Getting By way of the Recession in Industrial Actual Property: Time to Maintain?

Our property with a Walmart store is said to have lost 25% in value in the past six months. But the cash flow remains unchanged.

By John E. McNellis, Principal at Real Estate Developer Partner McNellisBecause WOLF SUGAR:

Years ago – beset by the Great Recession – one of Tennessee’s best developers shook his head at his financials and said, “My net worth has halved, but My cash flow is still the same.” He is not alone. Commercial real estate across the country has lost about forty percent of its value during those challenging times.

His poignant commentary acknowledges two things: his portfolio declines in value, but more importantly, the fact that it really doesn’t matter. Despite being worth half that, his property is still occupied by tenants who pay rent.

Because this savvy investor has been through so many recessions — they’re like high school reunions, they spy on you — he’s astounded with the mortgages he’s taken. put on your real estate. With little existing debt, he was not forced to sell his property when their loans came due; he can refinance instead. As a result, his only loss was on paper – the numbers shrink on his financial statements – and he still collects rent. And when the market rallied for several years, his financials recovered.

Fast forward to today.

Property values ​​may not have dropped much, but they are looking down a rabbit hole. We looked at our retail holdings in January, thinking we’d do a bit of pruning. We considered selling a Walmart in the Central Valley and asked one of our favorite brokers what it would take.

Because its Walmart lease is short-term, he said the property will be sold at a 6% capitalization rate; that is, a buyer would want to earn 6 percent a year on her purchase price. Therefore, if the rent is $200,000 a year (it’s not), the purchase price will be $3.33 million ($200,000 / 0.06 = $3.33 million).

We’re not ready to sell in January, but we did last week. We have double checked with our broker. Embarrassed, he explained that the nightmares of the past six months — bear markets, soaring inflation and interest rates — would have buyers demanding 8% interest today. This means our Walmart will now sell for $2.5 million ($200,000 / $0.08 = $2.5 million).

In other words, the property is said to have lost 25% in value in the past six months. Like that Tennessean canny, we decided we’d rather keep our losses on paper and decided not to sell.

This example shows a close resemblance to single-tenant retail properties to the bond market: The prices of both decrease as their yields increase and, conversely, increase as their returns increase. reduce. And, to simplify things a bit, the fluctuations in the value of each are irrelevant if you don’t sell: If you buy a $1000 Treasury bond that pays 5% interest and hold it to maturity, you will get 5% every year and all your own back. But sell when interest rates rise to 10 percent, and you’ll only get a much lower price. On the other hand, sell when the interest rate drops to 2.5 percent and you’ll get a much higher amount.

The same math applies to single-tenant retail: if you don’t sell, “your cash flow stays the same.” If you do, you run the market like a mechanical bull.

My example also implies another point: Even if we acknowledge a dramatic drop in commercial property values ​​- which can happen – we are unlikely to see the emergence of a boiling buyer market. motion. Instead, sellers with plenty of money will put their items back on the shelves and wait for a sunnier day before selling.

Instead of a buyer’s market, we might see buyers and sellers a mile apart, entrenched in their own expectations, while we watch as the market evaporates like spit on a grill.

Sellers who are forced out of their excess by death, divorce, dissolution, disaster, or simply excessive leverage can be truly decimated, but with too much money in the chase. real estate these days, they may even live to fight another day.

Back to that sneaky Tennessean. He understands that net worth is for bragging, cash flow is for eating. You too. Via John E. McNellisThe author of Doing it in Real Estate: Getting Started as a Developer.

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