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Declining Realestate Values

When To Use —and Not Use—Leverage In CRE

Positives, negatives, and the COVID effect

When people get involved in commercial real estate investments, their goal is to increase the property’s value, diversify portfolio holdings, avoid volatility while hedging against inflation, and gain some tax benefits. In short, it’s about making money.

One of the available tools to achieve that goal is leverage. Also known as debt-financing, the idea is that in some cases, assuming debt on a property may be more financially lucrative than bypassing a loan. That being said, there is a time when leverage makes sense and, more importantly, when it does not. 

What is positive leverage?

In the simplest of terms, positive leverage occurs when the cost of borrowing money is less than the return on that property. This results in greater profits for the investor, ROI that can then be used to upgrade the property or diversify into additional properties, especially those that are less risky. 

For example, let’s say a property comes on the market for $3 million. The buyer faces two options:

  • The first is an all-cash purchase, which results in an NOI (net operating income) of $250K. Without a loan, there is no debt service and a cash flow of $250K. The result is a cash on cash percentage (cash flow/cost of property) of 8.3%.
  • The other is to initiate a leverage option with a $2 million loan at 6%. The NOI remains the same at $250K, but this encompasses the debt ($120K) and cash flow ($130K). The cash on cash result is $130K divided by $1 million (the out-of-pocket cost of the property) or 13%. In other words, there is a 4.7% higher return with positive leverage rather than an all-cash purchase.

Depending on economic indicators, leverage may not be in the investor’s best interest, particularly if the cost of borrowing money vastly diminishes the cash return of the investment. The closer the cash-on-cash leverage result comes to the all-cash result, the less wiggle room there is to survive any unanticipated crises, such as immediate repairs to the property or an economic slump. 

Using leverage wisely

When leverage makes sense, some investors can fall into the assumption trap—assuming that if some leverage on a property deal is good, then more property leverage is better. But as the saying goes, never “assume” anything, or you can make an “ass” out of “u” and “me.”

To avoid the potential pitfalls of leverage, investors should wisely consider some key points:

  • The CAP rate should be higher than the Effective Cost of Debt (ECD), which takes into account other costs beyond the interest rate of the loan. These other debts include loan points and pre-payment penalties. Typically, pre-payment penalties occur before year 10 of the loan. If you’re planning on selling the property before that 10-year mark, this is a debt that must be considered before choosing the leverage route.
  • Investors need to have a firm understanding of both short- and long-term plans for their personal financial goals and how those match the best predictions for the economy and the property. For example, can the investor manage the debt stress if the market should turn south, vacancies increase, or the property needs significant repairs or upgrades? Build toward a payment that you can live with should times get difficult in the future.
  • When determining appreciation expectations on the property, lean toward the conservative side. Security is found in a lower expectation and leaves room for good news if the appreciation is higher than anticipated.

Leverage and COVID

Not surprisingly, COVID has left its imprint on leverage. And for guidance, many experts look to the Great Recession. Prior to 2008, a large number of loans were issued at peak property values and with high leverage amounts in the 85% and 90% range. When the bubble burst, investors found themselves in dire straits, with outstanding debt more elevated than the properties’ value. The solution for investors was to de-leverage, look for new, smaller mortgages, or default.

COVID is this and so much more—the fallout from the pandemic has been swift for specific sectors, and the overall impacts for CRE are still accruing and yet to come due. While interest rates are extraordinarily low, investors are also looking at a market that has resulted in higher-than-normal vacancies and tenants re-thinking space needs. And many tenants may not be able to return as Federal-relief loans are expiring in the face of surging cases. Nevertheless, there are two key developments:

  • Leverage can only happen if there are lenders. At the moment, lenders that are currently managing COVID-related defaults aren’t so eager to take risks. And many who anticipate defaults or maintain significant uncertainty about the pandemic are also carefully scrutinizing applications. Thus, leverage financing may be more challenging to acquire, particularly as many of the COVID-relief programs expire.
  • If there’s a clear exception, though, it’s in the warehouse sector—particularly those properties connected to e-commerce, which has grown tremendously during the pandemic. Read this blog on the COVID K-shaped economic recovery and which sectors may be winners and losers in the new normal.

To leverage or not to leverage? Get some CRE assistance in SoFlo

The biggest takeaway is that any decision to use leverage can only be made on a case-by-case basis. Excellent financing, for example, can easily become undone with the purchase of the wrong property or by overlooking current and expected trends and comparable properties. Using leverage properly can only be achieved with sufficient due diligence

For help in exploring your options, call Morris Southeast Group at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

Outdoor Space as a Solution to Maximize Building Use During COVID

Taking advantage of available outdoor spaces can make businesses safer for customers and employees while navigating the global pandemic.

We’re learning more every day about the novel coronavirus that’s wreaking havoc on our society, giving us additional insight on how to protect ourselves. 

For example, it’s now common knowledge that the virus spreads person-to-person through close contact, but evidence also suggests that COVID-19 can remain airborne for hours in indoor spaces. It can even travel through HVAC systems. As a result, the longer people stay in an enclosed environment, the greater the potential transmission risk. 

Indoor airborne transmission is causing problems in a variety of industries. Bars, restaurants, and retail establishments are riskier environments for staff and customers, while some office workers also feel unsafe returning to the job site. 

The good news in South Florida is that we’re well-positioned to take advantage of the mild winter weather and can make better use of outdoor spaces than pretty much any other location in the country. 

A vaccine is on the way, but it’ll still be many months before immunity is widespread. Until then, here’s a look at how some businesses and property owners are maximizing their use of outdoor space.

Examples from dining and retail

The restaurant industry is an excellent example of how to use outdoor space to keep a business open. The more fortunate restaurants have patios, and others are developing them, allowing patrons to stay outdoors while enjoying food and drinks. 

One drawback is that patios can get crowded, with tables next to each other allowing for transmission to occur between diners. 

We’re seeing some businesses create proactive solutions to this issue by expanding their outdoor dining spaces. While extending a patio often relies on cities making exceptions or changing their laws, municipalities worldwide are doing just that to encourage a safer environment for restaurant-goers. 

Open-air shopping centers also allow for a safer experience for consumers with fewer restrictions on the number of people who can be in an area at one time. This additional flexibility assists businesses as they attempt to stay afloat during this difficult time. 

New York City is taking the outdoor shopping experience to a new level by allowing retail shops to extend into outdoor spaces. As the holidays approach, as many as 40,000 small businesses could begin using nearby outdoor areas

The weather in South Florida is clearly better than winter in New York, so it makes sense for businesses and commercial property owners to begin exploring the concept of open storefronts to allow shoppers to socially distance. 

Using outdoor office space

It isn’t just retail spaces that can use the outdoors to their advantage in South Florida, as offices can also shift certain meetings and tasks outside

The easiest way to accomplish this is by using courtyards and nearby parks when face-to-face interaction is necessary. This trend isn’t new, either, as 79% of new construction in Manhattan since 2010 features outdoor space

If your building has some outdoor space, like a usable rooftop or a place to build a terrace, property owners can consider renovating to create a brand-new amenity for tenants. Even though COVID-19 likely won’t last forever, the addition of outdoor space can attract renters well into the future.

Making indoor spaces safer

Staying outdoors isn’t always feasible, as there are situations where the weather won’t cooperate or people have sensitive information that they aren’t comfortable discussing in a public setting. There’s also the fact that businesses are paying for these buildings, so they’ll want to use them. 

That’s fair, and there are ways to make interior offices, stores, and restaurants safer for all who visit. Of course, cleaning and sanitizing help reduce the spread of the virus, but what about the air?

Encouraging employees and customers to maintain distance and using physical shields are part of the equation. However, as mentioned earlier, aerosols can linger in the air for hours and spread through HVAC systems.

One solution is to add ultraviolet lights to the interior of the building’s ductwork. In doing so, 99.9% of seasonal viruses will die before circulating through the building, keeping people safer from this type of transmission.  

Morris Southeast Group is on top of the newest retail, dining, and office space trends, ensuring that you can make the necessary adjustments to thrive in the current business landscape. A little flexibility can go a long way, and maximizing outdoor space usage, can be a novel way to attract consumers and tenants while keeping them safer. 
Call us at 954.474.1776 to learn how Morris Southeast Group can assist you. You can also reach out to Ken Morris directly at 954.240.4400 or kenmorris@morrissegroup.com.

Technology is Changing Commercial Real Estate—But a Human Advisor Remains Critical

New CRE Technology and the Crucial Role of a Human Advisor

Despite new platforms that aim to shift commercial real estate into a self-serve proposition, true due diligence requires human insight

Technology makes many aspects of residential real estate more accessible, as anyone can go online, select a property, and begin researching. From there, interested parties can schedule tours, check market comps, or even make offers before ever speaking with a person.

Virtual tours make it possible to walk through a property without actually visiting, adding another layer of insight for prospective buyers. The process has become more efficient, and over 44% of home buyers begin their search online.

We’re now seeing similar technology make its way into commercial real estate (CRE), as investors and business owners can evaluate and even purchase or lease assets with minimal human contact.

This has its limitations particular to CRE, however. Online showings and virtual reality tours don’t supply comprehensive market insights or analyze all crucial available data before purchasing. Tech also doesn’t craft a CRE strategy that accounts for a client’s current and prospective needs. This missing information provides immense value—and many buyers will be left without it when shopping exclusively online.

Here are some of the effects technology is having on commercial and residential real estate and where these advances have benefits and limitations.

A look at residential self-serve real estate technology

Online property shopping has become a stable of the residential market, and many websites provide the opportunity to look for a home online. The best known, Zillow, has countless options for home buyers and allows them to get much of the information they require in one place.

At its core, Zillow allows you to search through available residential real estate listings in your area. You can also look at pictures, take virtual tours, and connect with a real estate agent through the platform.

More in-depth features include market reports, housing data, and inventory information, with much of this information presented as easy-to-read graphs. In short, Zillow provides a great deal of knowledge throughout the home-buying process. However, it can’t provide you with real, local insight, such as hidden trends or intangible quality-of-life aspects about a neighborhood; only an excellent real estate agent or more profound research by the buyer can do that.

Redfin, RealScout, Realtor.com, and OpenDoor are similar services that list houses and connect buyers with agents. Most real estate companies and agents have websites with their listings and other information, as well. These websites provide value through the ease with which sellers can list, and the easy access and information they give buyers.

Another innovative residential feature worth mentioning is that OpenDoor and Zillow will buy a seller’s home and then list it on the market. Buyers are purchasing directly from these platforms, in some cases.

Keep in mind that all of these services use local real estate agents and brokers to facilitate the deals. However, in the future, websites like Zillow and OpenDoor will likely begin making more direct sales online, adding an entirely new dynamic to the process.

New options in commercial real estate mirror some aspects of residential tech

Technology’s influence on residential real estate is evident, and it is becoming more prevalent in the commercial real estate world.

The most talked-about new platform is Ten-X. It links brokers, buyers, and sellers in the CRE industry, making it easier for these properties to change hands. This end-to-end platform can already facilitate an entire sales process, and it dominates the market—Ten-X is behind 90% of all online commercial real estate transactions.

There are also auctions on the platform, so sellers or brokers will set a starting bid, and interested parties can attempt to purchase it with the highest offer getting the property.

Currently, brokers are still a huge part of the process at Ten-X, at least when it comes to selling. However, buyers can place bids or agree to make purchases directly through the platform. This technology is sure to alter the CRE landscape even further as it becomes more common.

Why a human CRE expert is still essential

It’s easy to see why investors are considering technology like Ten-X, as it provides a quick look at properties all over the country without having to leave the office. This convenience makes the basics of evaluating commercial real estate more accessible than ever before.

But there is a drawback. Online CRE shopping could lead investors to make snap decisions without considering underlying market conditions and vital data that can make or break a deal’s profitability.

When it comes to finding information relevant to your objectives, there’s no substitute for speaking with a local, human expert on the subject. An algorithm or virtual real estate agent can provide you with data. But figuring out what the numbers really mean—or even knowing which data are crucial for your situation—requires a deeper dive.

The same can be said for commercial tenants, as tech seeks to take on some of the responsibilities of a tenant rep advisor. But no platform will help negotiate a deal, find the exact property to suit a business’s needs, or focus on your interests and understand your situation like an advisor does. And in-depth local knowledge is often the difference between a successful contract and a regretful decision.

Thus, some aspects of this CRE tech trend may leave commercial tenants and investors at a disadvantage.

Morris Southeast Group is excited about this technology and how it will provide CRE clients with greater knowledge and access. And we are already using much of it! But where we—and other highly-qualified advisors—shine is in helping commercial real estate investors and tenants conduct due diligence before signing any agreement.

Our team will gather all relevant data, organize inspections, go over the legal contracts, assess your financial goals to ensure the deal is right, “future-proof” decisions, and quite a bit more. And having a SIOR designee advisor on your side is an immensely valuable asset in many transactions. 

To learn more about what Morris Southeast Group can do for you, call us at 954.474.1776. Ken Morris is also available directly at 954.240.4400 or kenmorris@morrissegroup.com.

CRE Opportunities and Pitfalls in a K-Shaped COVID Recovery

K- Recovery
“Silver capital letter K, isolated on white background.”

Solid investments are out there. Finding them depends on assessing the changing demand.

In the rush to predict how an economy crippled by COVID will look, many experts have tossed around the shapes of letters to illustrate how an economic recovery will look. There is the gradual but steady upturn of a U, a V’s immediacy, and the yo-yo effect of a W. 

The newest letter to be added to the alphabet soup is K. While it assumes that everyone starts at the same point, it depicts what has taken shape since the virus reached the United States—different trajectories traveling away from each other. 

K represents the differences between Wall Street and Main Street, people who can work from home and many of those who can’t, and individuals with the liquid assets to survive or thrive in a recession and those without them. 

CRE and the upward K

The K-model can also be applied to commercial real estate, where each sector faces its own unique challenges and opportunities. Some will move upward while others will face a greater struggle during recovery—if they recover at all. 

For example, here are a few sectors seen as winners:

  • Perhaps the strongest sector is warehouses. These facilities were already robust before the pandemic, as the growth of e-commerce required more localized hubs for speedy delivery. But lockdowns plus the public’s reluctance to return to enclosed spaces even after re-opening have resulted in a far greater demand for efficient online delivery services.
  • Data centers have also thrived since the start of the pandemic. In early spring, millions of workers and students learned to work remotely for the first time. That trend remained strong over the summer as surges continued to erupt across the country. With re-opening parameters and continued preventative measures, as well as an erratic positivity rate, many companies and schools across the country will remain remote for months to come. And a portion of this shift is permanent.
  • During the lockdown, grocery stores filled the void of closed restaurants—and continue to do so, as millions of people find it more cost-effective to prepare meals at home or are reluctant to return to dining out.
  • People still need medical care. Despite some practices having to close until they could get preventative protocols in place, and others feeling the pinch as demand for elective procedures dropped, medical office buildings remain open for business. 

CRE and the downward spokes of the K

Sadly, COVID has had a more substantial negative impact on some sectors. These areas look to have a tougher time bouncing back to pre-pandemic levels:

  • Many pundits argue that the pandemic highlighted fundamental weaknesses in our society, from underlying health conditions to wage inequality to a lack of access to quality Wi-Fi. In CRE, perhaps there’s no better example than the venerable mall. For years, these mega shopping centers have battled the growth of e-commerce and the loss of major retail anchors through endless re-inventions, including housing fitness centers, entertainment venues, spas and salons, and restaurants. But all of these tenants have not only suffered under COVID but will have a more difficult time attracting consumers to return to indoor experiences.
  • While the Great Recession introduced the staycation into the American vernacular, COVID made the phrase feel like a life sentence—especially for any facility associated with the travel industry. The cancellation of large-scale events, conferences, and pleasure travel—as well as physical distance mandates—have had a tremendously negative impact on hotels. While the sector is expected to bounce back, the timeline for that rebound depends upon a vaccine and Americans returning to work. Even so, many companies will hesitate to spend on business travel and large conferences like they have in the past.
  • Restaurants and bars are arguably the primary faces of our derailed economy. Deeply impacted by the lockdown and subsequent virus-prevention measures, many owners and operators have fought to survive by increasing take-out services and turning parking lots and streets into outdoor dining spaces. This may continue to work in warmer areas of the country, but cold weather and predictions of a second surge will complicate recovery.
  • Not too long ago, co-work facilities were seen as a hot new wave in CRE. But the pandemic has changed the equation. Until a viable vaccine is created and distributed, the industry will have to convince workers that shared desks and offices are a safe alternative to working from home—and likely make significant property improvements to make these spaces safer. 

Where the two trajectories begin

When looking at the K recovery model, there’s that point where the two trajectories begin their outward journeys. It’s here that some sectors may linger for the foreseeable future before picking a definitive course.

  • The office sector was especially hard hit due to the virus as workers were sent home and doors locked. And many large-footprint office spaces are on a downward trajectory. But the American office should not be discounted, according to economists. Instead, the sector will need time to re-find its place in a world where remote work and physical distance are the norm. This evolution will likely include fewer open floor plans, flexible spaces and work shifts, and smaller footprints.
  • Multifamily property owners quickly felt the COVID pinch in the first months of the pandemic. The lockdown and loss of employment among many residents resulted in missed rents. Although government efforts provided some relief, months of lingering unemployment continued the late- or missed-rent cycles. Some of these losses may ease with the economy’s slow re-opening and the addition of foreclosed homeowners in need of housing.
  • As colleges and universities shut down to opt for online courses and students packed up to quarantine at home during the spring semester, many student housing operators found themselves having to re-negotiate rent agreements. With the fall semester, there was an expectation that student housing would bounce back via campus re-openings. As of this writing, the sector remains a rollercoaster ride as many college students fail to observe social distancing recommendations and requirements. The result has been localized spikes and quarantines, as well as some universities quickly returning to online study.

These examples, of course, are far from exhaustive. The crucial lesson of a K-shaped recovery and its impact on CRE is that different properties will have significantly different trajectories. Investors must closely evaluate an investment’s potential in the new environment.

Finding your place in a K-recovery

More than likely, the economy will recover in phases. And there may be setbacks (depending on a future surge) and lags (especially in sectors that cater to underprivileged socio-economic communities). At the same time, other factors—consumer confidence, virus positivity rate, cost-control efforts from the corporate sector, the arrival of a vaccine, and a Presidential election—are influencing not only the speed and scope of the recovery but also the exact shape of the K. 

As an investor, the reality is that any rebound, regardless of the letter, will take time. Therefore, it’s essential to diligently assess investments and property improvements and choose those that make sense. A regional mall project or an office skyscraper that requires significant capital investment, for example, likely wouldn’t be wise choices.  

For assistance in determining how to proceed with an investment or to find the right property for your needs, please call Morris Southeast Group at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

What is Going to Happen with Rent Payments?

CRE rental payments - Retail space available sign in a commercial real estate building
Commercial retail space available sign.

Commercial real estate landlords are understandably nervous about the future 

The economic impacts of COVID-19 won’t be fully measured for quite some time, but one thing is clear:  many commercial real estate owners aren’t receiving rental payments from tenants. 

Even as communities reopen, numerous restaurants, personal-service providers, and retailers don’t do enough business to pay their bills. Restaurants operating at 25% of capacity, for example, are seeing revenues well below normal, even though they are now technically open for business. In March, industry experts predicted that 2020 would see a loss of up to 75% of independent restaurants in the United States, representing five to seven million lost jobs and $225 billion in revenue. 

Small businesses are unable to pay their bills across the country, leaving commercial real estate landlords to ask, “What about the rent?” 

In the spring, as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act, the federal government imposed a moratorium on foreclosures and evictions, keeping both homeowners and small businesses in their properties during the initial shutdown. But that moratorium expired in July. 

In Florida, Governor Ron DeSantis extended the statewide moratorium to September 1st. But that extension only applied to residential tenants who have been “adversely affected by the COVID-19 emergency”—the order did not affect CRE rental payments.

Then, on August 8th, 2020, President Donald Trump signed four executive orders for coronavirus relief, including one that was positioned as preventing evictions. That executive order is widely seen as having no legal teeth, however. It merely recommends that federal agencies consider whether a moratorium on residential evictions is needed—it doesn’t actually prevent evictions of any kind.

And while Florida currently has no statewide order preventing commercial real estate evictions, both Miami-Dade and Broward Counties have enacted some moratoriums

Broward’s “order prohibits the issuance of any writs of possession until normal court operations resume,” and “the sheriff’s office has suspended serving eviction notices during the COVID-19 pandemic.” Miami-Dade has “suspended [police department] enforcement of any eviction orders until the COVID-19 emergency expires.”

Broward County’s order is in place “until further notice,” and Miami-Dade County’s directive is in effect until “expiration of the emergency period”—which was extended on March 18th and remains ongoing.

What does all this mean for CRE rental payments and contracts? 

All rental agreements are contracts, of course. And when contracts lose meaning, much of the foundation of our economy and society unravels. 

Landlords are caught in the middle—between compassion for their tenants and the need to make their own mortgage, insurance, and property tax payments. While almost everyone in the CRE equation understands and empathizes with the unique economic burden COVID-19 has placed on businesses, it’s vital that contracts become enforceable again—and that evictions happen when they are absolutely necessary.

In the meantime, is it fair if landlords lose their investments? And what about tenants who may be experiencing temporary economic hardship? 

The current situation calls for flexibility and a diligent eye on the longer-term implications of each tenant-landlord relationship. Landlords and tenants should keep open communication lines and review leases to see if any necessary accommodations can be reached as the economy reopens. 

Some high-profile tenants are pushing back on terms

Starbucks, for example, has reached out to all of its commercial landlords to renegotiate rental payments. 

“Effective June 1st and for at least a period of 12 consecutive months, Starbucks will require concessions to support modified operations and adjustments to lease terms and base rent structures,” said the letter distributed [in May] signed by Starbucks Chief Operating Officer Roz Brewer. 

Chipotle Mexican Grill and Shake Shack have followed suit. Dunkin’ Donuts, Applebee’s, and Yum Brands, which includes Pizza Hut, KFC, and Taco Bell, are undertaking similar efforts, including tying terms to lease extensions.

It’s not out of the question to expect this trend to continue as various businesses—large and small—operate under government capacity restrictions and other limitations. 

Should landlords forgive or renegotiate CRE rental payments? 

Many landlords hesitate to drop the amount for rental payments to accommodate tenants because “accounting rules still allow them to book income if rent is deferred, as long as it isn’t reduced. Temporary rent forgiveness or discounts would also reduce their property valuations, which could hurt an owner’s ability to get a loan.”

That said, landlords may be able to work out temporary deferments or other measures to keep some income flowing, tenants in business, and property values stable. 

Again, landlords and tenants should keep the lines of communication open. If you are a landlord, tell your tenants not just to go dark and stop paying: “Keep us in the loop so we can help, and let us know what’s going on with your income stream.” Having those numbers will make it easier to approach your commercial lenders with renegotiations or forbearance requests. 

Also, keep in mind: While landlords might work something out with bank lenders and insurance companies, commercial-backed mortgage securities (CMBS) are another matter. CMBS are a type of financing with no single “entity”—investors pull together into a security instrument, so there is no one to speak with about renegotiating terms.

Thus, if you have CMBS financing, tenants stop paying, and you can’t pay, there’s little you can do. The moment you are late with a payment, the financing goes into special servicing, and the property is in immediate jeopardy. 

This creates a unique problem for CRE investors with this type of financing—and getting overdue rent payments or being able to evict non-paying tenants becomes even more critical. 

Keeping an eye on the CRE situation

The pandemic continues to contribute to disrupted business and high unemployment, which snowballs into even lower business revenues, among other consequences. All of these factors are affecting the ability of many commercial real estate tenants to pay their rent. The federal government is still working on a follow-up to the CARES Act that may provide some relief, but government assistance can only do so much. And it’s essential for CRE investors to closely monitor the national and local economic outlooks and stay adaptable.

In these most uncertain of times, a trusted advisor and property manager can be a valuable resource. At Morris Southeast Group, we’re closely watching how all of this plays out, and we’ll be sure to keep our readers and clients informed as the situation changes. 

If you have questions about CRE investing strategies, property leasing needs, or property management services, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

CRE and Surviving The COVID Recession

CRE and Surviving The COVID Recession

Taking steps to evaluate the current situation and weather the storm

When it comes to hurricane season, Floridians know the drill: stock up on canned goods and water, fire up the generator for a test run, keep cash on hand, and ensure the storm shutters are in working order. It’s usually the same idea when it comes to weathering a bad economic forecast. For the most part, investors and tenants know the steps to take to somewhat manage an economic downturn. 

But hurricanes, as we all know, can be unpredictable—and the COVID recession is proving to be just as difficult to anticipate. The timing of a vaccine, lingering surges of infections, the prospect of a second wave, and the financial fallout of lockdowns and relief packages have resulted in the great unknown. And that, in turn, is creating uncertainty that surpasses that of the Great Recession.

A “normal” recession vs. a “new-normal” recession

Markets always go through cyclical changes, and these swings are usually separated into four distinct phases, with unique CRE impacts: 

  • Recession: In a typical recession, sellers have accepted the economic situation (at about the four-month mark), and it becomes a buyer’s market. Real estate prices start to come down. A few months later, foreclosures peak and prices bottom out, creating an excellent time to buy. Property values on both residential and commercial properties are severely impacted.
  • Recovery: This phase is marked by two consecutive months of decreasing unemployment numbers, declining rental rates, and a leveling off of vacancies. This phase’s beginning is pretty much rock bottom, still making it an excellent time to buy.
  • Expansion: Low vacancies, higher rents and values, and booming construction switch the market to a seller’s one. Good deals are still out there but require a bit more effort to find.
  • Hyper-Supply: The construction boom from above results in an abundance of properties combined with low rents and high prices—until these factors return to alignment. This is usually not the best time to buy. 

COVID-19, though, is making it difficult to predict any of these “normal” phases. 

The current factors are mixed. Technically speaking, for example, we have seen more than two consecutive months of employment gains. As of this writing, there have been four straight months of decreasing unemployment, from April’s astounding high of 14.7 million to July’s 10.2 million. But the combination of uncertainties, as well as a full recovery that may be dependent upon a vaccine, has made these “definitive” phases not so well-defined. 

Preparing for the long haul

The typical first step in grappling with a recession is determining what phase the economy happens to be in. But with so much uncertainty, that’s no easy task. 

With the onset of the school year and the potential for new outbreaks—as well as additional phases of reopening and closing—there’s a genuine possibility the market will behave more like a ping pong ball, bouncing back and forth between economic stages. 

But there are still ways to analyze the situation and take action:

1. Analysts have speculated about a V-shaped economic recovery (good) or a W-shaped recovery (less than ideal), with the shapes of the letters indicating the course of the economy. But it seems more likely that we’re in for a “K-shaped” recovery, where various sectors rise or fall based on fundamental changes to demand brought on by the pandemic. Thus, evaluate all CRE decisions based on your resources and the unique demand for a potential investment type.

2. Consider property improvements that make sense, if you can afford them. Some actions may not only help maintain the property’s value during a recession but also prepare for new tenant needs in a post-COVID world. Again, evaluate this through the framework of a K-shaped recovery; capital improvements in a smaller office space that make it safer for tenants are likely more valuable than doing anything to a large retail property.

3. Evaluate when and how to keep money on the sidelines, and when you should use it. This piece of advice is tricky, since trying to “time the bottom” of the CRE market is difficult to impossible. This maxim is especially true since specific sectors are trending upward, and we really don’t know what post-election economic sentiment and consumer confidence will look like. Also, record-low interest rates may provide a solid floor for property values. But this level may be broken if the broader economy, including the stock market, drops significantly due to longer-term factors. 

Thus, investors must again use the framework of whether an individual investment makes sense in a post-COVID world. Investing in a high-rise structure in an urban center is likely a bad idea, as social distancing requirements and a trend toward remote work make the viability of these properties questionable. Similarly, regional malls are probably big losers. In contrast, a modern office with a smaller footprint and great amenities may still make sense, and any well-located facility that can be used as an e-commerce distribution center is likely to do very well.

Evaluate each opportunity based on how it may play in the new economy—and deploy your capital wisely.

A final thought on getting through the recession and prospering on the other side of it

Perhaps no other bit of advice matters more than a reminder to be patient if you can afford to do so. The uncertainty of the pandemic demands a mid- to long-term view, along with the ability to adapt. 

Harbor enough liquidity to weather new challenges to investments that you maintain and scrutinize all potential opportunities in light of the pandemic’s significant social and economic changes. The advice that’s vital in any economy applies here, as well: base every decision on a diligent examination of potential ROI.

For assistance in determining how to proceed with an investment or to find the right property for your needs, call Morris Southeast Group at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

CRE and the True Cost Of Capital During COVID-19

CRE and Capital During COVID-19
Portrait fragment of Benjamin Franklin close-up from one hundred dollars bill

The wisdom and ability to tap “cheap” capital for commercial real estate investments

There’s very little doubt the 2020 global economy isn’t pretty. Ravaged by COVID-19 and government actions to curtail the public health crisis, there is record unemployment, record stimulus-relief packages, and record-low interest rates.

Many view these “easy money” rates as sound economic policy to head-off—or at least better manage—the recession. That said, economists and lenders are looking at the long-term implications for a post-pandemic economy. And in practice, the rates set by lenders are often significantly higher than the target rate set by the federal reserve.

The LIBOR transition has not happened yet, and could be slowed

In addition to direction from the Federal Reserve, banks also look to the London Interbank Offered Rate (LIBOR). Based on five currencies (the US dollar, the euro, the British pound, the Japanese yen, and the Swiss franc), LIBOR determines the average interest rate at which major global banks borrow and was, at one time, considered the world’s most influential interest number. In the United States, it was the most popular index for adjustable-rate mortgages.

Then came the scandal. More than a decade ago, regulators discovered that traders were manipulating rates set by some of the largest banks in Great Britain. For 10 years, there’s been a phase-out process as countries worldwide seek alternative risk-free reference rates.

COVID-19, though, may be delaying this transition, which was expected to be completed in 2021. In a world of pandemic-related uncertainty, many officials in different markets are sticking with the devil they know rather than look toward something new. 

HousingWire states that a Moody’s Investors Service report shows that “Regulators such as the Federal Reserve have increased the nation’s reliance on LIBOR by using it as an index for emergency lending.”

Lessons learned from 2008

Not looking to repeat the harsh lessons of 2008, banks wandered away from collateralized debt obligations (CDOs)—since such loans made to homebuyers before the subprime housing collapse led to the Great Recession. Instead, lenders shifted toward collateralized loan obligations (CLOs). This has created a new vulnerability:

After the housing crisis, subprime CDOs naturally fell out of favor. Demand shifted to a similar—and similarly risky—instrument, one that even has a similar name: the CLO, or collateralized loan obligation. A CLO walks and talks like a CDO, but in place of loans made to home buyers are loans made to businesses—specifically, troubled companies. CLOs bundle together so-called leveraged loans, the subprime mortgages of the corporate world. These are loans made to companies that have maxed out their borrowing and can no longer sell bonds directly to investors or qualify for a traditional bank loan. There are more than $1 trillion worth of leveraged loans currently outstanding. The majority are held in CLOs.

Loans in a CLO are bundled together, and if they default, the risky bottom layer loses more. Once the lower levels are wiped out, the damage trickles upward to the safest loans. Right now, the CLO market is bigger than the CDO market at its peak. 

To offset these losses—pending and actual—banks have kept more capital on hand to protect against a downturn. But no one could have predicted the across-the-board economic wreckage caused by COVID-19. 

On their own, CLOs will not eat up capital reserves. But when they’re combined with losses in other asset areas and dried-up revenue sources, financial institutions could be looking at a Lehman Brothers-sized meltdown. 

This, of course, had caused them to look for ways to hedge this risk. This effort includes charging interest rates well above the fed target rate and carefully scrutinizing borrowers’ creditworthiness.

The inflation question

On the tips of tongues and in the backs of minds is the idea of post-pandemic inflation. In a sense, it could be the second gut-punch in the fight with COVID-19. In fact, the ingredients are already in the pot—trillions of federal dollars in the economy via loans and relief packages that translate into trillions of dollars of national debt, people out of work, defaulted loans, businesses either shuttered or skimming by, and disruptions in supply chains. 

The ingredient that’s missing is a vaccine. That will be a great and glorious day, of course. But once it exists, people could entirely leave lockdowns and resume their consumer lives, which will result in increased demand—but this could involve shortages and stagnant wages that can’t keep up with rising prices. The result is inflation.

It will then fall to the Fed—followed by the banks and other lenders—to determine a course of action to slow it down. Generally speaking, higher interest rates tend to lower inflation—and this, in turn, can slow down available capital for investing.

Easy money isn’t always so easy

When it comes to raising capital, most investors turn toward banks or private lenders. In general, banks are typically more affordable but have more requirements to be approved. Private lenders, although more flexible, are often more expensive because they get funds from investors looking for decent returns and/or banks that lend them money. As a result, the private lender’s cost is passed on to the borrower.

The uncertainties surrounding COVID-19, though, are forcing banks and private lenders to apply more stringent risk assessments to loans, and pricing accordingly. For example, while the Fed establishes a specific rate, LIBOR helps the bank determine points above that interest rate, making it more expensive to borrow money.

At the same time, loan standards have tightened to make the process even more rigorous. This includes more significant documentation, larger down payments, and higher credit scores.  

What’s an investor to do?

Investing in anything has a bit of uncertainty in the best of times. But the current environment has loads of it. To better prepare, investors need to ask themselves some serious questions before raising capital:

  • How long do you plan on holding onto the asset? Short-term and long-term holdings can have different risk factors, and these have to be weighed against the best predictions for how long COVID-19 will last, when a vaccine will become readily and widely available, and the time it takes for the economy to rebound in a vaccine and a non-vaccine environment.
  • Will the investment be a good hedge against inflation? Generally speaking, real estate values and rents increase with inflation. This, however, is a COVID world, and that creates its own set of questions: Will people be able to afford higher rents in a post-pandemic economy? Will small business tenants be able to secure loans? What will be the demand for different property types?
  • Are my office/retail buildings going to be worth anything? Because of social distancing, lockdowns, and remote working, the office and retail sectors were especially walloped by the pandemic. Will that change with a vaccine? Will you be able to adapt your structure to meet the new conditions of the new normal? Are you prepared to work with new tenants to help them survive, for your own survival?
  • If you’re unable to secure funding through a bank, can you afford financing through a private lending firm? Remember, these options are more expensive, and detailed due diligence and projections for the investment are still required.
  • Are you able to weather the uncertainty? Because of uncertainty, values are expected to encounter volatility as the market adjusts and corrects. There will be significant opportunities, but the time horizons for anything are unclear.

A heightened awareness

Many of the issues raised here are nothing new. In many ways, they’re the same concerns and questions to have during any investment time-frame. COVID, though, demands a heightened awareness because of the degree of uncertainty. 

While the cheap cost of capital via low interest rates will drive some investments, an investor must also consider both mid- and long-term scenarios based on intended hold periods and the nature and future of the property.

For assistance in determining how to proceed with an investment or to find the right property for your needs, please call Morris Southeast Group at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

Potential CRE Property Improvements To Adapt To COVID-19

Potential CRE Property Improvements To Adapt To COVID-19
Social Distancing in Modern Office With Glass Cubicle.

How the pandemic is changing—and could transform—commercial real estate spaces

In addition to everything else we can blame on COVID-19, the pandemic has altered what’s important in commercial real estate. Not long ago, landscaping, security, and lighting were among the key elements to increase property values, and often ranked high on the list of tenant wishes.

But with the pandemic and re-openings, the most significant concern is the health and safety of anyone entering a property. Much of that reflects growing health concerns and awareness of how the virus spreads. But there’s also a very practical interest in limiting liability and the potential for lawsuits.

To that end, preventative measures come in numerous shapes, sizes, and price points—and many of them are contingent on property usage.

Immediate steps for reopening

At the top of any reopening checklist is evaluating the floor plan of the property, followed by making adjustments based on the best practices outlined by leading health authorities, such as the CDC. Generally, this means keeping at least 6’ of space between people, limiting group interactions, and mitigating air-droplet spread.

Steps that some properties are taking include:

  • Using furniture to create distance. Desks, for example, should be at least 6’ apart. If space is tight, some furniture may be removed or roped off. Bookshelves and other office furniture may be moved into positions that help maintain distance, while temporary walls and partitions can be brought out of storage and put to better use. In some cases, plexiglass partitions are attached to furniture to create boundaries.
  • Since communal spaces are discouraged, converting that space into storage for any pieces removed from the main work area is an option. So is using it as a workspace for a portion of socially-distanced employees.
  • Implementing foot-traffic patterns that make sense for the property. For example, signage can remind people to move in one direction when walking about the office, up and down the aisles of a retail space, or when entering or exiting a conference room.
  • Steps to maintain distance can be as simple as signage, arrows, and colored tape on the floor, or as elaborate as “The 6-Feet Office,” which uses bold colors and patterned carpeting to delineate social distances for offices and traffic.
  • Enacting policies that stress flexibility, choice, and wellness. These can include elevator etiquette reminders, the creation of cohorts or teams to limit the number of people actually in the office on any given day, hand-sanitizing stations, and a clean-desk policy so surfaces can be disinfected easily. Enhanced cleaning protocols are considered critical.
  • One possible way to minimize COVID’s spread in interior settings is to open windows and allow fresh air to circulate. For many buildings, however, that’s not an option—either windows don’t open, or the weather is too hot and humid. But some companies are moving specific workspaces, such as conference rooms, outside.

Looking to hospitals for CRE inspiration

By reopening, many commercial properties and their occupants have joined others on the frontlines of the COVID-19 battle. It only makes sense, then, to look to the veterans of the war: hospitals. These facilities have valuable lessons for preventing the spread of diseases to others.

  • For decades, we’ve been warned about the dangers of ultraviolet (UV) light, specifically UVA and UVB, which are responsible for sunburns and skin cancers. But there’s also UVC, which, because of its short wavelength, cannot penetrate Earth’s atmosphere. There is a subset of wavelengths (far-UVC) that has been shown to kill “99.9% of seasonal coronaviruses present in airborne droplets.” Handheld, mounted, and mobile UVC devices have already appeared in hospitals, nursing homes, and food establishments.
  • Because weather and design keep many windows sealed, there is growing interest in how recirculating air from HVAC systems helps spread COVID-19. One potential solution is the addition of UV lights into HVAC ductwork to sterilize indoor air and improve ventilation. Also, proper air filtration (depending on the size and scope of the unit) and maintenance contribute to better indoor air quality.
  • One of the challenges hospitals have faced in the COVID battle is having to increase Airborne Infection Isolation Rooms, also known as negative pressure rooms. Air from the positive pressure space is forced under the door opening into a room with negative pressure, where dangerous microbes are then “captured.” From there, microbes are released into the outdoors, where they disperse and eventually die. The fundamental difficulty for many commercial buildings, however, is in maintaining an even, positive pressure due to HVAC issues and building usage.
  • COVID may call for leveraging Internet of Things (IoT) technology to make energy systems in the property smarter. With changes in the work dynamic, such as fewer in-house staff or staggered hours, owners may see savings by embracing an adaptive energy system. The building’s energy system knows when and how to operate based on the changed occupancy and hours of operation.

Reopening in SoFlo

While debates continue about states reopening too quickly, businesses are opening as cases are skyrocketing, and people want to get back to work. For owners, property managers, and tenants, the challenge is ensuring that enough has been done to protect the health and safety of occupants.

The complicating factor in COVID-based property improvements is that people are using commercial spaces differently—and the demand for some buildings is waning. And many of the most useful property upgrades—such as enhanced HVAC systems—are expensive.

Money may seem cheap due to very low interest rates. But many lenders are factoring risk into rates, and some institutions only lend to applicants with exceptional credit and significant resources.

In addition, the benefits of any property improvement must be balanced against the financial risk to owners. Installing a new HVAC system for a 10-story office building, for example, is a major capital investment. This expense may be unrealistic in light of diminished demand for a space and increased demand for shorter leases, which reduces the odds of recouping the investment. Then, there is the risk of lawsuits from customers and employees who may become infected on the premises.

We will cover many of these issues in future blogs. For now, sound advice for tenants and owners is to stay current on best practices for reopening as safely as possible. And everyone must carefully evaluate their financial and health-risk scenarios—and make decisions that make sense for their people and businesses.

At Morris Southeast Group, we stay on top of commercial real estate trends and will continue to update our clients and readers. As always, we are here for all of your CRE needs, including helping you evaluate potential steps to create or lease a safer property.

To learn more about what Morris Southeast Group can do for you, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

5 Reasons Commercial Real Estate Occupiers/Tenants Benefit from Using a Tenant Rep Advisor

5 Reasons Commercial Real Estate Occupiers/Tenants Benefit from Using a Tenant Rep Advisor  morrissegroup.com
Lease Agreement

Negotiating the new normal during the pandemic’s fallout and beyond

Over the past few months, we’ve written a lot about the impact COVID-19 has had on commercial real estate. In a short span, the landscape drastically changed—from commercial real estate (CRE) prospects to rent strategies to strategies for business survival.

Another area that has been affected is the role of tenant advisors. For many tenants, the reasons they chose an advisor in a pre-pandemic world have taken on an urgent and even essential character. And in some ways, tenant reps are uniquely positioned to help businesses manage a new normal characterized by new space requirements, issues, and opportunities.

1. Negotiation

When it comes to tenant broker/advisors, many people believe their sole purpose is to broker lease negotiations. In fact, there are many other benefits. But there is no denying that knowledge of comparable amenities and monthly rents, as well as keeping a wary eye out for hidden fees, lease pitfalls, concessions, and confusing language all come together to assist the tenant in achieving the best terms.

2. Access

It’s common for a tenant to search for available properties on public websites. But these sources are only the tip of the CRE iceberg. A professional and well-seasoned tenant advisor, armed with local market experience and internal tools of the trade, will have greater access to properties, many of which will be better suited to your needs and price range.

3. Networks

Tenant reps, particularly those who are well-established, can recommend a team of experts to assist the tenant in turning a newly leased space into something that meets his or her needs. The importance of this service has grown as businesses must adapt structures to social-distancing requirements. Resources can include architects, designers, space-planning experts, air-quality companies and maintenance contractors.

4. Representation

In most cases, tenant rep fees—just like fees for the listing broker—are covered in the price of the leased space. In other words, landlords already expect that a tenant rep will be part of the process. In transactions without the involvement of a tenant advisor, the landlord’s leasing agent will just be paid more. When a tenant contracts with a qualified advisor, it’s an indication that they are serious about negotiating and will do so in good faith. And the advisor always maintains a constant focus on the tenant’s interests.

5.  COVID-19

Ultimately, all of these benefits are tied to the current state of affairs, as COVID-19 has significantly changed the CRE equation. Just a few months ago, it was a landlord’s market. But quarantines have forced landlords and tenants, very often with the assistance of tenant reps, to renegotiate leases to keep both sides of the table afloat.

Now that the economy is re-opening and utilization requirements have changed, tenants have more leverage as landlords compete to fill vacancies with reliable income streams.

Using a tenant advisor representative in South Florida

Tenants in South Florida are finding themselves in a unique position as they work to start new endeavors or save existing ones while navigating leases, re-opening phases, and the spike in new COVID-19 cases. The tenant advisory service at Morris Southeast Group can alleviate the stress of searching for the ideal space and negotiating lease terms, while helping businesses adapt to new requirements.

To learn more about what Morris Southeast Group can do for you now and in the future, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

Millennials on the Move to the Suburbs?

The new downtown is often in suburbia

Leave it to the Millennials. Regardless of the misplaced blame that generation receives, there’s no denying that they have single-handedly changed the real estate landscape as much as Boomers have.

Consider the urban downtown landscape, a space that was transformed by a live/work/play lifestyle that embraces walkability and experiences. With Millennial needs and developer visions coming together, city block after city block filled with residential towers, galleries, cafes, and coffeehouses.

There comes a time, though, when every generation grows up, and priorities change. For a generation of Millennials on the cusp of middle age, those changes have meant children, skyrocketing rents, and the realization that cities may not provide all that’s necessary—things like detached homes, private yards, and good schools.

In other words, suburbia.

Not your parents’ suburbia

In many ways, Millennial desires closely mimic those of the Boomers, the generation that grew up in the first suburbs. This new generation, though, isn’t exactly interested in their parents’ or grandparents’ suburban experience, first made popular in places like Levittown, NY. Instead, they’re looking for suburbia with an urban twist.

For developers, this trend is significant. Studies indicate that Millennials will form two million households per year for the next ten years. In Jacksonville, Orlando, and Tampa, for example, Millennials are the number-one new-home purchasers. Similarly, Miami, Miami Beach, and Fort Lauderdale are in the top 10 Florida communities with the largest increase in Millennials since 2010.

The suburban resurgence & CRE

Just after World War II, when William Levitt devised his master plan for Levittown—“the prototypical American suburb”—one of its hallmarks was a town green. Located within easy walking distance to various neighborhoods, the spaces were reminiscent of the city neighborhoods from which new residents had come. They included greenery, a playground, and a strip mall with essential services, such as a laundromat and delicatessen. At some point, though, suburbs sprawled, and convenience felt farther away.

With the Millennial push for suburbia, developers are taking a look at the master plan for both new and established communities. Developers are examining how to create town centers that embrace the same live/work/play lifestyle that made city downtowns the place to be.

Desired tenants may include craft breweries, rooftop restaurants, cafes, retail, service businesses that present employment opportunities, shared workspaces, event venues, galleries, and pop-up opportunities to test market ideas. Another priority is businesses that provide Millennials ways to include their young families. A shared trait is that all of these areas should be easy to get to, and just as easy to get home from.

The COVID-19 connection

As with most things these days, there’s a pandemic factor. While COVID-19 isn’t responsible for the new interest in suburbia, it has certainly played a role in revving it up.

As metropolitan areas around the country were quarantined, wealthy residents fled the cities for their summer homes in the suburbs to escape contagion and claustrophobia. Many younger generations rented homes or moved back into the suburban houses in which they were raised. In the suburbs, it was simply easier to be socially distant and still get outside, even if that outside was a private yard.

Offices are also looking at the suburban landscape in response to COVID-19. CDC re-opening guidelines suggest employees commute alone and that businesses restrict the use of elevators—two concepts that don’t gel with working in an urban high-rise. For some companies, relocating to properties outside of the city center may make it easier to manage risk.

The new American Dream

It’s important to remember that this isn’t a one-size-fits-all American Dream. The span of Millennial ages runs from 24 to 40 years of age. That’s at least two to three different life stage brackets and an income span that’s just as wide.

While some Millennials may be looking in more affluent suburbs, others are opting for more affordable options. In either case, developers have been presented with an opportunity to look beyond metropolitan centers—and this may be one element of a post-COVID world.

To learn more about what Morris Southeast Group can do for you now and in the future, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.

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