Encourage your clients to be prepared and nimble, but to limit risks whenever possible
Consider this: It’s the fall of 2023, and the country is deep in recession. Commercial real estate is feeling the pinch, and your clients are getting nervous. But as you know from experience, there are opportunities in every kind of market, and various ways for real estate professionals to get through a recession. So, what do you tell your clients when they turn to you for advice?
“As investment advisors in a recession we are often asked if properties should be sold in order to increase the cash position,” notes Tobias Schultheiß, SIOR, managing partner, Blackbird Real Estate GmbH, based in Konigstein, Germany. “In Germany, finance usually is long-term, and selling could lead to a pre-payment penalty. I believe the most important ‘tool’ is to advise clients to keep calm and not to rush into bad decisions. On the other side, liquid investors can profit from a recession by acquiring properties with a discount.”
Aaron Barnard, SIOR, senior director at Cushman & Wakefield in Minneapolis, Minn., clearly agrees with that last statement. “Change begets opportunity!” he asserts. “An investor may not be seeing the same return on an asset as prior and may want to exit; when others are on the sidelines, it can be a great time to acquire. A less competitive buyer pool allows you to have some flexibility on terms and due diligence items.”
“Everybody thinks there will be blood in the streets, and a huge number of foreclosures, but those things won’t happen,” counters Paul Kluck, SIOR, first vice president at CBRE in Denver, Colo. “What you’ve got to do is track the buildings you want to buy, get in there and buy when they just drop a little in price.”
“We see recession as opportunity for clients to either get into real estate or continue keep building wealth.”
“Good deals become available, both for investors that have dry cash and also for tenants that want to secure long-term leases at attractive buildings for low rates,” says Bjarne Bauer, SIOR, managing partner, Commercial Real Estate Transactions, NAI Sofia Group Shanghai. “We have in the past successfully helped tenants to snap up leases with discounts of up to 50%, have renegotiated ongoing leases, enabled reductions of around 20%, and have supported clients to pick up assets at favorably low prices.”
“We see recession as opportunity for clients to either get into real estate or continue keep building wealth,” adds Tim Tran, SIOR, president for The Ivy Group, in Fremont, Calif. “We have some clients sitting on cash and being opportunistic; if you pick up an asset at a discount and manage it well, it will go up. Our job is to find the opportunities, and identify good properties with good locations and upside value.”
INFORMED BY THE PAST
SIORs who have successfully navigated recessions in the past lean on those lessons as they advise their clients in the latest recession. “One learning is that each situation is unique,” Bauer shares. “Another learning is that markets may seem to act irrationally, and yet another one is that central bankers may not necessarily understand the complexity of economic interdependence. This means that assumptions such as 'higher interest rates must lead to lower purchase prices,' which may have been true in the past, will not necessarily be true right now—especially since a lot of other parameters are different and money is being printed at unprecedented speeds and amounts.”
Accordingly, he shares the following strategies with his clients:
- Keep some cash dry in case even better opportunities present themselves further down the road.
- Put some of your capital to action immediately when opportunities arise, because prices might go up again earlier than expected.
- Also note that a recession doesn’t necessarily mean that asset prices, e.g., real estate prices, will decline. Real estate prices will go down if there is an oversupply of real estate. If there’s no oversupply, then prices might remain strong.
Schultheiß shares the following lessons from previous recessions:
- Communicate early with the financing bank in case you are about to run into trouble.
- Talk to your tenants and find out how they are affected by the recession and find out how the landlord can help.
- Developers are a usual target in a recession, because they usually don´t have much equity in their developments and when interest rates rise, they may run into problems. This is a good time for equity investors to take over control of such developments.
In addition, he says, “Most important is to keep calm and be aware of possible issues like tenants not paying rent because of the recession. In some cases, a rent deferral can make sense. Also, communication with banks in challenging times (not only recession) is very important.”
“Be realistic—if not pessimistic—on lease up and carrying costs. This will give you cushion as the market starts to turn for the better.”
Barnard shares that in 2012-15, “we looked at every suburban office sale opportunity that we could; we were one of the few buyers willing to lean into the ‘recovery’ at that time. We were able to fill up a few of the assets and sell them a few years later with solid returns.”
This experience, he continues, taught him that the old adage, “You always make your money when you buy” still holds true. “Be realistic—if not pessimistic—on lease up and carrying costs,” he advises. “This will give you cushion as the market starts to turn for the better. Also look for value: what can be added to the property? How can you reposition it so that you attract higher and better uses?”
He also cautions that on any given day a tenant can make the decision to combine into other sites, either leased or owned. “Assume that the larger the tenant the more risk,” he cautions. “Stay away from one tenant having 40%-50% of a multi-tenant rent roll; 20% is a much safer number when things start to change.”
“So many lessons,” adds Tran. “To summarize, our type of business is really about building that relationship and trust—which is not something you do overnight. It takes years and years, guiding clients through the decision-making process and risk analysis.”
That opportunity, he continues, presented itself in the last recession. “A lot of our smart clients who were eager and had the financials were buying,” he shares. “We started to manage a lot of the projects, particularly mini storage. When we came out of recession, we had a chance to continue working with those same clients because we helped them through the recession.”
One thing he’s learned, he adds, is to be patient, consistent, and to never give up. “Just be steadfast, trust yourself, and your instincts,” he says. “You’re there to advise clients with all the experience you’ve accumulated.”
Based on his experience, Kluck resists the term “recession”—at least for the industrial market. “What about the pandemic—why didn’t that have an effect? And what happens this time with interest rates going up? What will be the effect?” he challenges. “I don’t think we’re going into recession; for real estate, let’s just call it downturn. If you’re talking industrial, Amazon did 80 million sq. ft. of leases during the pandemic.”
He shares that he was on a regional call yesterday with West Coast brokers. “Their vacancy is sub 3% in some cases, where equilibrium is 5%,” he says. “There’s no place for e-commerce distributors to go. You have two to three years for a building, even if it’s build-to-suit. Vegas and Salt Lake are almost full. Denver is 1,000 miles from there; we’re building 10 million sq. ft. and filling up; there are 17 million sq. ft. of deals we’re tracking.”
On the office side, Kluck continues to advise the ‘blend and extend’ approach, which entails extending a tenant’s lease term and blending the current rental rate with a newly negotiated rate—considered by some observers to be a “win-win” for both tenants and landlords. “If you renew early at a 10% reduction in the rental rate, you might prevent having to renew a year later when it would be down 20%,” Kluck explains. “We’ve done a lot of ‘blend and extend’ for both tenants and landlords.”
A DIFFERENT KIND OF RECESSION?
Even with all their experience, SIORs still remain aware that every downturn can be different from the previous one, which could require some adjustments from the more traditional approach. “In the past during times of crises, governments around the globe had certain measures at their disposal, for example, to increase the amount of money in circulation,” notes Bauer. “In recent years, despite relatively strong economic growth, governments in countries like the U.S., most of Europe, and most of Asia, kept interest rates at low levels and have increased the amount of money in circulation enormously. All these governments are now facing a time of economic downturn. Maybe one could compare it to a marathon runner that drinks all his energy-drinks at the very beginning of a race and then when it gets tough towards the end of the race doesn't have that extra booster in his back pocket anymore.”
“The future is being written for office space consumption now,” adds Barnard. “We may not be halfway through whatever change this is. Working from home is here to stay, but firms are also seeing productivity changes up and down. In the end, people need to be together. We are ultimately social beings, and this gives me hope for the longevity of spaces that are work-specific and away from our homes.”
“The last massive downturn was after the Lehman Brothers’ bankruptcy, and obviously today’s causes are totally different: rising interest rates and margins, inflation, rising building costs and global supply chain issues,” notes Schultheiß. “Back then, markets clearly shifted to a seller´s market and this situation lasted until earlier this year. Given the current circumstances, banks are reserved in granting new loans and if they do, conditions are deteriorated compared to last year: e.g., we wanted to buy a clinic last year and the bank was willing to finance 100% of the purchase price at 1.5% intertest and 2% payback. The deal delayed and just recently, we confirmed our interest in buying the clinic to the seller at a lower price, because conditions changed massively: only 60% of the purchase price will be financed at 4% interest rate and 3% payback.”
“I think this one is different in the sense that we reached this point very quickly —in a matter of 6-8 months,” notes Tran. “In most cases interest rate rises take a long time. Now, interest rates have almost doubled since February, and that caught a lot of people by surprise; they do not know how to react when something comes that quickly.”
His advice to clients? “We tell them to think through their decision instead of making a [quick] move to buy or sell.” It also requires some adjusted thinking in terms of value —as shown by a recently closed deal in Sunnyvale, Calif. for a commercial kitchen. “We priced it at $5.2 million,” he shares. “We had it on the market for a good six months and got a couple of offers. One buyer came along, and we initially took off about $700,000 from the off listed price since the market had changed that much. Then when the appraiser came in and only appraised it for $4.15 million, the seller ended up backing off $1 million on the price —he needed to sell, and if he didn’t sell now, he thought he might sit on it for 3-5 years. It was not a fire sale, but we were surprised the appraisal came in that low.”
The building sold for $4.2 million. “We can say we sold above appraised value,” notes Tran. “The seller was happy, we were happy. You have to be able to pivot outside the box; there will always be motivated sellers and buyers out there,” he notes.
As for Kluck, it’s perhaps less important what the experts say about the economy, or the real estate market, than what investors think and feel. “Investor sentiment is almost more important than statistics,” he asserts, noting that current sentiment is not at a level that should cause concern. “If they feel good, they’ll continue to make good decisions. If they start to panic, they’ll make bad decisions,” he concludes.
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
CONTRIBUTING MEMBERS
Aaron Barnard, SIOR
Bjarne Bauer, SIOR
Paul Kluck, SIOR
Tobias Schultheiß, SIOR
Tim Tran, SIOR