Akin to the infection we are dodging by staying home, wearing masks, and distancing socially, another disease is lurking — commercial real estate distress!
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 on 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.
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 on an occupant to write a rent check. Therefore economic interruption which affects the ability to pay can lead to distress.
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, you used to – now you’re working there. A landlord can’t collect rent and he 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, hmm, 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, the owners of commercial real estate are your neighbors. They own their business 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. An 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. 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 that collections would slow.
Pension fund dollars are regularly poured into commercial real estate as is the case 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 also 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, that will depend 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.
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May 30, 2020 at 07:10PM
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An illness much worse than COVID-19? Try distress! - Press-Enterprise
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