People in real estate circles have been talking about this for some time. We all expected it to happen last year, but then the pandemic hit and the government started pumping money into the economy. That action has postponed what many know will happen.
One might look at me and say that the real estate markets are as hot as a pistol. They might also say that there is a shortage of housing currently pushing up the markets. I would certainly not disagree with either of those statements, because they are true.
But anything that goes up will sooner or later go down.
The coming recession will begin in the commercial markets. Many are calling it the “Amazon Effect”, but the point is that few people leave their homes to buy anything anymore. As such, retailers have either already gone out of business, or are having difficulties paying their rents. If they are in the second category, then they will either close their doors or radically downsize to handle a primarily online retail presence in the future.
Most who still own retail commercial spaces are having difficulties if they have a mortgage. Tenants simply can’t pay their bills, and when landlords have problems, the banks have problems.
The last real estate recession was primarily a residential real estate melt down, but let’s remember that residential mortgages are guaranteed by Fannie Mae and Freddie Mac. Commercial loans aren’t guaranteed by anyone other than the borrower.
If a bank has a problem with a landlord paying a mortgage then the loan goes from being an asset on their books to a liability. If they end up with too many liabilities, they become insolvent and the FDIC takes over the bank to protect the depositors.
Again, there are no guarantees on these loans.
Can you imagine the number of foreclosure – bankruptcies that are coming? Look down any main street in America at the storefronts. Every third or fourth window has a sign in it that says, For Rent, For Sale, For Whatever.
Can you then imagine what will happen to many real estate prices when there is a glut of foreclosures on the market?
Let me leave you with this.
My point is that now is not the time to buy. Wait two or three years. There will be deals out there that are unimaginable. Real estate may be the largest investment that many of you make in your lifetime. When we invest, we buy low and sell high. Can you imagine how angry you will be if you buy now and realize three years from now that you could have saved thirty or forty percent of the price? Be patient.
If you are already in real estate then we may want to talk about repositioning your debt portfolio. If you have an average debt to equity ratio of 40% on the rest but one building is at 70% then you should probably spend some time and money getting that highly leveraged property averaged down with your other equity. As real estate devalues, you don’t want a cash call.
Please understand that commercial loans are normally five year balloons based on a debt to equity ratio agreed to in the original loan. If they lend at a 70% ratio, and your building devalues faster than you can pay down your debt, in order to refi at five years you will be forced to pay down the debt to re-establish the debt to equity ratio. These “cash calls”, in deflationary environments can be substantial. If you cannot make the cash call and cannot refi elsewhere, they will normally foreclose. This might force you into bankruptcy because you made a personal guarantee on the loan.
Be careful. Plan ahead.
We’re all going to get through this. Let’s get through it together.
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