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First.
A bit of a primer on what causes distress - meaning widespread pressure on
commercial real estate owners to sell their holdings. Commercial real
estate is a complex web of owners, occupants, lenders and locations. Owners
either reside in their business homes or rely upon rent paid by a tenant to
fund their livelihood. Occupants are synonymous with the operation housed or
are independent of their landlord. Lenders run the gamut from community banks
to public pension funds. Locations are varied into several broad categories -
Industrial, Office, Retail, Land, Specialty, and Multifamily. Dissecting
further - Industrial buildings could be used for manufacturing, warehouse
logistics, or service and maintenance - or a combination of all of these.
Regardless of ownership or the class of commercial real estate - one thing is
consistent. All rely upon a business occupant to write a rent check. Therefore
economic interruption which affects the ability to pay can lead to distress.
Ok.
With that backdrop you can start to understand why the pandemic has been
devastating to certain types of commercial real estate. Your stylist? Crushed.
The location from which they operate? Who’s paying? You got it. No one. That
huge apartment complex you depart each day - well used to - now you’re working
there. Wow! A landlord can’t collect and can’t evict. What does that owner tell
his bank? How about the landlord with an empty office building? Chances are
he’s getting rent. But for how long? Will all of his residents start to downsize
as they realize less is more?
You
might be wondering - hmmm. I don’t get it. A monthly payment is missed. So
what? These are wealthy property owners with deep financial resources. In some
cases, yes. But in many circumstances - owners of commercial real estate are
your neighbors - they own their business and it’s address or they’ve made an
investment into a small retail strip center or quad-plex for passive income.
Additionally, some may have borrowed to acquire the asset and therefore owe
money each month to a bank. Even if there is no debt - ongoing expenses occur -
property taxes, insurance, maintenance, gardening, etc. So. If no one is paying
monthly - the property owner must fund the shortfall. Inability to do so can
cause distress.
Sure.
There are some major players in commercial real estate who own thousands of
square feet across all classes - industrial, office, retail and multi-family.
Are they immune from distress? Nope. Massive portfolios operate under the same
premise - someone must pay rent. Kudos to those who were preemptive with their
retail or apartment tenants and provided rent relief. But there is a risk they
may never be repaid and must suffer the loss. Some large commercial real estate
groups have lumped the rents they receive into securities and formed a real
estate investment trust. You witnessed a dramatic devaluation of REIT stocks
early in the lockdown. Now you understand why - there was fear collections
would slow. Pension fund dollars are regularly poured into commercial real estate
as is the case with with Cal-STRS and Cal-PERS. That’s right. Your friend who
fought fires now relies on a commercial real estate tenant for a portion of his
retirement. Institutional property owners with Office, Retail, and
Multifamily - because their receipts are challenged - face potential distress.
Will
we see volumes of distressed real estate flooding the market as was the
case in 1991-1992 or during the Great Recession? In this columnist’s opinion.
It depends on how quickly we get back to work, start generating revenue and
ramp up that rent machine!
Allen C. Buchanan, SIOR, is a principal with Lee &
Associates Commercial Real Estate Services in Orange. He can be reached
at abuchanan@lee-associates.com or 714.564.7104. His
website is allencbuchanan.blogspot.com.
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