It’s important for owners to be acutely aware of market conditions. Gone are the days when owners can sit back and count their residual cash flow streams. The world moves too rapidly. To stay ahead of the game its essential to have accurate and reliable information.
CrediFi was founded with the belief that greater transparency into commercial real estate finance can help professionals across the spectrum – owners, investors, lenders, brokers, fund managers, and regulators – make better, smarter decisions based on facts. The value of information is heightened during uncertain times. Equity traders know this well. Commercial real estate professionals would be wise to follow their lead.
On the one hand, the economy appears to be firing on all cylinders. Asset prices are at historical highs, interest rates are at historical lows, and inflation remains under control.
But if the economy is doing so well, why did the Fed just cut interest rates by 0.25%, a complete reversal from the rate increase last September? With the recent spike in equity market volatility, rising geopolitical risk from the U.S. trade wars with almost every country, Iranian war ships seizing British oil tankers, and our country’s drones being used for target practice, the future of the global economy is anything but certain.
Over the past decade investors have seen their portfolio values significantly increase. But, should this turmoil continue, those gains could easily be reversed. In part one of this series, we’ll provide some answers to the question of, “What should property owners do?”
Global macroeconomic trends are flashing red
The Trade and Development Report 2018 by the United Nations Conference on Trade and Development (UNCTAD) notes that capital flows as a percentage of GDP have declined 14.5% between 2002 and 2017. More recently, CrediFi’s own data indicates that commercial real estate capital flows are slowing for the second consecutive year.
Although asset markets have surged over the last 10 years, capital flows have become more volatile and debt levels have exploded on a global scale. At the end of Q3 2017 global debt skyrocketed to about $250 trillion from less than $150 trillion at the start of the Global Financial Crisis of 2008.
Recession likely by 2020
Nearly 50% of chief financial officers in the U.S. believe the country will be in a recession by Q2 2020, while 69% believe a recession will begin by the end of 2020, according to the June 2019 Duke CFO Global Business Outlook survey.
Independent research firm Pulsenomics LLC, whose honorary adviser is Robert Shiller, echoes Duke’s predictions. In a report sponsored by Zillow, more than 100 real estate economists and experts were surveyed. Half expect a recession to begin in 2020, while another 35% believe a recession in the U.S. will begin in 2021.
What should property owners do?
Today, property owners are faced with the dilemma of cashing out or weathering the storm. Some investors may feel it’s prudent to sell now while prices are high, then hold their capital on the sidelines and watch the economic game play out. Others may choose to refinance long term debt at low rates as a defensive position for the treacherous waters that lie ahead.
Sell: Turn to cash
While cashing out allows investors to spare the pain of watching property values fall and capital markets freeze, holding cash creates two disadvantages: 1) recurring cash flow income from the asset will no longer be available, and 2) tax on any capital gain will reduce the amount of cash to hold. Although 1031 Exchange plays may seem like a solution to the tax issues, if the entire reason to sell is to be out of the market, then going back in puts you right back where you started.
Refinance: Ride out the storm
Refinancing at historically low rates and holding assets until the economic storm clouds clear may be a good option, assuming prepayment penalties aren’t a substantial issue. Owners should consider moderate LTVs, perhaps several percentage points lower than those offered in lender term sheets, to allow for a debt to equity cushion. This simple tactic would’ve saved millions in lost equity and lost property in 2008.
Acting sooner rather than later
Owners considering refinancing should move quickly. Rates are low, capital is flowing, and many economic indicators are still strong. However, history tells us that change comes quickly.
When banks become anxious, lending slows down. If lending decreases dramatically, it may become difficult to refinance no matter how low interest rates are. Property is intrinsically a long term very capital-intensive asset investment. Without a crystal ball, lenders are generally forced to look at the future through a risk adjusted lens. The further out they look, the more risk they see. When normal concerns are compounded further by the additional issues mentioned in this article, it’s not surprising that CrediFi’s data indicates lending is already slowing.
Control your emotions
Many things have changed since 2008, yet some remain the same. For property owners, it can be difficult to take money off the table when the good times seem to still be rolling. Yet, that’s exactly what professional traders and investors do. They maintain control with pre-planned decisions to take profits off the table. Don’t fall in love with your property. It’s a tool to make money, and nothing more.
Lenders and equity investors may find it hard to pull back the capital throttle and stop putting their money to work, but the point at which these thoughts enter the conversation, is probably the point at which terms should tighten and money flows should slow.
Ironically, when lenders pull back, the likelihood of owners profitably cashing out is also reduced because potential buyers may be unable to arrange financing with reasonable terms.
Time doesn’t stop. Be decisive and act.
The decision to cash out or refinance are determined by individual investment strategies. But, with many CFOs and real estate economists predicting a recession in 2020, it makes good business sense to act sooner rather than later.
CrediFi can provide in-depth data on which lenders are making what types of loans and where. By monitoring real estate trends based on in-depth loan data, and property and market information, owners and lenders can be armed with the market intelligence needed to make the right moves.
In our next article, we’ll explore the different types of lenders, which ones are currently the most active, and which may be best suited for your portfolio.
See how a new generation of owners and investors rely on CredifX to accelerate capital sourcing. Request your custom financing report here.
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