Although the news changes on a moment-by-moment basis about the credit and liquidity crisis, there are some enduring principles that can help you to make wise choices in this turbulent business climate.
“If you own, lease or invest in commercial real estate for your business, you need to be aware that commercial real estate values are entering a period of high volatility due largely to this national credit and liquidity crisis,” says Bill Tyler, senior vice president of debt and equity finance at CB Richard Ellis.
Smart Business spoke with Tyler about the current real estate investment market and how to capitalize on these opportunities.
What are some of the causes of the current real estate landscape?
Banks created credit velocity by periodically selling their loans through securitization. This enabled them to make more loans with less equity on their balance sheet. The process of slicing commercial real estate loans and selling them in the open market ceased more than a year ago. This was due to buyers’ inability to get comfortable with the risk and associated pricing of these loans, led primarily by residential defaults. This has decreased the amount of available capital to the commercial real estate market by 35 to 40 percent annually.
Without securitization, banks have become overweighted in loans and underweighted in equity. To solve the problem, they need to sell loans (often at a discount), make fewer loans and raise equity. This is called de-leveraging. Wall Street firms have suffered from the same securitization problems as the banks. But due to higher leverage on their balance sheets, they have required higher amounts of equity to stabilize their financials, and several haven’t been successful there. Life insurance companies are now the primary providers of capital for commercial real estate loans.
Why is it essential to re-evaluate current investment strategies?
In this capital constrained environment, equity is the key. Today, you need 30 to 40 percent equity to purchase or finance commercial property as opposed to 10 to 25 percent just a year ago. As a result of this lower amount of leverage availability and potentially higher interest rates, property prices are declining for the first time in several years.
What are some of the opportunities in today’s market?
If you are a renter, now could be the time to buy as prices fall. As an owner with leverage, you need to know that commercial mortgage capital is severely constrained, and it takes more time to locate and negotiate leverage. In many cases, credit enhancement in the form of a guarantee may be required to access affordable capital.
For a person with access to enough capital, this could be a great time to buy reasonably sound properties at a discount. Some owners who are over-leveraged or just need cash flow may be willing to sell at a previously unacceptable price point. In the commercial market, I think office buildings and warehouses are some of the strongest properties. Due to the availability of capital from government agencies, multifamily properties are also a solid option. But with reduced consumer spending, retail property is one of the weakest real estate investments.
What other factors should contribute to investment decisions?
In addition to a reduced supply of debt capital and potentially higher interest rates, underwriting standards have also increased. To ensure the best debt execution for purchase or refinance, the factors that matter the most to lenders are the quantity, quality and duration of the income stream. Put another way, the best properties are those with the highest occupancy, the strongest and most diverse tenancy and the longest lease terms.
How can companies develop an effective plan?
Current and correct information is paramount in this volatile environment. Seek out professionals of all types in the commercial real estate arena including leasing brokers, sale brokers, appraisers and mortgage bankers. These professionals can assist with realistic market evaluations because they see many transactions. Not only can they show you the historical data but they can also tell you what the market will say to you if you’re looking to buy or sell.
Also, an effective plan would include finding access to the right level of capital, such as senior, mezzanine, bridge capital or preferred equity. Real estate professionals can help with locating this capital and also may know of investors interested in joint ventures.
What tactics should be avoided?
Do not be pressured or rushed in this market. This process of de-leveraging of balance sheets will likely take 12 to 24 months. Although the headlines will often contain stories of failure and bankruptcy, these are necessary steps and will provide positive opportunities during the process and into the future.
Now is the time to begin your property and market analysis. If you look at alternatives now, you’ll be prepared to quickly and confidently make a decision when the time is right, and properties adjust to the lower leverage environment.
BILL TYLER is senior vice president of debt and equity finance at CB Richard Ellis, Atlanta. Reach him at (404) 923-1575 or email@example.com.