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Understanding Real Estate Finance: In a Down Market, Investors May Find Surprising Opportunities

by | Aug 13, 2020 | Real Estate

The COVID-19 pandemic has created significant uncertainty for commercial and residential real estate investors. In June alone, commercial mortgage-backed securities saw their largest-ever one-month surge in delinquencies, according to Fitch Ratings.

The hotel and retail sectors experienced the highest overall delinquency rates and the largest month-over-month increases, Fitch reported. Eighty-three percent of the 30-day delinquencies came from those two sectors—an unsurprising result given COVID’s outsized impact on the travel and retail industries. By the end of the third quarter, the overall delinquency rate is expected to top 8.25 percent. In May, by comparison, the rate was 1.46 percent.

In spite of those numbers—or, perhaps, because of them—the coming months may yield a number of opportunities for savvy investors. Industrial and multifamily properties appear to be holding their own, according to real estate industry analysts. In the retail section, certain segments, like convenience, remain a bright spot and may present a viable method to investors to expand or diversify their portfolios.

MULTIFAMILY INVESTMENTS

Like other commercial segments, the multifamily market it experiencing turmoil. Shelter-in-place rules in many locales have made it difficult to show properties. Listings are up, and rents are decreasing. New projects may be finding it more difficult to attract capital because underwriting requirements are tightening.

However, the delinquency rates for multifamily properties remain far lower than other sectors – .59 percent. Rent collections have remained at 90 percent or better in many markets, and distressed landlords with federally backed loans have been able to take advantage of federal forbearance programs.

One potential silver lining is that pricing for multifamily properties, particularly in major urban markets, has been on the high end in recent years and these value continue to trend downward. As distressed landlords look to exit investments or default on their loans, investors may be able to secure multifamily properties at a reduced price.

This trend is unlikely to continue in the long term, however. First, demand will continue to exist as people will always need a place to live. Also, homeowners who have defaulted on their mortgages may be entering the rental market as well, thus driving up demand. Millennials who may otherwise be buying their first homes, might have seen their ability obtain financing undermined by the current economic conditions and will seek rental housing.

Investors may also look toward suburban areas for investment possibilities. The move from urban cores to the suburbs is likely to grow in the months and years to come. COVID-19 may accelerate a trend that was occurring even before the pandemic: millennials moving to the suburbs as they outgrow smaller, city apartments. As analysts from RCLCO recently noted in a webinar about the current real estate investment climate, even if they do not have the money available for a down payment, millennials may be looking for more space for their growing families. Options like build-to-rent communities may fill the gap.

INDUSTRIAL PROPERTIES

RCLCO, which surveys real estate owners and investors, found in July that investor sentiment about the commercial real estate marketplace was at an even lower ebb than during the Great Recession of a decade ago. One bright spot is the industrial sector, particularly warehouses and cold-storage facilities, because of the dramatic increase in e-commerce.

Moody Analytics recently reported that in spite of this short-term uptick, global production of goods and services is also expected to contract by 3 percent in 2020, the worst downturn for the world economy since the Great Depression. Industrial vacancies will likely rise as a result.

This could create another opportunity for investors with capital on hand. Though industrial properties are not expected to experience as deep a decline in value as other sectors, prices are expected to fall by 10.2% in 2020. According to Moody’s the industrial decline, however, is “half the magnitude … expected for retail and much less than the 16.8% drop forecasted for office properties.”

Over the long term, industrial property values are poised rise as the shift to e-commerce continues. E-commerce retailers require more warehouse space to operate, because they must cope with the logistics of serving individual customers. “To generate $1 billion of revenue, a brick and mortar retailer needs about 350,000 to 400,000 square feet of warehouse or distribution space while an ecommerce retailer needs about 1.2 million square feet,” Moody’s reported.

“It is likely that the industrial sector will be net beneficiaries from trends that the COVID-19 crisis has either produced or accelerated,” the Moody’s report stated. “The increased shift to online shopping, greater space needs from online versus physical retailers, and structural flexibility allowing some (but not all) industrial space to evolve alongside the economy as it transforms all belong on the positive side of the ledger when it comes to the prospects of performance metrics like rents and vacancies.”

A RETAIL BRIGHT SPOT

This might not be the moment to run headlong into a retail box store or mall investment—the e-commerce trends that may help industrial spaces are clearly taking their toll on larger retail spaces. On a more positive note, one area of retail appears to be positioned to thrive in the post-COVID environment: convenience stores.

A recent Globe Street article reported that transactions in the convenience space have grown from the $2 million to $4 million range a decade ago to the $5 million to $8 million range now. The trend is being driven, the real estate news site said, by “the increased sophistication of the assets – as c-stores diversify their product and service offerings to try to compete with traditional restaurants, coffee shops, dollar stores, and even grocery stores … Properties are grow[ing] larger with higher-end build-outs to accommodate and attract more customers.”

The sector, Globe Street reported, is likely to continue growing because:

  • Stores are generally in “solid real estate locations” that are “incredibly attractive to investors.”
  • The sector is “home to strong creditor operators” like 7-Eleven, WaWa, and QuikTrip.
  • The properties offer long-term passive leases and accelerated depreciation tax benefits.
  • Tenants are “essential retailers,” which means that they are able to stay open to provide consumers with necessities even if the pandemic and social unrest continue.
  • Unlike traditional grocery stores, convenience stores generally have lower foot traffic, which may attract shoppers concerned about coronavirus transmission.

Naturally, Investors should use caution when making any investment—particularly in a turbulent market. The attorneys at Kaplan Voekler Cunningham & Frank have decades of experience advising real estate investors about acquisitions and investment opportunities. Contact us for a consultation.