COVID-19 has significantly impacted the global economy as countries took sweeping measures to combat the spread of the virus. Halts in production, logistics activity, and consumer demand have had outsize effects on the globally intertwined supply chains many companies have built. Zencargo, a logistics startup, predicts supply shocks will generate $700 million in losses for the U.S. retail industry alone in the period from March 9 to April 20. This has led many supply chain experts to formulate risk mitigation strategies accounting for a variety of factors from labor costs, to capital investments. Many companies had one pain point in common: high supply chain concentrations in China. The effects of production halts are still being felt across many sectors. It is likely this crisis will force companies to assess the risk of reliance on one source for so many inputs and finished goods. One potential effect is the increased buildup of manufacturing and distribution capacity in the United States. A large-scale shift to domestic buildup has important real estate implications, particularly for industrial properties. From modifications to existing properties to entirely new development of custom facilities, the new demand could represent a strong opportunity to generate returns for investors that can lead and respond to these changes.
The COVID-19 crisis has brought significant stress to the commercial real estate financing market resulting not only from the obvious effects of putting the U.S. economy on hold, but also because commercial real estate and social distancing don’t mix.
The inevitable result will be missed rent, forbearance, and potential defaults by tenants. Landlords will need to accept this and work with tenants or risk sending tenants into bankruptcy. This will create unoccupied spaces in their buildings and destroy relationships with otherwise good tenants.
When crises hit, the biggest challenge in underwriting commercial real estate is in sorting out which issues are brief interruptions, and which will have long-term impacts on value (i.e. understanding the difference between a suspension of the rules and a changing of the rules). For example:
Topics: Market Update
“As the current coronavirus pandemic reaches a (hopefully) peak in the U.S. and the extent of the devastation to the economy comes into focus – 22 million unemployed, thus far, with downstream impacts to everything from retail sales, sporting events, the price of oil, and the stock market (regardless of a mini bull market in the past week or so) – we have begun to think about what the recovery is going to look like, which real estate segments will be the winners and losers in the “Great Lockdown,” and what is happening in the real estate capital markets? And so we asked our client base of real estate market professionals to tell us what they thought, in this special edition COVID-19 Real Estate Sentiment Survey.” (RCLCO Real Estate Advisors, 4/21)
What you need to know:
- The Fed will also begin purchasing CMBS issued by government-sponsored entities (i.e. Fannie Mae, Freddie Mac) that will help stabilize multifamily properties.
- The Fed also maintained the possibility of including private label CMBS and adding other asset classes in the future.
“Learn from the mistakes of others. You can’t live long enough to make them all yourself.”
Having spent my entire career in commercial real estate (CRE), I have made more than my share of mistakes and witnessed countless others. There are literally thousands of decisions made in any commercial real estate transaction. Many of them are so small they are virtually unrecognizable. Early in my career, I was introduced to a very simple chart that I have grown to rely upon when making capital allocation decisions. It very simply shows that as time elapses, your ability to influence the outcome diminishes, and the cost to influence that outcome grows.
In simple terms, a dollar spent early in the process has a much greater influence on an outcome than a dollar spent later in the process. I’ve seen this simple truth repeatedly played out in my career. Not enough invested up front can be the difference between profit and loss. This concept leads us to the first mistake CRE sponsors make: undercapitalizing the business plan.
Commercial real estate (“CRE”) private credit has a place in every portfolio, especially in the current economic environment, which is marked by peak prices, volatility, and slowing growth. This asset class has gone from being virtually untracked 20 years ago to $60B in dry powder (raised but uninvested capital) in recent months.
Regulations on banks after the last financial crisis combined with new laws benefiting smaller investors have allowed this space to thrive in the last five years. Investors have discovered its appeal and we think it’s here to stay. Before we dive into what investors are finding so compelling, let’s define what “CRE private credit” is.
CRE private credit is an asset class that consists of loans backed by commercial real estate properties. The properties act as the loans’ collateral such that, in the event a loan does not perform, the lender can take ownership of the property. This structure can increase security for a lender and reduce the risk of loss on an investment.
Opportunity Zone investor incentives can sound compelling. Where else can an investor receive increased returns (by paying little or no federal capital gain taxes) and at the same time help revitalize a local community?
Although Opportunity Zones provide substantial tax breaks for investors, they can be risky endeavors for bridge lenders and sponsors alike. In this article, we will explain what Opportunity Zones are, why they were created, and how bridge lenders may approach their underwriting of projects within these zones.
What are Opportunity Zones?
Opportunity Zones (OZs) are designated areas throughout the United States that have been selected by state and federal agencies for economic revitalization. In order to invest in OZs and receive federal tax breaks, investors must invest in a Qualified Opportunity Fund (“QOF”). According to the legislation, a QOF is “any investment vehicle which is organized as a corporation or a partnership for the purpose of investing in qualified Opportunity Zone property…that holds at least 90 percent of its assets in qualified opportunity zone property.” The legislation imposes a “substantial improvement” requirement on the QOF. In order for an existing building to be designated as a qualified OZ project, the QOF is required to make improvements to the building in an amount equal to or in excess of the purchase cost of the building (less the land value). Additionally, these improvements must be substantially completed within 30 months of the QOF’s purchase of the building. As an example:
A Qualified Opportunity Fund buys a property for $1 million. The land is worth $250,000 and the building is worth $750,000.
In this example, an additional $750,000 must be invested into the building within 30 months of the purchase date.
As you may have read in the Real Estate Crowdfunding 101, 102, and 103 articles, crowdfunding is a relatively new phenomenon that has changed traditional methods of raising capital for real estate investments. However, crowdfunding is just one piece of the larger picture: namely, that technological innovation is inherently disruptive. How has this disruption affected the world of real estate elsewhere?
Historically, the real estate industry—particularly the commercial side—has been slow to adapt to rapid increases in technological innovation. While other industries have welcomed innovation with open arms, real estate has not been so quick. However, the efficiency and success in other industries have inspired many property technology companies (dubbed “proptech”) to quickly rise in the real estate world. Although real estate has not caught up to other sectors quite yet, there has been a significant change in a relatively short amount of time. This article will discuss some of the emerging trends in the real estate industry spurred by technological innovation.
Obtaining commercial real estate debt financing is no easy task. In certain scenarios, gathering and organizing the required information can be a monumental undertaking. Many times, closing timeframes or difficult sellers can make it impossible. However, when presenting an opportunity to a lender, the more information you can provide the better. More importantly, you can expect more accurate feedback. From a lender’s perspective, the overall focus or theme is “don’t lose.” Because of this directive, lenders can be seen as “Debbie Downers” or “Negative Nellies”, seemingly unable to focus anywhere but on the downside scenario of the opportunity. Because typical debt structures do not allow the lender to participate in the upside, the downside risks take the majority of the lender’s focus. From this perspective, it is easy to see why lenders will tend to take a conservative approach. As a broker (or sponsor), it is important to try and not let a lender replace missing information with overly negative assumptions (sometimes they just can’t help themselves). A debt package that provides a complete picture of the opportunity will help manage any lender concerns upfront. This allows the lender to focus on the business plan presented, rather than stalling out with questions about missing information.
Below is an outline of important parts of any debt package that, when included, will help to keep the lender’s attention on the deal.
- Sources & Uses
- Capex Budget
- Historicals + Pro Forma
- Sponsor Background
- Market Data
- Differentiators in offering refer to the regulatory offering types (accredited vs non-accredited investor offerings), which are of the utmost importance to real estate sponsors thinking about raising capital online.
- Differentiators in platform refer to both the purpose (marketplace vs captive) and the incentives behind the platform, which is a critical investment due diligence item for anyone intending to invest through crowdfunding.
To date, the most successful real estate crowdfunding websites tend to be crowdfunding marketplaces focused on accredited investor offerings. These include CrowdStreet.com, RealCrowd.com, and EquityMultiple.com. Because these sites attract multiple sponsors (a marketplace) and can bring more money to real estate transactions (no fundraising cap), they garner the highest quality deals and attract the greatest quality and quantity of investors. In addition, they protect their brand by vetting the deals and sponsors before permitting them to market their offerings on their platform.
There has been a glut of crowdfunding platforms erected with the hopes of emerging as the real estate crowdfunding market leader. However, this glut has outpaced user-adoption. As a result, numerous crowdfunding companies have closed down or consolidated as they have struggled to generate the fee income required to outpace their large overhead.