve for repairs and maintenance. Some
investors look to take out all the equity in a
property without properly funding ongoing
repairs and maintenance. This will get the
investor in trouble during times of low occupancy or depressed rents since investors will
have difficulty making loan payments, keeping real estate taxes current, and simply
maintaining the property. A lack of maintenance leads to higher vacancy and, ultimately, a lower property value.

Why should investors have cash reserves?

There will always be highs and lows in the
real estate market, along with unforeseen
expenses. A cash reserve and/or the ability to
inject equity into a property will assure that a
property will retain or increase its value even
during difficult economic times. Investors
must look at their properties as a long-term
investment and be prepared for whatever
challenges may arise.

MICHAEL MASON is senior vice president and commercial real
estate team leader with FirstMerit Bank. Reach him at (216) 694-5654 or [email protected].