Investing in Commercial Real Estate in COVID-19

There are many questions circulating within the commercial real estate investment landscape as the COVID-19 crisis unfolds. Will the market return to normal soon? When will rents be collected? Am I going to lose my investment?

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I’ve gathered some of the most common questions I’ve been asked and have provided answers that will help guide you through the next 90 days.

If I have money tied up in real estate investments, can I tap into the equity to pay bills and my mortgage?

It depends. If you have buildings that have not been critically impacted or if you have properties that are low leveraged, you may be able to tap some of that equity. The challenge now is that the lending market for borrowers is uncertain. There’s money available, but the terms can be prohibitive. For example, some lenders are requiring additional reserves to cover six to 12 months of mortgage payments. Other lenders are prohibiting cash-out loans. For some owners, a line of credit may be the best option.

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Additionally, your available equity is predicated on the property’s cash flow and debt coverage, so money may not be as readily available as it had been in the past. Here’s why: If you own commercial real estate, you likely also have tenants, whether they're commercial or residential. The majority of U.S. states have shelter in place orders and/or social distancing restrictions, which may not be lifted until the end of May or early June. Many commercial tenants cannot open their doors because of these orders and may not be able to pay their rent. Residential tenants are profoundly impacted as can be seen by the climbing unemployment figures. The CARES Act as of now provides for enhanced unemployment and a one-time stimulus check, but there is no requirement that the tenants use the funds to pay rent.

Given this uncertainty for collections, I would say that tapping into your investment is going to be more difficult today than it would have been even two months ago.

Should I hold off on new investments, then?

At present, we’re seeing transactions that were already near the finish line closing. Most other real estate transactions are being put on hold, or the closing is being extended by 90-120 days. Collections are a big unknown for many properties right now. Collections and net operating income set the value of the real estate, but just as important, sets the size of your loan.

We’re also seeing across the market, no matter the property type — multifamily, office or retail — there’s a moment of pause right now. As an example, a multifamily acquisition transaction cycle normally takes two months from start to finish. We’re seeing these same types of transactions now pushing their due diligence out to a 90-day period, with 60 days to close after that (five months). If buyers and sellers are willing to cooperate and take current conditions into consideration, deals will get done. They're just going to be a little different than it would have looked like two months ago.

There may be options for opportunistic investing in 2020, depending on how long COVID-19 disrupts the economy. Good buying opportunities could include properties approaching the end of their financing term or those with troubled operations. Loan maturities are “drop dead” dates that force owners to either sell or refinance. Refinance options have become a lot less attractive in this lending environment, which may prompt sellers to just take a discount on sale instead of taking a loan with low leverage and large reserve requirements.

The same goes for owners who are over their heads with failing operations. When property cash reserves and owners’ own resources are unable to float a property through lean times, then owners may choose the better of two difficult options and sell at a discounted price to avoid foreclosure.

Why is asset management such a hot topic right now?

One reason that investors go into sponsored real estate investments is because the sponsor also oversees asset management on their behalf. It’s a passive investing strategy for those who want the benefits of commercial real estate investment, without the hassles of being a landlord.

Asset management is that layer of oversight between the property’s daily operations (property management), and the owner or investor. And now more than ever, asset managers are scrutinizing property operations with the goal of balancing the needs of the property with the goals of the investors.

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An experienced asset manager can navigate an investment property through shocks to the real estate cycle. In the event of a pandemic, natural disaster or any other threat to the property, they are prepared to operate in a very conservative mode to protect the investment. Good asset managers also keep an open dialogue to communicate with owners and investors in real time. Examples of communicating effectively could be sending updates on instituting new procedures to protect the health of residents and staff, changes to business plans, or outlining new rent-collection policies.

The impact of COVID-19 is shaping up as a defining moment for real estate asset managers. Some of the weaker asset management teams and sponsors have “gone dark” leaving their investors wondering if rents are being collected or if mortgage payments are being made. The ability to quickly reprioritize the business plan (e.g., stop capital projects to reserve cash) also distinguishes strong, proactive asset managers from more passive counterparts.

Economic fallout of COVID-19 introduces a real possibility of foreclosure for some properties, and inexperienced asset managers may be unprepared for such a challenging scenario.

So, what’s a ‘sponsored investment’?

The term “sponsor” is used to describe the individual or company responsible for sourcing, purchasing and managing a real estate investment — from acquisition through the eventual sale.

First, a real estate sponsor pools together a group of accredited investors and acquires a property. Then, the sponsor continues its investment oversight as an asset manager, overseeing the business plan, driving value and eventually directing the property’s sale.

Typically, investors receive monthly or quarterly distributions throughout the ownership period. In the case of a crisis, such as COVID-19, distributions might be suspended for a period of time in order to build cash reserves. Investors understand that real estate is a long-term investment strategy and will eventually receive funds.

Should I look at real estate over other traditional investment types?

At the end of the day, real estate is a long-term game, with a long-term horizon. When we talk to investors interested in sponsored real estate, we tell them the same thing. Right now is no different, and we're reminding them of this exact same game plan.

Yes, the next six months are uncertain. Real estate and lending markets are not stable at the moment. But, again, commercial real estate investing is about the long term. We know that rents will get paid — perhaps temporarily with payment plans — and property incomes will stabilize. We know we will go back to a normalized model.

When we have that data that rent collections are going in the right direction and the debt markets begin to normalize, my recommendation is this: Move quickly.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Karlin is Principal and Executive Vice President of Investors Management Group, a privately held real estate firm headquartered in Woodland Hills, Calif. IMG has transacted over $1.6 billion nationally in this cycle, with over $500 million in multifamily assets (3,000 units) currently under management nationwide. She holds an MBA from the University of Oregon.