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 Michael.Mason@firstmerit.com.