InSight

The coming distress in office real estate and how to make the most of it

Financial Planning Dentist

The squeeze in commercial real estate in the office group is causing a challenging situation faced by owners of office buildings who need to refinance their loans amid a record-high vacancy period. As a result of the COVID-19 pandemic, many businesses have shifted to remote work, which has led to a decrease in demand for office space. This has caused vacancy rates in commercial real estate to reach record highs in many cities.

When owners of commercial properties need to refinance their loans, they must provide proof of occupancy rates and rental income to lenders. With the high vacancy rates, it may be difficult for owners to meet the lender’s requirements, which could lead to higher interest rates or even the inability to secure financing.

The cost of borrowing money in the US has gone up a lot in the past year. This has caused big problems for banks and could cause problems for owners of commercial real estate, which means buildings used for businesses. They might have trouble getting new loans to pay for old ones that are due soon. A lot of money, almost $450 billion, is due to be paid back in 2023. This is happening because the Federal Reserve, which is a group that controls the money in the US, raised the cost of borrowing money from almost nothing to 5%, which is the biggest increase in a long time.

With nearly $450 billion in commercial real-estate debt set to mature in 2023 – meaning a final payment on those loans are due, per data cited from Trepp by JPMorgan. This situation may cause a fire sale in the commercial real estate market because more distressed sellers may enter the market, looking to offload their properties quickly. This increase in supply, coupled with decreased demand, may lead to a drop in property values and lower selling prices.

 

What does this mean for investors in traditional REITs and Real Estate Mutual Funds:

A vicious cycle can occur in mutual funds and real estate investment trusts (REIT) within the fund underperforms, leading investors to redeem their shares. This can cause a chain reaction where more and more investors exit the mutual fund or the REIT, which can lead to a further decline in performance.

When a mutual fund invests in a REIT, it purchases shares in a company that owns and manages real estate assets. The performance of the REIT depends on the value of these assets and the ability of the company to generate income from them. If the assets decline in value or the company is unable to generate sufficient income, the REIT‘s performance may suffer.

If the REIT underperforms, investors may become dissatisfied with the mutual fund’s overall returns and may choose to redeem their shares. This can cause a reduction in the assets under management of the mutual fund, which may force the fund manager to sell off some of the REIT shares to meet the redemption requests. If this selling pressure exceeds the demand for the REIT shares, it can further decrease the value of the shares, causing more investors to redeem their shares and leading to a further decline in performance.

This cycle of poor performance, redemptions, and a further decline in performance can continue until the mutual fund or the REIT is no longer viable, and the investment is liquidated. To avoid this cycle, investors should carefully evaluate the performance of the REIT within the mutual fund and consider the long-term potential of the underlying real estate assets before investing. Additionally, investors should have a long-term investment horizon and avoid making impulsive investment decisions based on short-term market movements.

 

It’s already having an effect on one of the most high-profile REITs

Currently, Blackstone has suspended the redemption program for BREIT, meaning that investors are unable to sell their shares at this time. This decision was made in response to the economic uncertainty caused by the COVID-19 pandemic, as Blackstone believed that selling assets in the current market would result in losses for investors.

The effect of this decision is that investors who were planning to redeem their shares in the near future will have to wait until the redemption program resumes. This could cause financial hardship for some investors who may have relied on these funds for liquidity or other financial obligations.

However, it’s worth noting that the suspension of the redemption program is a temporary measure, and Blackstone has stated that they will resume redemptions as soon as they believe it is in the best interest of investors. In the meantime, investors can continue to receive dividends from their shares in BREIT, which may provide some financial relief.

What does this mean for the coming “Fire sale” on Office Properties?

Furthermore, as more distressed sellers enter the market, it could create a downward spiral in property values, leading to further distress in the market. This could cause lenders to tighten their lending criteria even further, making it even more difficult for owners to refinance their loans.

If there is a fire sale in office properties in 2024 and 2025, prepared investors may be able to take advantage of the situation by following these strategies:

Be Ready with Cash: Prepared investors should have cash available to take advantage of the potential buying opportunity. With cash in hand, investors can quickly make an offer on a property and close the deal without the need for financing.

Conduct Due Diligence: Before investing in any property, it’s important to conduct thorough due diligence. This involves analyzing the property’s financial performance, tenant mix, location, and potential for appreciation. Prepared investors should conduct their due diligence in advance so that they are ready to move quickly when the opportunity arises.

Look for Distressed Assets: A fire sale often involves distressed assets, which are properties that are being sold due to financial difficulties. Prepared investors should look for distressed assets that have the potential for appreciation and can be turned around with some investment and management.

Negotiate a Good Price: In a fire sale, the seller may be motivated to sell quickly, which can provide an opportunity for prepared investors to negotiate a good price. Investors should be aware of the current market conditions and the true value of the property to ensure they are getting a fair price.

Have a Long-term Investment Strategy: Investing in office properties requires a long-term investment strategy. Prepared investors should have a clear plan for how they will manage and improve the property over time to maximize their return on investment.

Overall, the squeeze in commercial real estate in the office’s group could have significant impacts on the industry and the broader economy. It may take some time for the market to adjust to the new normal of remote work, and it remains to be seen how long the high vacancy rates will persist.

More related articles:

Market InSights
Kevin Taylor

There Is Too Much Money

You read that right, there is simply too much cash in the capital markets to not see a handful of effects that could impact your investments and plan. The supply of money floating around is massive right now. There is a lot of risk, COVID has us concerned about the economics of the coming year, but it’s getting harder and harder to ignore how much cash has been made available. Even relative to itself, it’s a volume of cash in the money supply that will take at least a decade to settle into long term investments, or be recaptured by the Fed. At the beginning of the year there was roughly $15T in circulation held in cash and cash equivalents. We are in December and the number is closer to $19T of more highly liquid cash in the world. This $4T expansion in only 12 months is remarkable. Here’s some history on money supply. It took until 1997 to reach the first $4T in circulation, the decade from 2009 to 2019 saw that supply double from $8T to almost $16T (the fastest doubling ever), resulting in a major part of the expansion of the stock market for that decade. Now, in twelve months we have seen a flood of almost 27% more money in the supply than there was at the beginning of the COVID-19 pandemic.  One of the best leading indicators for where capital markets are headed, can be found in how much money, especially highly liquid money like cash, is available in the system. This is a reflection of how big the pie is. Usually in investments we are focused on cash flow, and a companies market share – or how effective a company is at capturing cash flow from a given size of market. That’s becoming less relevant as the sheer volume of cash has exploded. The pie is so big right now that there will have to be a a few notable adjustments to make: Inflation – While I have heard that Jerome Powell has not registered an increase in inflation yet, it is hard to believe that as the newly introduced money will not have an expansive effect on the costs of goods and services. Many mark the inflation rate off the CPI, grievances with that benchmark aside, it would be irresponsible to assume that the basket of securities they mark to market does not see an above average increase as more money finds its way into the same number of consumer goods. Additionally, elements like rents will see a disproportionate increase in the coming decade because while supply of say consumer goods will increase quickly to capture this cash, construction of rental properties is a less reactive market and a slower roll out to correct the market. In the meantime expect rental costs and revenues to see above average inflation figures.  Interest Rates – Permanently impaired. As I write this the current observation, the 10 year US Treasury is paying 0.9%, a third of where it was even 2 years ago. It is heard to believe that such a robust introduction of cash doesn’t become a permanent downward pressure on fixed income assets for the foreseeable future. Unless there is a formal and aggressive contraction of the money supply, it will take decades for the amount of cash in circulation to let up that downward pressure on bonds. Interest rates in short term assets will be particularly affected as the demand has become less appetizing in contrast to long term debt, and the supply of cash is chasing too small of demand.  Equities – The real benefactor here. It is hard not to believe that over the course of the coming decade, this cash infusion doesn’t trickle its way up and into the stock market and other asset values. Generally the most “risky” part of the market is the historically the benefactor of excesses in cash. Companies will do what they do best and capture this supply of cash through normal operations, this will expand their revenues and ultimately the bottom line. Additionally, the compressed borrowing costs from low interest rates will lower their operating costs. Compound the poor risk reward ratio in bonds and you will see more of those investments seek out stocks, real estate, and other capital assets. This sector will see a virtuous combination of more revenue, and more demand for shares. Expect permanently elevated P/E reads for the time being.   

Read More »

Definitions: Equity

The term Equity represents any ownership rights over an asset’s cash flow generation potential. As an asset class, there is no guarantee of a return on your investment, it is the most speculative of assets classes and is the only asset class that can have its intrinsic value brought to zero. But because it is ownership without end, and a right to the value in perpetuity, it is also the source of the greatest returns. The math looks like this: The most common sources of Equity are stocks, your home, and other real estate assets. But equities can also include ownership in a business through your own formation, or as the result of a private placement and they also include art, royalty agreements, or leasing agreements.  Other terms for Equity are shareholder value, book value, or stake.

Read More »
Boulder Financial Planning Experts
Articles
Kevin Taylor

How to draft an Investment Policy Statement?

Define the investment objectives: The first step in drafting an IPS is to define the investment objectives. This involves assessing the risk tolerance of the trust or family office and determining the desired return. Establish the asset allocation: Once the investment objectives are defined, the asset allocation strategy can be established. This involves determining the proportion of assets allocated to each asset class based on the investment objectives and risk tolerance. Develop the risk management strategy: The risk management strategy should be developed based on the investment objectives and the risk tolerance of the trust or family office. The strategy should define how risks will be managed, monitored, and evaluated. Establish the roles and responsibilities: The IPS should establish the roles and responsibilities of the investors, fiduciaries, and investment managers. It should define who is responsible for making investment decisions, monitoring the portfolio, and evaluating performance. Evaluate performance: The IPS should include a performance evaluation process that assesses the performance of the investment portfolio relative to the investment objectives. The evaluation should be conducted regularly and used to make adjustments to the investment strategy.

Read More »

Pin It on Pinterest