Commercial Real Estate - Is it going to crash?

Question

Hi BP,

I've been doing some research on commercial real estate and large apartment buildings.  I currently invest in SFH but looking to get into some larger deals now. In all of my research there are mixed feelings on whether or not there is a huge crash coming in this segment.  Does anyone have any feedback on this?

Thanks

Rick M. · Answer

Now that I have my first deal under my belt, I’m looking for my second Multifamily so I’m hoping for a crash or at least a dip in prices so the buyer has the upper hand. Currently, at least in my market, the seller is holding all the cards and with inventory low, the seller has even more of an advantage. I have an investor with cash on hand, all this crash talk is getting me excited for 2018…it has been 10 years since the catastrophe of 08, I doubt it will be as Earth shattering as 08 but some leverage would help a brotha out.

Fred Heller · Answer

In Houston, we're already in, maybe not a crash, but a deep downturn in office buildings. I recently read an article in the Business Journal that vacancy rates in Houston average over 25%, the highest of any city in the country.

I'll drive by on an elevated part of the freeway and look over at a building. I can see all the way through for several floors. No offices in sight. I notice this especially with all the shiny new high-rises along the Beltway between 290 and Tomball Parkway.

David Thompson · Answer

Trying to time the market is difficult to do and most will say not a sane business strategy.  A foundational model based on a strong market (jobs/population exceeding averages and projected to continue), conservative deal assumptions / modeling (rents, occupancy) and an experienced team should weather downturns.  I point to 3 things w/investors when we discuss risk.  Our only concern is a black swan / cataclysmic event that we cannot predict or have not weathered.  The typical downturns or even strong downturns you should have evidence of how your investment can hold up.

1) In 2008, most consider a very strong correction, MF loan delinquency nationwide was 1% vs 4-5% for SFR

2) In Houston, 2013 oil fell from $100 to $50 barrel.  Being an oil dependent city economy, this is a good test on a local level of what can happen.  Class B/C value add occupancy held steady while Class A fell off a cliff.

3) In Dallas, we have data on avg occupancy dropping to 85% at the worst point in 2009 (REIS data) in some key submarkets where we are buying today, our sensitivity analysis is built to show investors that rent can drop 10% from projections and fall to 75% occupancy and breakeven.

Joel Owens · Answer

There is talk of the pro-tax environment possibly pushing out the overall average cycle time another few years before the next down turn.

Michael Bishop · Answer

I have to disagree with @Henri Meli, if you firmly believe that a crash is coming and you still want to invest in RE, it might be the best to move cash in to commercial MFs. There are extensive studies that prove that commercial MFs (100+ units) are much more recession-resistant than other asset classes. Numbers like occupancy rates, loan defaults, etc. all remain quite favorable when compared to those of SFHs during a recession.

On top of that, if you work with a good syndicator, they'll only bring you deals that will perform (albeit not to projections) in a down market. A sensitivity analysis will show you this. For example, it might show you a scenario along the lines of 'what will happen to investor returns if occupancy rates fall to 82%.' Hence why conservative underwriting is so crucial.

Henri Meli · Answer

Who really knows the future? I know people who couldn't sleep at night knowing they have car loans. I know many people who predicted the crash of the economy in 2012, 2014 then 2016 ... They are still sitting on cash (or bought into the Gold hype) ... If you believe CRE will crash soon, then you should stay away from it or just risk very little money on it.  The 2008 crash was really brutal on a lot of us. I survived and learned lessons. Which segment do you think is safer?

Matt K. · Answer

As a casual observer of the commercial side I've noticed some big portfolios (or at least big by my opinion) coming up for sale. I've also seen people post about getting good deals on portfolios..... so my first thought is someone must know something I don't. I've literally seen entire neighborhoods for sale... but again I'm just a casual observer of this realm. I will say though prices seemed healthy and didn't make sense to me (seemed like lot of work for tiny return).

Todd Dexheimer · Answer

I hope it does crash. That will allow me and others to buy at lower prices and still be ok on our current holdings. Right now on my buildings 70-75% occupancy is our break even point.

I would be aware that we are closer to the top than the bottom, but not let that stop you. Underwrite conservatively and you will be able to weather the storm

Sam Shueh · Answer

Really depending on the location. Overbuilt shopping malls, housing etc in Vegas and Florida are potentially sluggish.  If Amzn model will work then Americans will depend less on retail stores. The vacation towns, second home communities are always depend on a strong economy and favorable tax rules.  In not distant future, a recession can make property owners miserable.

Nate Waters · Answer

Who REALLY know if or when there will be a huge crash? Not me. But, what I do know is some big banks are becoming much more conservative in their lending practices. Wells Fargo, specifically. How do I know that? A WF rep visited me at my "day job" to discuss the new lending standards. She stated that WF believes there are a significant number of over-leveraged commercial properties and speculative loans out there and they are paring back to help protect themselves in the event there is a market correction. She mentioned that most new loans will require an LTV of 50% or less. Granted, my day job is not in the RE field so lending on apartments may be different...but she made it sound like this applies to all loans.

I am not speculating on future market conditions - each of us needs to decide for ourselves when and where to invest - but I thought this information may be helpful to some fellow BPr's...the more we know the better decisions we can make.

Commercial Real Estate - Is it going to crash?

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