Today’s post is written by Michael Green, Commercial Loan Originator for Counsel Mortgage Group, LLC.
A recession is unlikely to hit this year, but that doesn’t mean that you shouldn’t start preparing. Experts say that this is the perfect time for investors to reevaluate portfolio performance to prepare for the next downturn—whenever it may come.
“Real estate is a cyclical industry, and it is impossible to predict exactly when a downturn will happen. As was once said by a well-known and celebrated source (paraphrased) …
“It’s very difficult to make predictions, especially about the future.”
Most experts agree that the current economic expansion began in June 2009, and last summer made it 10 years old, the longest in U.S. history,” Ed Hanley, president of Hanley Investment Group, recently told GlobeSt.com. “An economic downturn doesn’t impact every market and every investment the same. So, as the current election year unfolds and whether a downturn is around the corner or not, this is the perfect time to evaluate the current performance of your portfolio, and (determine) how to best position it for the future.”
There you have it! Now, Mr. & Mrs. real estate investor, you know just what to do to secure your real estate portfolio against the downturn that is sure to come … just evaluate the current performance.
But what does that mean … exactly?
A portfolio evaluation may include deferred repairs and preventative maintenance, and also perhaps some upgrades where needed, all of which can be essential to tenant retention during a correction. Mr. Hanley continues, “Properly evaluating capital expenditures now to retain tenants and stable occupancy levels may put you in a better position for the next downturn or market correction.” And of course with capital improvements comes the question of how to pay for them, cash or debt – access your liquidity pool or increase your leverage.
Of course, the CRE fundamentals are much different (and better) in this cycle than at the end of the last cycle, but some of the lessons learned during the last downturn are still important. In the last cycle, one of the biggest mistakes investors made was being over-leveraged or not having sufficient reserves to weather an economic downturn. Most CRE investments should be performing well and have good cash positions.
Although interest rates remain at historic lows, it is prudent to review current loan terms now to prevent any potential inability to refinance an existing loan in the future, or the need to refinance in a not-so-permissive environment.
A couple years ago, we refinanced two properties for an investor. These were stabilized and had been performing well for several years. The loans were originally placed when the investor bought the properties several years before and had substantially higher interest rates. The apparent goal was to reduce his payments, but in the process we found that his capital appreciation and amortization had reduced his leverage level to about 50%. We refi’ed him back to a modest 70% LTV and were able to get him $1,000,000 cash for his next investment. At that stage of the cycle he was looking to add to his holdings. That investor recently contacted us to re-fi two more of his properties with a similar outcome anticipated. While we expect to be successful in the re-financing, we cautioned him on maxing out his leverage at this stage of the cycle when cap rates are low (prices high) and banks are aggressively funding loans with “cheap” money – typical behaviors at end-of-cycles.
The bottom line in surviving a downturn is to prepare for one. Recognize that a downturn, correction, re-cycling the cycle (your choice of terms) is a process, not an event. (Going through it is a process; historians will call it an event.) Part of managing the survival is being in a position to take advantage of opportunities that will occur along the way. A little cash will go a long way then.
Incidentally, our $1,000,000 cash-out investor still has his $1,000,000 cash in the bank. He hasn’t found that next investment yet. So why re-fi the other 2 properties now? To be even better prepared to not just survive, but to capture more of those end-of-cycle opportunities during the process – and to lower his payments!
For consultation in evaluating your CRE loan portfolio, give us a call at Counsel Mortgage.
Footnote: We have written about black swan events earlier and the inability to forecast them, or the impact they may have economically, and financially on the various markets. The current caronavirus outbreak is such a swan. How this will impact the CRE and CRE lending markets is unknown – perhaps suspected, but unknown. We encourage all to take prudent healthcare precautions in your day-to-day activities. We understand that the flu is more of a menace than the coronavirus, and that the preventative measures are the same for each.
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