A California Perspective: Real Estate Principals Navigate the Current Lending Market
April 23, 2020
By Michael Morris
Early in 2020, the market was extremely liquid for real estate investors and operating companies. Interest rates were relatively low, asset values were high, unemployment was low, and there was little inflation—overall, the market was performing well. And then the lending market began to change in March in response to the COVID-19 pandemic. The number of defensive draws by companies to preserve their liquidity has been unprecedented, and the number of loans has drastically increased. Other forms of capital have slowed due to the inability to forecast risk. It’s a challenging time for real estate companies to stay abreast of market trends, as well as quantify the current and anticipated business impacts in this dynamic environment. With data constantly changing, how are real estate companies navigating this seemingly open-ended period of uncertainty?
On April 17, EisnerAmper hosted a “Real Estate Principals Virtual Roundtable” with the Bay Area Council, Kennedy Wilson, and Wells Fargo. This online event provided a forum for industry leaders to share their experiences regarding the current lending market and to hear first-hand from their peers regarding how they’re navigating the current environment. Here are some key takeaways from that discussion.
Real estate owners are proactively developing protocols with their property managers to find out how their tenants are doing and what their plans are. These communications are weekly, sometimes daily, in order to stay up to date as events develop. Identifying which tenants are in most need of assistance helps landlords prioritize their efforts. They are finding creative ways to make the current situation manageable for both parties. Owners are doing things like offering tenants payment plans and connecting them with government assistance resources. Showing loyalty is important.
Current deals are taking a 10% to 15% haircut and are largely being done between parties who are familiar with each other and have previously done business together. It’s necessary that each party understands the other’s outlook for the specific asset. There has also been a shift regarding the tenor of deals. Companies that were previously getting deals done on a five-, seven- or 10-year basis are now more likely to be getting them done on a one-, two- or three-year basis. Longer-term acquisitions are currently on pause until travel resumes.
Since the economic downturn began, real estate companies have been focused on their existing portfolios. These companies are now broadening their attention beyond asset management to refocus their deal team on strategic opportunities. Many companies remember the 2008 Great Recession and are more liquid today than in the past. Real estate companies with dry powder are looking for deals. These can range from distressed loans that lenders no longer want on their books to a significant drop in land values. So far, only transaction volume has decreased. They are waiting on the sidelines to see what level of stress comes through the market. Some will further expand their options by identifying an investment partner.
Proposed Rent Cuts
Rental property owners are closely watching Assembly Bill (“AB”) 828. Introduced by Assemblyman Phil Ting, San Francisco (D), this bill aims to protect tenants by requiring landlords to cut rents by 25%. As written, this ruling extends to tenants who are not facing economic hardships. Landlords were impacted earlier this year by the passing of AB 1482, a rent control bill that caps the increase of annual rent at 5% plus the Consumer Price Index. With AB 828 up for a vote, housing providers are concerned that this bill doesn’t provide them with adequate safeguards to collect rent or evict negligent tenants.
Real estate companies don’t have the same line of sight that they once did. Many are exercising caution as we go into May and anticipate the worst over the next six months. Within the real estate industry, some sectors will fare far better than others during this economic downturn. How long we reside at the bottom of the seemingly U-shaped recovery will partly depend on the sector and how quickly the capital markets begin to thaw. The biggest unknown is what things will look like after COVID-19. How will the current crisis affect long-term trends? Will we rethink office space, high-density living and so forth? It’s important that real estate companies continually re-evaluate their investment strategies as market conditions evolve into that often-repeated refrain of a “new normal” over the coming months and years.