Economists, CEOs and business owners each have their own opinion on if or when the U.S. economy will fall into a recession. Some experts indicate that there is a good chance an economic downturn or recession will happen within the next two years, making it logical for real estate professionals to begin bolstering protections. Regardless of the timing of the recession in the future, adequately addressing a down market is essential to business survival. What steps can real estate firms take now that will help them get through a recession and come out the other end even stronger?
Evaluate your portfolio to determine which properties will be most vulnerable during a recession. If passing your loan covenants are an issue today, would the company still pass if there was a decrease in occupancy or if you were forced to freeze or decrease rents to retain tenants?
Decreased occupancy or rents would also result in a lower net operating income and a decreased valuation. This could be an issue if the loan on your property is maturing within the next several years and the company will need to refinance. What you can do now is run various scenarios and evaluate if it makes financial sense to refinance today, as rates continue to be low, or wait for the maturity date of the loan. Most commercial loans have a prepayment penalty outlined in the agreement that would have to be taken into consideration.
One potential result of performing your projection on loan covenants or ability to obtain necessary financing during a recession could lead to a decision to sell the property. Better to sell the property now than during a recession when your valuation is likely to decline, and the company may be dealing with loan covenant and financing issues with the bank.
Improve Quality of Assets
Do you have significant deferred maintenance on your property? You should consider completing deferred maintenance through funds available from current cash flow. During the downturn, this could prove to be difficult due to decreased cash flow, issues with capital calls with existing owners and the potential difficulty in obtaining financing to complete the maintenance.
In addition, consider performing renovations or investments in technology that will improve the quality of the property and even result in reduced expenses and increased attractiveness to tenants. More and more properties are being built or retrofitted with smart technologies that will enable the building to operate with greater efficiency. An example of a smart technology is the ability to easily track and perform preventive maintenance on the property. As a result, this will reduce the likelihood of equipment breaking down, ensure the equipment is running as expected, and prolong the life of the equipment.
Whether you are reducing your deferred maintenance projects, performing renovations, or making investments in smart technologies, this will only improve the quality of your property and the attractiveness to buyers or tenants regardless if you are in a recession or not.
Another way to improve the quality of your asset(s) is to evaluate the likelihood that your tenants can withstand a downturn. Your net operating income and valuation might be acceptable today, but what if your tenant is negatively affected by the downturn and vacates their space? Performing financial stress tests on your property based on the likelihood that the tenant will stay in business and pay their rent is an important component of financial planning and will help you make informed decisions in the areas previously discussed.
Planning now for the next recession will only help you stay ahead of the curve and continue to capitalize on opportunities as they arise before, during, and after the recession.
Jason Borofsky, CPA, MBA is a Partner at Sax LLP and a member of the firm’s Real Estate Practice. He has provided industry-specific accounting, auditing, tax and consulting services to property owners, developers and investors for 14 years. He can be reached at email@example.com.
For more information, visit Sax LLP.