It’s been an uncertain few years for Commercial Real Estate (CRE) investors. Following the Great Recession in 2008, the industry generally experienced a solid decade of strong growth, fueled by low interest rates and a strong economy.
However, the pandemic rocked many CRE assets. Office workers stopped coming to work every day – and don’t appear to be coming back to the office at anywhere near their pre-pandemic rates. At the same time, interest rates have shot up, with the Federal Reserve raising base rates from close to zero in the first quarter of 2022, to north of 5% today.
In tandem, these two issues have had a major impact on the CRE market, wreaking havoc on many investors' portfolios. With so much economic uncertainty, many investors remain unsure about their next move. Is it time to batten down the hatches and ride out the storm, or does all this disruption mean opportunity?
Today, we’re exploring several steps that CRE investors should consider exploring to both protect and grow their portfolios.
G-Squared Partners serves as a strategic financial advisor to a wide variety of CRE investors and operators, providing a sophisticated suite of outsourced CFO, accounting, and bookkeeping services to the CRE community. To learn more about how we can support your CRE business, schedule a consultation now.
1. Work Closely with Lenders
As investors face challenges across their portfolios, a strong relationship with bankers is crucial. Focus on building strong partnerships with lenders that are willing to work with you. If tenants demand significant renovations to their office space before signing a new lease, it’s important to have access to a line of credit that comes with affordable borrowing costs.
If the financial performance of an asset is extremely challenging, as is the case for many Class B and C commercial office space assets, it’s especially important to have a strong relationship with your lender. Many lenders would rather work with you to renegotiate the terms of your debt financing than take outright ownership of the asset. Strong relationships also play an important role when it comes time to refinance debt.
2. Form Lasting Partnerships with Tenants
A constructive working relationship with tenants is vital to the success of your CRE portfolio. This is especially important at a time when many tenants, particularly in office space, are considering downsizing to smaller footprints or moving to a different building entirely.
Acting in good faith and being responsive to any issues gives tenants less cause to look around for a new office to call home at the end of their current lease. Retaining in-place tenants is often preferable to having to source new tenants, eliminating turnover costs including renovations, marketing, and broker fees. In many cases, that holds true even if landlords have to accept new lease agreements that are less profitable than the previous contract.
3. Tightly Manage Cash Flow
Closely tracking the cash flow of your real estate business is vital to your long-term success. For many investors, interest expense is higher now than they have been at any point in the previous decade. It’s crucial that your business has enough cash flow to support these commitments while also dealing with the other capital-intensive issues that owning real estate often throws up.
In today’s highly inflationary environment, operating costs may be rising faster than rental income. This demands that investors focus more on the monthly and weekly cash flow of their portfolios, and tightly manage both costs and rental income to ensure their portfolio remains sustainable.
4. Conduct Comprehensive Due Diligence on New Opportunities
Due diligence has always been an important part of investing in commercial real estate, but the recent turbulence in the market has made this process even more important. By conducting a comprehensive due diligence process, you can be sure that the economics of an investment make sense for your portfolio.
For fund managers, it’s particularly important to conduct this analysis to ensure the fund is able to deliver a return to Limited Partners while also making a profit. There are several steps involved in due diligence, including:
- Analyze Historical Numbers: verify that existing financial statements are correct and normalize these for any anomalies that will not be included going forward, such as add-backs and exclusions.
- Look at Trends: a seller may claim to have made a 20% annual return on a property over the past ten years, but it could be the case that in the past two years, they only made 2%. Validate how assets have performed over both the short and the long term.
- Forecast Growth Potential: make sure that the deal makes sense i.e. that the pro forma financial statements you produce show a tangible path to your desired ROI for the investment.
- Verify Existing Leases: check the length and terms of existing tenant leases to ensure that the property’s revenue base will continue to be consistent.
5. Stay Disciplined on New Investments
In today’s market, many property owners have an unrealistic opinion of the value of their properties. The value of commercial office space in January 2020 is markedly different from the value it commands today. In many cases, this leads to a significant disconnect between buyers and sellers when determining what an asset is worth.
For investors aiming to expand, these misaligned expectations mean many deals might not make sense. Investors must remain disciplined and consider how opportunities fit within their model. Keeping money in the bank, or even returning it to investors, is better than investing in a bad deal that will lose money – even if it feels like you’re sitting on the sidelines.
6. Explore Alternative CRE Asset Classes
As we’ve noted throughout this guide, some areas of commercial real estate, particularly office space, have faced a tough time in recent years. However, while the market remains tough across a variety of asset classes, there are many opportunities still out there.
These may require CRE investors to explore alternative asset classes within the CRE space. At G-Squared Partners, we’re seeing significant opportunities in areas such as self-storage, industrial, student housing, and multifamily. Identifying these opportunities and capitalizing on them may pay dividends for investors.
G-Squared Partners: A Trusted Advisor to the Commercial Real Estate Industry
In the midst of upheaval in the CRE market, investors must have experienced advisors who can provide strategic guidance and operational support.
At G-Squared Partners, we provide outsourced financial services to investors and operators across a variety of CRE asset classes, from office space to self-storage. Our team brings first-class financial leadership skills and a wealth of experience.
With the ability to provide everything from routine accounting and bookkeeping services to big-picture financial strategy support through outsourced CFO services, G-Squared Partners is the perfect partner for commercial real estate investors.
To learn more about our support, contact an advisor today.