ADVERTISEMENT

ADVERTISEMENT

Business

Overcoming the recession in commercial real estate: time to wait?

ADVERTISEMENT

Written by admin

ADVERTISEMENT

ADVERTISEMENT

Our Walmart property may have lost 25% in value in the last six months. But the cash flow hasn’t changed.

John E. McNellis, director of real estate development company McNellis Partners, for WOLF STREET:

Years ago, during the Great Recession, one of Tennessee’s top real estate developers shook his head in his financial statement and drawled, “My net worth has halved, but my cash flow hasn’t changed.” He was not alone. During those difficult times, commercial real estate across the country lost about forty percent of its value.

His sad comment acknowledged two things: the fall in the value of his portfolio, but more importantly, the fact that it really didn’t matter. Although his property was worth half as much, his property was still occupied by tenants paying rent.

Because this savvy investor has lived through several recessions—they’re like reunions, they sneak up on you—he’s been completely reticent about the mortgages he’s placed on his real estate. With little existing debt, he was not forced to sell his property when the loan came due; instead, he could refinance. So his only losses were on paper—cut numbers on his financial statement—and he was still getting his rent. And when the market bounced back a couple of years later, his financial record bounced back.

Fast forward to today.

Real estate values ​​may not have dropped much yet, but they are looking down the rabbit hill. We looked at our retail holdings in January thinking we should do a little trimming. We were considering selling a Walmart supermarket in the Central Valley and asked one of our favorite brokers how much it would bring.

Because his Walmart lease is short-term, he said the property would sell at a cap rate of 6 percent; that is, the buyer would like to earn 6 percent per year on their purchase price. Therefore, if the rent were $200,000 per year (it’s not), the purchase price would be $3.33 million ($200,000 / 0.06 = $3.33 million).

We weren’t ready to sell in January, but we were ready last week. We contacted our broker. Somewhat shyly, he explained that the nightmares of the past six months – the bear market, soaring inflation and interest rates – would cause buyers today to insist on an 8 percent yield. This means that our Walmart will now sell for $2.5 million ($200,000 / 0.08 = $2.5 million).

In other words, over the past six months, the value of this property may have dropped by 25 percent. Like this crafty Tennessee, we decided we’d better keep our losses on paper and decided not to sell.

This example demonstrates the close resemblance of single-tenant retail real estate to the bond market: the price of both decreases when their yields rise, and conversely rises when their returns fall. And, to simplify things a bit, fluctuations in the value of each don’t matter unless you’re selling: if you buy $1,000 worth of Treasury bonds at 5 percent and hold them to maturity, you’ll earn your 5 percent every year and all. your main back. But sell when interest rates go up to 10 percent and you’ll get a much lower price. On the other hand, sell when interest rates drop to 2.5% and you’ll get a much larger amount.

The same math works for single-tenant retail: if you’re not selling, your “cash flow stays the same.” If you do this, you will ride the market like a mechanical bull.

My example also implies another point: even if we allow a dizzying drop in the value of commercial real estate – it is possible – we are unlikely to see the emergence of an active buyer market. Instead, sellers with the financial means will put their items back on the shelves and wait for a sunny day before selling.

Instead of a buyer’s market, we are more likely to see buyers and sellers a mile apart, rooted in their own expectations, as we watch the speed of the market evaporate like saliva in a frying pan.

Sellers forced out of their redoubts by death, divorce, divorce, disaster, or just overleveraging can indeed be killed, but there is so much money chasing real estate these days that even they can live to fight another day. .

Let’s go back to that shrewd Tennessee. He understood that net worth is for bragging rights and cash flow is for food. So you can. John E. McNellis, author Succeed in real estate: start as a developer.

Enjoy reading WOLF STREET and want to support it? Use ad blockers – I understand why – but want to support the site? You can donate. I really appreciate this. Click on the mug of beer and iced tea to learn how:

Want to be notified by email when WOLF STREET publishes a new article? Sign here.

#Overcoming #recession #commercial #real #estate #time #wait

ADVERTISEMENT

ADVERTISEMENT

About the author

admin

Leave a Comment