The real estate investment community is in a state of uncertainty at the moment. Industry experts are advising investors to try to be as prepared as possible for further disruption. It’s important to be proactive. In this series, I’ll share key factors that may hold the biggest risks facing real estate investors.
Investing in real estate is normally a long-term play. Instances of market downturns or economic bumps are, for the smart investor, anticipated and weathered by implementing this simple investment philosophy. However, this is unchartered territory. In my opinion, the longer the COVID-19 pandemic continues it may become more difficult to raise capital, borrow or service existing debt. Do you finish renovations or conserve the capital? Instead of rent bumps you’re now forced into more concessions just to survive. What happens if you start to go negative over time, unable to recover? Investors will have to consider the need of divesting themselves of their real estate assets, as a long-term play may become more problematic than a viable solution.
There’s too much uncertainty. Uncertainty causes confusion. A confused mind says NO! The inability to understand what lies ahead, in my opinion, will put real estate investment dollars on pause; the classic wait-and-see approach. Investors should expect an era of tighten lending and tempered investing moving forward. It’s safe to assume, deal activity will slow because underwriters are unable to size loans under what was once considered a “normal environment”. However, the smart investor should not rely solely on leverage and cap rate compression to produce returns. The smart investor, during this time, will benefit from a focus of adding value at the property level and improving tenant retention to keep economic occupancy high.
There’s an infamous Baron Rothchild quote, “Buy when there’s blood in the streets.” Although the statement, in my opinion, is both morally and ethically questionable, buyers of real estate may be mindful to hold off making investment decisions in the hope that they may be able to take advantage of the possible downturn trajectory in property valuations as a result of the pandemic. There is no question that there may be huge opportunities to be had. As distressed sellers look to offload assets they can no longer afford, the biggest problem for investors however, will be what it has always been, distinguishing which investments are opportunities and which are temptation.
Whether the time ahead for investors proves to be a challenge or a fantastic opportunity, grossly depends on whether or not you have cash on hand. Cash is king! With enough dry powder on hand some investors will have the luxury of taking advantage of the opportunities while others will not because many will be trying to rebalance their portfolio. Borrowers will be looking to refinance loans as recent as 1-2 years ago simply to reduce the rate. The investor that’s liquid in a buyer’s market can win big time. However, a word of caution, if the time of opportunity comes and you feel like a kid in a candy store, be sure not to leverage yourself too much. You need to still be conservative and plan for rainy days or you may find yourself on the other side from whence you came.
It is important that owners monitor the financial health of their existing tenants. Familiarize yourself and inform tenants of any local, state or national governmental rental assistance programs. Taking those steps will hopefully help soften revenue shortfalls from tenants and anticipating downstream problems that distressed tenants can create for you. The objective is to be proactive and not reactive. Tenants will likely be under stress, and landlords need to review their leases to ensure they understand their rights in these unusual times, but also be prepared to have those rights limited by law or by social pressure. With recent talks of owners having the inability to evict (this also includes the inability of lenders to foreclose, the key with tenant retention will be communication. Investors would be wise to work with tenants to come up with creative solutions by agreement that would allow tenants to maintain occupancies and landlord to maintain compliance with its loan and other operational obligations.
Much like with investors’ relationships with their tenants, investors should communicate with their lenders early to determine if a short-term loan modification is appropriate or applicable. Owners should first review their loan documents to make sure they are aware of the loan requirements. Pay special attention to the debt-to-income ratios and other covenants that require a certain amount of rental revenue on a monthly or annual basis. At the very least, any workouts with tenants will need to comply with those requirements. If the strain to keep compliant with the loan requirements becomes great enough, there may be force majeure (act of GOD) or some other similar provision that can absolve an owner of compliance given these extraordinary and unforeseen circumstances. This should be reviewed with an attorney before any discussions with the lenders.