Originally Posted: November 1st, 2009
Over the last 5 years, we have seen an extreme bubble in the commercial real estate market, due to overspeculation on real estate. During this bubble, many people disregarded the true fundamentals of what really makes commercial real estate work over the long-term. This is not unlike the Internet stock bubble that occurred back in the late 1990s where people threw out the fundamentals of what the true multiples of EBITDA or profit that a company earns which is truly how you gauge the value of a company. When gauging the value of a company with forward earnings, you price that into the value of the stock; however, this number needs to be within reason. Not unlike commercial real estate, people will speculate on appreciation over time, but if it is factored in unreasonably with a very high level of appreciation into the calculations of the real estate, you run the risk of overpaying for that real estate. Whereby, losing money in the end.
As the market continues to correct itself, there is quite possibly one of the biggest generational opportunities to purchase real estate. The transfer of wealth from one group of investors to another group will be evident by certain owners not being able to withstand either a refinance or a loss of tenants, whereby they must sell or give the property back to the bank. In essence, an investor comes along, will take advantage of this opportunity and purchase at a very low price.
As we all know, markets go up and down. This market will certainly go back up over time; however, over the next 12 to 24 months, the commercial real estate will experience a tremendous amount of turmoil. There are a lot of adjustable rate mortgages or short-term loans that will be required to refinance. A lot of those instances, the personal guarantee that will be required will simply not be enough to get it done whereby the banks will begin the foreclosure process. As the balance sheets of these banks continue to improve, they will be less likely to extend any sort of extension on these loans, whereby making foreclosure more of a reality than it’s been over the last couple of years.
Completing a financial pro forma on a prospective must have sensitivity analysis. Sensitivity analysis allows you to factor in different variables such as interest rate and purchase price, and others to determine what sort of range you can expect on your rate of return if certain variables change over time.
The fundamentals of investing in commercial real estate are more important now than ever. To truly understand the space, capital and property markets when going into a sizable investment are critical. More on this concept in future blogs. For now, luck is the where preparation meets opportunity. And the opportunity of a lifetime is just around the corner.
Darren Nakos, CCIM
Resort Realty Capital
111 Main St
P.O. Box 630
Frisco, CO 80443-0630