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ARE WE TOO BLIND TO SEE?

The current pandemic environment is bringing a generational opportunity to acquire commercial properties. This opportunity is appearing in different ways. 

Many buyers define opportunity in terms of cap rates. However, recent surveys indicate that the pandemic has only widened the disconnect on caps between buyers and sellers. Although we’ve seen some well-priced deals come to market—a 300,000 sf Texas office portfolio priced at $85 psf or a 200,000 sf office tower near the Denver Tech Center at $125 psf—we haven’t seen cap rates move more than 100 points in our target markets.

Absent another economic shock, we don’t believe that cap rates will generally become more favorable to buyers. Billions of potential real estate investment dollars await on the sidelines. As cap rates rise, more investors will jump in. The investment potential will hedge cap rates. Although we lack specific data, these events will probably mirror what happened in the 2008 recession.

If you are too focused on cap rates, however, you’re likely to miss opportunities. Good properties are coming to market. The historically favorable interest rate environment has supported weakened owners, but selling pressures are emerging for several reasons. Good buying opportunities are out there now and will continue to come to market, if you’re not too blind to see.

Some owners are just unlucky. Although they own good properties, they will lose tenants who are more vulnerable to the pandemic. They may lose other tenants due to factors like weak oil prices, changes in consumer preferences, or a new administration’s policies. Because we are in a less dynamic leasing market, backfilling those vacancies quickly will be challenging. The owners of such highly leveraged properties have an incentive to sell once they feel cash flow pressures. They will explore selling as an alternative to coming out-of-pocket to fund deficits.  

Some owners will sell stable, well-occupies properties to raise defensive cash. They will use that cash to protect their interests in other properties. And then there are panicky owners. Fearing the future, they will sell to reduce exposure to real estate or selected segments of the real estate market. 

We must remember that, especially for the long-term investor, quality remains long after price is forgotten. In real estate, we like to say that money is made on the buy. But the great buy may not be fully defined by price. It may be more significantly realized by acquiring an exceptionally located and leasable property at a reasonable price. 

But even if properties are underperforming, we expect that many of these sellers will be firm about selling at a target price that does not require taking a major haircut. At some point, it’s worth taking the risk of losing a property as opposed to throwing in the towel, selling, and realizing a large hit to equity.

For these reasons, we expect that sellers of better properties will be reluctant sellers. They will list properties, market them widely, and they will sell—but only if they get their price. This frustrates our friends in the brokerage industry; It’s just very hard to make a deal.

But buyers may be forgetting something. They forget how difficult it was to buy good properties before the pandemic. I see the current opportunity defined less by price and more by the opportunity to make strategic buys. Now is the time to acquire great properties that might not otherwise be available absent this crisis. Please do not misunderstand: Risks persist. The economy may take another hit before a sustainable recovery arrives. But lots of money can be made in buying these properties in a way that will sustain a potential downturn and perform phenomenally in an eventual recovery.  

What are the alternatives? Are investors better off keeping their money in bonds and delaying real estate investments until those markets are on a clear, upward trajectory? What makes anyone think they can time the markets with that level of precision? If you are committed to real estate investing for the long term, it makes sense to buy the best properties available and build a strong portfolio of core holdings.

While investing in an unstable environment can be considered an art, many ways exist to acquire properties—core or value-add—and minimize risk.

Real estate will always have value—and quality remains long after price is forgotten.

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