Where are we in the CRE cycle?

Question

I’m new to commercial real estate and am looking to see if it offers any opportunities in the current market, which I am assuming to be somewhat over-bought. Can anyone tell me what is the most reliable price index used? Which sectors are the least volatile? How much does geography play a role. Even when assuming the Offeror of say a syndicated investment is experienced, does the way leverage is used concern anyone? For example, what happens if a property can’t be sold before principal payments kick in. Are the offerings adequately reserved or insured for that eventuality? I know they can change to LLC status in order to refinance etc, but how common and successful is that? What are key ratios benchmarks (debt to equity etc) for analyzing offerings? Where can I find default rates for DST-type offerings?

Ivan Barratt · Answer

CRE of course is hyperlocal. That being said. As rates continue to drop (they have to due to what's going globally) cap rates will drop further. For example; prime cre in Europe trades at a 3.5 cap vs 4.5 cap in US. Their rates are zero and ours are 2.25 respectively.  US CRE should perform well overall.  My preferred niche... workforce multifamily in emerging midwest submarkets where we have a higher likelihood of outperforming the average.

Ian Ippolito · Answer

Victor, like you, I'm conservative and much more interested in capital preservation, rather than projected return (or stretching for yield). More aggressive investors than us have hundreds of opportunities to choose from each month in CRE. It's much more difficult for a conservative investor, but in my opinion there are still a few jewels out there. These are those rare sponsors who have full real estate cycle experience with no investor money lost (or very little), conservative use of leverage, put significant skin in the game, etc..I know both a multifamily operator like this, and a triple net lease (NNN) fund also. The MF operator has been around for multiple real estate cycles with no money lost, goes no more than 65% leverage and always puts at least 10% skin in the game and each deal. The NNN operator diversifies into hundreds of properties in multiple CRE asset classes across the country. They have also been around for full cycle (with no losses), have targeted leverage of just 40%, and are the only fund of the type that I know of that has an investment grade rating. Both of these operate under 506b and are not allowed to solicit publicly, so if you are interested in more info then message me privately.Regarding sourcing deals: many of the most experienced sponsors like this are not going to be found through a broker (as they have naturally accumulated considerable investor followings and have no need to pay a broker to raise money). You  find them through networking through joining an investor club or personally etc.

Mike Dymski · Answer

There's no silver bullet to generating outpaced returns from safe investments.  Either invest in index and bond funds or go to work learning your asset of choice.  It's a good start here asking questions.  Review 100 offerings and talk with XX sponsors and you will start catching your stride.  If you don't enjoy that analysis, I'd recommend moving on to something else.  Good luck.

Joel Owens · Answer

"I'm new to commercial real estate and am looking to see if it offers any opportunities in the current market, which I am assuming to be somewhat over-bought."

Impossible to give an educated answer without talking with you on the phone and reviewing financials. What is a GOOD deal is in the eye of the beholder.

You are mentioning commercial real estate with a broad brush stroke and commercial has many sub-asset classes within it. Additionally the area with growth or non-growth can have an impact at where in the cycle things are at. The SIZE of the deal and property can also be a factor.

For example you can have over saturation levels for instance in a 40k sq ft commercial building for less demand  BUT have strong demand for well located assets 15k sq ft and below. That tenant base could be growing and expanding. So there are tons of metrics at play.

Ask an investor what a good deal is and they might view a property multiple ways.

1. Investor for example makes 50k a year. They bought and rehabbed a few commercial properties over a 5 year period and are now worth close to 2 million for net worth. The job doesn't give them net worth growth or recapitalization the properties do. So they might lean heavily toward value add and more risk.

2. Investor that has a business or a doctor making 1 million a year or more income. They want to have real estate eventually provide and replace the income stream they have now if they want to retire from being a doctor or selling out their business to go passive for income stream and returns. To them tax and wealth preservation might be number one and having the best credit tenant and long term lease. Yield might be a distant 3rd place because they already have lots of income.

I often see people come on here and ask broad questions and really without knowing a persons specific situation it's hard to define a more clear path of options for investment.

Taylor L. · Answer

Lots of questions in there!

CBRE puts out a lot of reports on this topic, from Global surveys to regional. Some markets and assets are in hypersupply, others are not. Good deals are still out there to be had, they're just harder to find than they have been so far in this cycle. You can find CBRE's reports here.

Leverage is absolutely a concern. I prefer long term debt when possible, because you don't want to have to sell or refinance during a credit crunch. Good sponsors will plan their renovation budget and interest only period meticulously, so the i/o period ending doesn't happen unexpectedly. Your offering should be able to handle it, but whether any individual syndication is adequately reserved is a question for the sponsors!

Lately it seems like more sponsors are choosing to sell rather than refi, because they've been able to earn a nice return for their investors and themselves.

If you were to ask me my top 5 key numbers, I would include: Debt Service Coverage Ratio, Expense Ratio, Unit mix, interest only period, and loan term.

Joel Owens · Answer

Victor there is a TON of capital out there for syndicators I mean A LOT.

Doctors and others with tons of cash and people selling off businesses. They are either buying to own directly, investing in syndicates, or both.

What you are wanting syndicators do not typically have to offer that to be competitive. Some buyers never buy or never invest when looking for terms outside of market conditions. They eventually come more inline with market expectations for deploying capital or still looking for the unicorn years later.

Not talking about you specifically just saying there can be a disconnect between what investors expect for deploying their capital and then the realities of the market. Syndicators often go to individual investors for better terms to them on their deals.

If the deals have structures that you mentioned syndicators can go to corporate equity groups and get almost unlimited funding and not even have to worry about raises deal to deal. Syndicators put in that work to get better terms with individual investors. Some syndicators use big equity and individual investors to structure a deal but tend to make the big equity a smaller percentage of the equity stack. Sometimes you can get more optimal terms to you the investor with a newer syndicator but after a few deals that syndicator will search for cheaper money or renegotiate the structure.

Greg Dickerson · Answer

We are definitely at the top in most markets. That being said there are always opportunities in every market cycle with every type and class of real estate.

Real estate is hyper local so you need an intimate understanding of local markets and how the will be affected in this current cycle to be successful.

Long term debt is the only play right now. You never want to count on a refinance. Although it looks like rates will not be on the rise anytime soon we do not know where the capital markets will be in the future.

The time to sell is when everyone needs to buy and the time to buy is when everyone needs to sell. The key is necessity.

The top commercial brokers all put out market reports as well as National multifamily and commercial real estate publications.

Bjorik Mutize · Answer

Questions all over the place. The market wiggling between it's peak and contraction. One index to pay attention to is GDP. Geography is huge as markets change moving across, up and down the us. IE coastal markets vs inland. Don't over-leverage. Offerings usually should hedge against any hiccups with debt service, something you need to verify with your operator/attorney for entity structure. Analyze ROE, ROI(w/Cash on Cash), NOI, Bottom Line Cash Flow, Entrance and Exit Cap.

Jack Martin · Answer

@Victor Saumarez from what you've shared, it sounds like your goal should be to find good sponsors who specialize in an asset class with the ability to weather the next recession.  As mentioned by @Ian Ippolito those kind of sponsors with a conservative strategy will stand out compared to other syndicators out there.

Personally, I focus on mobile home parks in Arizona, where we can acquire below market, add value, and maintain stable cash flow, without using high leverage. (many times using no debt at all)  Like you, our goal is capital preservation through conservative acquisitions inside a recession resistant strategy.

We have found that investors seeking a more conservative approach tend to appreciate low leverage/no leverage and an asset class that has proven to weather market volatility well.

All the best,

Jack

Victor Saumarez · Answer

@Michael Bishop Thanks for that. It was what I’d read was the norm and was very concerning to me.

Where are we in the CRE cycle?

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