From Bullish To Bearish: Tips To Prepare For The Inevitable Real Estate Downturn

It is the question often discussed among panelists at the latest industry events, the buzz passed among colleagues during coffee breaks and a factor investors are weighing heavily before making a move and deploying capital: When is the correction going to hit? 

MRI Software Industry Principal Brian Zrimsek said the question owners and operators should be asking themselves is not when the next downturn will hit, but are they prepared for when it does? 

“It is like preparing for a storm," Zrimsek said. "You put yourself in the best position to ride out the storm."

Commercial real estate has been experiencing a record run of rising valuations for about eight years, and many experts believe the industry still has room to grow. But recent drops in national CRE pricing, rising interest rates, a lack of attractive product on the market and the age of this cycle have some wary of a correction on the horizon. 

Zrimsek said now is the time to take what is left of the good times — while money is relatively cheap, vacancies are low and rents are high — to prepare for the inevitable downturn.

For some, that could mean offloading assets not strong enough to weather the storm. For others confident their properties can hold up long term, these four tips could prove beneficial: 

1. Negotiate Long-Term Leases

During a downturn when overbuilding has pushed vacancies up, having long-term, stable tenants on the books to generate steady cash flow is imperative, Zrimsek said. Operators should examine their tenants and take note of the best performers to determine which have expiring leases that need to be renewed, and which should be replaced. 

“Maybe if you look at which tenants are doing well and which sectors are doing well and are more recession-proof, you can discuss a renewal or an extension instead of waiting until the lease ends,” Zrimsek said. 

Keystone Properties President and Chief Operating Officer Richard Gottlieb, who is particularly bullish on real estate right now and does not foresee a downturn hitting soon, said flexibility and staggered leasing is key. 

“Be more flexible on the type of space [leased]. Even in a downturn, small companies are still looking for space,” Gottlieb said. “Try to extend lease terms and get long-term value anytime. You want fully leased buildings with strong leases and tenants who can pay rent and weather a downturn.”

2. Pursue Rehabs And Upgrades

Investing in property upgrades and face-lifts ahead of the inevitable downturn is important, Zrimsek said, pointing to the current low-interest-rate environment and stable cap rates as an incentive to improve the quality of one’s assets.

Owners should aim to have their assets in tiptop condition ahead of a correction, so their product will remain attractive to tenants seeking a renewal or looking to expand their offices.  

“If you don’t believe in the long-term viability of your asset, then you should sell before the market takes a downturn. If you think you have good real estate, make sure you have the ability to maintain the property and go through a downturn. In a good market, even mediocre property can do well,” Gottlieb said. 

3. Stop Putting Off Maintenance

Deferred maintenance is the simple act of delaying repairs on a property to save on costs and balance one’s budget. While this is common practice, Zrimsek said now is the time to tackle all building upkeep while capital is still relatively cheap and readily available. 

“Short-term thinkers can easily justify to themselves deferring maintenance,” he said. “[But] when in a downturn, the purse is tight and money is expensive."

Gottlieb said Keystone makes a habit of tackling all deferred maintenance on any recently acquired assets. 

“When we underwrite and buy a building, we want to fix everything, especially deferred things. Then we keep on top of it. It is easier to keep up than to try to get capital to fix everything [at once],” Gottlieb said. 

4. Embrace Technology

The time to invest in tech solutions to automate aspects of one’s business is now, while new CRE solutions are hitting the market to make the act of trading and managing commercial properties more efficient, Zrimsek said. 

“Look at your business again while times are good and there’s more cash available  — whether cash flow from businesses or money from lending — and use those dollars to make yourself more efficient,” he said. “It’s much harder to scale up or down when relying on manual practices … if you add tech, you can scale up and repurpose people to more valuable activities [or] scale down and have more flexibility with what you do with your workforce.”