March 25, 2024

What investors should consider amid challenging market conditions

Source:AZBigMedia

It’s a hard time out there for real estate and it’s an even more difficult time for commercial real estate investors. The Fed’s interest rate hikes resulted in capital to be harder to get hold of. It has also caused credit standards tightening and fewer transactions taking place in the market.

In 2021-2022, many investors purchased properties at high prices, using 2 and 3-year bridge loans. They underwrote these deals with aggressive rent growth and price appreciation assumptions, which matched with cheap capital, and allowed for record prices. Meeting their mortgage and investor obligations will be difficult for these aggressive operators. Some will make it. Many will under perform. And when their high-leverage debt obligations come due, they will have no choice but to recapitalize by paying down their existing loans or selling at prices in line with a more capital-starved market.

When this happens at a large scale across the market, it is called deleveraging. After deleveraging has happened and leverage rates in the market are in line with current growth expectations, reflation and price appreciation can once again proceed. There are many buying opportunities in a deleveraging. However, the capital to allow for this deleveraging typically comes from investors who are well-positioned to take advantage of an environment like this – not traditional banks.

 

Biggest risks for real estate investors in the current market

If you are a buyer in the current market, the good news is that downturns are typically the best time to buy if you are able to hold onto your property until more normalized market conditions have returned. However, holding on is not a foregone conclusion! Here is a list of risks to consider:

  • Property Condition: Issues such as structural defects, environmental hazards, or unexpected maintenance costs can pose significant risks. Many current sellers have begun a renovation but have run out of money prematurely as inflation has caused cost overruns and capital is less available to fund shortfalls. Thorough due diligence, including property inspections and assessments, and adequate cash reserves are crucial to identify and address potential concerns.
  • Supply and Demand Dynamics: We are coming off of a construction boom where record numbers of units were built in the aftermath of the pandemic and are delivering now and in the coming months. Oversupply of properties in a given market can significantly impact the ability to maintain higher rents, occupancy, and, ultimately, property values. Understanding what other properties are coming online and targeting similar renters in your market is essential for making informed investment decisions.
  • Interest Rate Changes: Interest rates play a crucial role in real estate financing and rates are higher today than in many years. This increase in interest rates will likely lead to higher exit cap rates when you go to sell and mortgage costs at acquisition. This should reduce property values today as buyers will need low all in costs in order to make a return with higher expected interest expenses. Investors should conservatively underwrite how interest rates will affect their investment.

What should investors be considering when purchasing

 

  • Capitalization: The best way to alleviate these risks for real estate investors is having the right capital stack. Having moderate leverage and adequate liquidity reserves will allow an investor to weather market volatility or any capital requirements that come along. Particularly having fixed-rate debt, with plenty of time before maturity and adequate reserves to manage the inevitable surprises.
  • Location, Location, Location: Location is critical to real estate investment success. Consider the property’s proximity to amenities, transportation, schools, and employment hubs. Research the neighborhood’s growth potential and overall desirability. Well-located assets will typically always have buyers. Now is the time to look for premium locations at more reasonable prices.
  • Market Pricing and Financial Analysis: Buy at a low basis relative to other properties in the market and buy at a price where your income at current market rents can generate adequate cash flow even with current mortgage rates. That way, even if market prices drop in the meantime, you will be able to maintain operations until conditions become more favorable.
  • Understand your Risk Tolerance and Execution Capabilities: Define your risk tolerance and investment goals before shopping for properties. Do you seek to renovate a property to generate short-term gains, or would you like to purchase a stabilized property for long-term stability? Be honest with yourself about your ability to execute on and tolerate the risk inherent to renovations or a value-added business plan.
  • Exit Strategy: Develop a clear exit strategy before making an investment. Whether it’s selling the property for capital gains, refinancing, or holding for rental income. Having a well-defined exit plan with conservative cap rate assumptions will help you make informed decisions throughout the investment life cycle.
  • Network and Expert Team: Build a team of real estate professionals, including real estate agents, property managers, and construction experts. Seek advice from experienced investors who can provide valuable insights based on their own successes and challenges.

 

Despite the harsh current market conditions, there is a significant amount of potential for real estate investors in today’s market environment. It is in times of market dislocation and lack of liquidity that the best deals are made. Investing at a time with fewer competing market participants allows for better pricing. With an expert team and diligence to manage typical pitfalls- not only can investors survive in today’s market, they can thrive!

 

Have questions or looking to invest? Team Trbo is happy to help – don’t hesitate to reach out!

 

Team Trbo,

Craig Trbovich

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In the News, Phoenix Commercial Real Estate News, Uncategorized
About Craig
Craig Trbovich is a commercial real estate broker with Commercial Properties, Inc. in Scottsdale, Arizona, specializing commercial sales and landlord representation in the Phoenix Metro Area. He applies 35 years of experience as a CPA and an investor to help other owners and investors maximize their returns, bringing a strong financial and tax perspective to all aspects of commercial real estate ownership. His strengths include sales and leasing, as well as an in-depth knowledge of the development community and the local market.