Trying to buy or sell a house or building right now is a tricky proposition. Keep in mind, the value of global real estate is more than all the world’s stocks and bonds combined. It’s also a key growth driver, and will be vitally important moving forward. Unfortunately, what we are seeing in many parts of the global real estate market right now is an explosive combination of oversupply, under-demand, and major uncertainty.
Our family had signed a contract to purchases another building in Kansas City “pre-corona”. The deal was scheduled to close April-15 and has been pushed back. There have many moving pieces to the puzzle. The seller accepted our offer in late-January, which was about -30% off their original high-ask, we thought we were making a great purchase. We were going to put 30% down and have the bank finance the rest at 4% on a 15-year note. I couldn’t have been more pleased, interest rates were tumbling, the building was in a prime downtown location, and the seller had gotten more aggressive.
Wow, how quickly things change…. corona hits the U.S. and the commercial real estate market immediately hits the pause button. I heard banks started backing off residential jumbo loans and commercial loans were going to be extremely difficult to get done. Our 128-page appraisal came back on the building with +20 pages related to coronavirus and the economic fallout that could impact the value of the building i.e. other nearby business and building projects that might go under. WeWork was a primary leaseholder on three large KC commercial projects that are close to completion. There’s some worry that those leases might not happen and WeWorks or coworking style office leases across the city could in jeopardy. I should also mention, it’s both good and bad, we were using a local KC bank, so our 4% rate is still good despite other banks rates bumping rates higher on commercial investment property, but now the bak is overwhelmed with hundreds of “PPP” loans they are obligated to try and get processed and expedited. Bottom-line, what I thought was going to be a great deal has turned into a deal I’m very uncertain about. We are moving forward with our delayed closing, there are some tax incentives and several other caveats that make me want to add it to our real estate portfolio, but I no longer view it as a big bargain purchase. I think there will be some much bigger bargains 6 to 12 months out. Don’t get in a nearby hurry… Below are some things we are thinking about:
Do We Really Want to Own the Big Bargains and What We do Want to Own!
What About Commercial Office Space? We suspect we will see some of the biggest big bargains in commercial office space, restaurants, and event space. My question is, do I really want to own that type of property and will there be a buyer for it down the road. I’ve learned to always start with the end in mind, meaning who will I sell it to 2, 5 or 10 years from now? It may seem like a perceived bargain based on the “recency effect” inside our minds, but will it really be a longer-term bargain if demand is lacking as we move forward? As businesses learn they can cut cost with all or some of their staff working from home, how strong will demand for commercial office space be? I have to imagine there will be a glut of supply for as far as I can see.
What about Restaurants? We know the sector was massively “over-built” heading into corona but what happens now moving forward? Will there be new waves consisting of more and more restaurant buyers coming into the space? I question it. Yes, a portion of the current restaurant owners will stay in the space and need real estate to lease, but for many, they were already on their last leg and will not be reentering. We worry that more of the bigger players like Chipotle, Starbucks and McDonalds will gobble up most of the lost market share and the smaller restaurants will find it even more difficult to compete without scale and margin.
What about Event Space? We also worry that event space has been grossly overbuilt and may struggle to come back in the same capacity. Even though these may look like perceived bargains make certain you play out the cards and think about who will be buying the property from you and providing your eventual exit?
What We Are Looking For… I think there are many residential and multi-use property owners that are going to be over-extended as short-term rental bookings via Airbnb and VRBO dry up. From what we are seeing with our own properties, most Airbnb bookings from mid-March to mid-June have been canceled. Most aren’t being canceled because people are scared to travel but mainly because the events or functions they were planning to attend have been canceled. This spillover is going to kill the property owners who are leveraged up. If they can’t collect rents there are going to be a lot of folks that have a tough time making their payments. Sure the banks might issue some forgiveness early on, but I don’t see this short-term rental market immediately reigniting in the same capacity when the economy comes back online. Meaning it’s going to take some to get the big events and functions back online and people traveling as freely. My thoughts are these property owners and the home flippers who are stuck with properties are eventually going to get stressed, i.e. our 6 to 12-month forecast and need to stay patient. Remember for most landlords, rent growth is correlated directly to job and wage growth, which I’m not sure we will be seeing anytime soon. I look for credit to be hard to come by and cash will be king!