What Does the Current Economic Situation Mean for Commercial Real Estate Investors?
While the stock market has plunged and rebounded since the onset of the coronavirus pandemic, real estate investors are watching and waiting with bated breath to see what implications the first half of 2020 will have on the housing market. Thus far, residential prices have remained pretty steady, but many expert investors predict that will change.
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Only time will tell what will really happen to residential prices, but another sector—commercial real estate—is poised to be even more significantly impacted by COVID-19-induced temporary shutdowns, as well as mandatory operational changes even as lockdowns are lifted.
So, what does the current economic situation mean for commercial real estate investors?
I HAVE ALMOST NO IDEA!
Even the World’s Most Successful Investor Has Made Missteps in 2020
As a commercial real estate investor, I should really know the answer to this question. But let’s be honest… before this is over, this whole mad unprecedented mess will make a fool out of everyone who says they know.
Even our "friend" and investing mentor, Warren Buffett, apparently made one of the more significant mistakes of his career in the early months of this crisis. Buffett has not made many large equity purchases in the past five years, but one group of stocks he invested in heavily was the airline industry.
Now, I can’t say that investing was a mistake in itself. Because who could have predicted the current situation? Who could have guessed that a person’s meal (or lab) in Wuhan, China could have shut down airline travel and the rest of the world’s economy?
Besides, the way to evaluate a good or bad decision has much more to do with the process one uses to make a decision rather than the outcome. The outcome is subject to so many unpredictable and random effects that I find it is better to ask myself if I went through the appropriate due diligence up front. And we know from over six decades of his personal history that Warren Buffett did that due diligence in these purchases.
Anyway, Buffett revealed in his 2020 annual investor meeting in early May that he sold off his stakes in four airlines in the midst of COVID. This was his apparent mistake.
What has happened to those stocks since he sold them? CNBC reports that calculating from the dates that Berkshire completed selling shares of each airline, as listed in SEC filings, American is up 64%, Delta has gained 54%, Southwest is up 27%, and United has increased by 53% as of the first week of June.
Buffett obviously has a long time period in mind when he makes decisions like this, and we should check back in a year (or a decade) to see if his decision paid off in the long run.
Now, what were we discussing anyway?
The Investment Outlook of Commercial Real Estate in 2020
That’s right, I was talking about commercial real estate investing in the current crisis. And like I said, every forecast, including mine, will be wrong. We just don’t know how far off they will be in timing or magnitude. So while I don’t want to make specific forecasts, I will offer some suggestions here for your consideration.
Beware of a W-shaped recovery
We all hope for a V-shaped recovery. But a V-shaped recovery is the first half of a W-shaped recovery, and that first “false” bottom could cause misplaced optimism that results in investors overpaying for assets.
The current release of pent-up demand will undoubtedly cause a quick upward shift. But will it be sustainable? The delay of a medical solution and/or a virus repeat could cause the W-shaped effect on Main Street. But the emotional state of investors will likely be the ultimate driver in a market up or down, especially on Wall Street.
I can also imagine a partial V-shaped recovery followed by a drawn-out L-shaped recovery for a large part of the economy. This could look like about 60% to 80% of the jobs being restored quickly while the remainder take years to get back to work.
Look for unprecedented buying opportunities at the right time
Study the timing of the GFC (Great Financial Crisis). There was a significant lag between the cracks in the ice (2006 and 2007); the bottom of the equities markets, which coincided with the highest number of foreclosures (late 2008 into 2009); and the bottom of real estate prices (Q4 2011 to Q1 2012).
This is the time for patience. This is the time to build yourself, your team, and your tribe. You have time to prepare.
Don’t waste it binge-watching another Game of Thrones season. I’ve written about this before.
Be ready to be somebody’s hero
There are going to be a lot of people losing their properties, a lot of banks who don’t want them, and a lot of investors who want to get in on this. Many investors are already sick of the Wall Street slot machines and will be looking for answers that you will be in a position to provide.
Specifically, in commercial, you may be in a position to buy distressed debt and provide a solution for distressed owners by giving them a path to work out their payments and refinance. This serves local banks and your investors, as well.
And in residential, learn to do subject-to deals and lease-option sandwiches. This is a huge win for property sellers, tenant-buyers, banks (made of stockholders), and you.
Look for an acceleration in both the life and death of certain sectors
Malls and other retail were already in trouble. In 2019’s boom economy, we saw about 12,000 retail closures. Now we’re watching this accelerate with the bankruptcy of JCPenney, Nieman Marcus, and more. Shared office businesses like WeWork were also in trouble, and their demise may be accelerated.
Conversely, data centers, e-commerce, self-storage, and mobile home parks were on the rise. They are now flourishing in this mess, and I expect that to continue.
Think outside the box and look for repurposing opportunities. What about converting malls and their parking lots to self-storage or data centers? Or converting hotels to senior living? We’ve already seen that big box retail can be profitably converted to self-storage, and I expect this to continue.
Similarly, look for demographic shifts to accelerate
Millions of people were already moving out of locations they disliked to get to where they want to live. For example, there was already a mass exodus from California to Texas, Colorado, Idaho, Utah, and more. I’m guessing the work-from-home trend coupled with the time people have had to reflect on their priorities will result in a lot of accelerated movement.
Brandon Turner moved to Hawaii years ago. And another big BiggerPockets syndicator just confided to me that he is leaving the big city to move to a large tract of land to create a family homestead in a southern state. I’m tempted to do the same.
One size won’t fit all locations
Commercial and residential properties will perform much better in some geographies than others. Places in Utah, Idaho, and Texas are predicted to fare better than some northern locations like Orlando and Las Vegas, which are both heavily dependent on tourism.
The sand states of Florida, California, Arizona, and Nevada almost always swing wildly in good times and bad. But don’t write these locations off. If you time it right, these can be the best locations for the deal of a lifetime.
I'm personally zeroing in on Sanibel Island and Fort Meyers, Florida, favorite travel destinations for my family, to pick up deeply discounted single-family rentals on a subject-to basis. The wild swings help the informed investor (the BiggerPockets crowd) while crushing the uninformed, who bought high and will sell low or hand their properties back to the bank.
Don’t generalize on either asset type or location.
Expect a continuing gap between seller and buyer expectations
Sellers are still hoping to get top dollar for their properties. Many were banking on appreciation and playing musical chairs when the music stopped in February. Smart buyers, seeing the risk of the unknown, are not paying full price right now. You can expect this will hamper a lot of deal flow.
I believe this will continue, as it does in most downturns until there is a recovery or until sellers successfully work through the five stages of grief (denial, anger, bargaining, depression, then acceptance) in their mental and emotional space. This can take a long time, so don’t expect a quick resolution here. I think most sellers are still in stage one or two right now.
Look for some puzzling results
I’m thinking about office space, for example. I can imagine a significant negative shift as thousands of companies realize their employees work well remotely. At the same time, I can imagine some companies needing more space as they spread out to observe social distancing and move to less costly, less parking-constricted locations in the suburbs.
Don’t expect the current collection results to continue
I really hate to sound like a pessimist. But current collections for all flavors of real estate asset types are going surprisingly well. Usually at or above pre-COVD levels. I can’t imagine this will continue forever, especially as government assistance wanes and the burden of long-term unemployment settles in. This is one point I really hope I’m wrong on.
Look for certain industries and jobs to come back to America
Watch for tension with China to continue to increase. Since our dependence on them could prove detrimental, I’m expecting a resurgence in some American jobs. This could benefit several types of commercial real estate.
How can you prepare for this possibility?
Be a purveyor of hope
This isn’t the end of the world. Older generations have seen cycles repeat over and over, and part of wisdom is realizing that the sky isn’t falling. I get that it will one day, but it’s very likely that this isn’t that time.
So, take a deep breath, count your blessings, be thankful for what you can, love your neighbor, and look for ways to profit in this downturn without harming anybody in the process. Some of the greatest fortunes in history have been made in times like this, and many of you BiggerPockets members will benefit greatly from the results of this crisis in the coming years.
Spread hope to the fearful in the meantime.
For someone who doesn’t know what’s coming, I’ve happily provided some guesses on what could happen. How about you?
What do you see coming down the pike in commercial real estate, and how will you respond?
Share below in the comment section.