Strategic Real Estate in 2014
2014 Real Estate Forecast
Should the world enter another recession, real estate investors need to focus on 2017 and beyond where an enormous buying opportunity will be presented; an opportunity of generational proportions. Surviving intact will be paramount to investors, and strategic real estate may be one of the lifeboats. Strategic real estate will provide the cash flow that is absolutely necessary to survive a difficult economic environment, as yield will become increasingly scarce. Strategic real estate needs to have low or no debt, and if encumbered, any balloon or re-finance clause needs to extend beyond the 2018 period, preferably completely fixed and amortized. Rates could trend considerably higher in the coming years and properties financed now will be perceived as having favorable terms going forward. Not only may rates be higher, but appraisals may be much lower and underwriting criteria vastly more restrictive than today. Rates are currently trending lower; another re-finance opportunity may be at hand. In a downturn, prepare for lower valuations but fairly stable cash flow. A decline of perhaps 15-20% is possible. This should eventually be mitigated by lower vacancy, lower taxes through a lower tax assessment, lower insurance costs, lower labor and material costs.
The tenant quality needs to be excellent. The tenant credit rating should be above average and care should be used in accepting tenants in economically sensitive segments. An economic slowdown will affect everyone, delinquencies will rise, revenues will shrink, and job losses will ensue. However, losses can be mitigated by observant and proactive management addressing expenses and tenant quality. Not all segments will be as badly impacted and some will even prosper. Long-term government leases with such entities as the IRS, FAA, FEMA, etc., or commercial tenants in the medical sector, the defense industry, entertainment, or food and beverage businesses etc. should be less impacted, and their employees as well. Rental homes and apartments serve a basic need and will retain much of their appeal. New construction will probably suffer a severe downturn limiting additional supply, which will lower vacancy rates. Tenant migration would probably reverse as “A” tenants migrate to “B” complexes as price points should become very important. Rental rates would probably suffer as they will follow the economy lower, but rents may not suffer the full impact if the property is well located in a strong multi-industry market, another requirement for strategic real estate. Rentals in demand areas will fare the best.
In conclusion, strategic real estate properties are well located in growth and demand areas; they are leased by strong creditworthy tenants in industries that are less likely to be affected by economics, have no or very low long term debt, and have dependable cash flow. These properties will do well in an expansionary market and perform better against their peers in a challenging market. Review holdings and adjust accordingly. There is no clarity; the economy does not have to turn down, but the odds are rising and the time to prepare is running out. The current year should be the defining year if a downturn is imminent.
This article should interest investors in the iShares U.S. Real Estate ETF (NYSE: IYR), SPDR S&P Homebuilders (NYSE: XHB), Bank of America (NYSE: BAC), Wells Fargo (NYSE: WFC), J.P. Morgan Chase (NYSE: JPM), MGIC Investment (NYSE: MTG), Annaly Capital (NYSE: NLY), American Capital Agency (Nasdaq: AGNC), PulteGroup (NYSE: PHM), K.B. Homes (NYSE: KBH), Equity Residential (NYSE: EQR), Apartment Investment & Management (NYSE: AIV), AvalonBay Communities (NYSE: AVB) and others.
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