SURVIVE, DEFEND, CAPITALIZE

How Experienced Commercial Real Estate Developers Are Navigating Market Dislocation and Uncertainty

by Brad Blake and Bradley Griggs of Blake|Griggs Properties

The commercial real estate (CRE) market is going through another transition, different from past cycles. The Federal government’s current policies and actions on tariffs, deportations, government firings, and the economy in general are causing confusion and chaos in all sectors, including real estate. No one really knows what is going to happen, so with great uncertainty comes anxiety, stress, and paralysis—so few want to make decisions, let alone commitments, particularly in the capital markets. 

What is happening or going to happen?

What appears likely to happen over the next year or two (hopefully not longer) are:

• Tariffs will cause equal to or greater inflationary pressures, causing interest to remain high or go higher;

• Unemployment will increase, which creates lower consumer confidence and lower spending;

• Tax rates will likely be reduced without a commensurate reduction in spending (despite DOGE’s claims), which means a larger Federal deficit, which means inflation, which means higher interest rates;

• Tenant leasing demand will slow due to lower sales, losing money, and/or a lack of capital, which means chronic vacancy or increased vacancy that causes the inability to pay debt service.

We hope we are wrong. But we have seen this movie before, although with different characters and different scenery.

SURVIVE | So, what does it mean for CRE? 

If the above scenario plays out, then for commercial real estate, it likely means:

• Lower leasing demand for all CRE product types;

• Less new development of new products, especially housing;

• Even less availability of equity capital (investors freeze) than today;

• Higher distress levels for office and hotels – even more defaults and foreclosures.

• Sales of “better assets” (like multi-family) at discounts to replacement and/or actual cost in order to generate cash to cover shortfalls on other assets that are “underwater.”

DEFEND | What should you do in the short term?

What do commercial real estate developers and investors do to manage these types of cycles, which are inevitable but usually occur for different reasons? Most of these things apply to almost all businesses facing a downturn or disruption, but real estate seems exposed to more regular cycles. Because it is an asset—and capital-intensive business, it can have different outcomes than other types of businesses or venture capital.

• Quickly adjust your attitude to a defensive and resilient mode for the immediate term while you wait to see what transpires over the next year or two. Don’t wait to see and wish for it to get better soon;

• Communicate with your team, investors, and lenders to let them know what may happen and that you and your company have been through it before and are prepared for what’s coming;

• Conserve cash;

• Tighten operations and reduce overhead. If layoffs are likely, do them sooner rather than later;

• Depending upon the level of debt on properties, be prepared to “negotiate” loan terms on existing loans by extending repayment dates (for loans of five years or less duration) and deferring or reducing and accruing interest payments for at least a year;

• Communicate with tenants and see if they are willing to extend their lease terms by offering them a lower rate overall for the extended term, taking a “blend and extend” approach. If you perceive the market is going down, then lead it down and don’t follow, hoping things will get better soon.

CAPITALIZE | Be prepared to be opportunistic and strike quickly

Opportunities have arisen in most past downturn cycles and periods of dislocation or distress. Identifying the opportunities is not that hard. What is hard… is predicting the right timing to pursue them and having the conviction, courage, and patience to do so. And yes, having liquidity and/or access to discretionary capital is critical. 

As with most market disruptions, it is hard to “time the bottom,” so take a “wait and see” approach and look for signs of capitulation by property holders, lenders, and investors.

 Here’s what to look for:

• The first wave of asset sales was well below replacement cost. Once the initial wave of sales occurs, there will be a second wave and perhaps a third wave. The initial wave of office building sales in this cycle was 50% or less of replacement, and the next wave was at or below this level;

• Articles in news sources about defaults, special services, and lenders filing notices of foreclosure. These are also of public record, so if you are motivated, you can track them through filings or by subscribing to one of the services that track various types of debt, especially CMBS;

• Sales of loans by lenders. This often precedes actual asset sales as it doesn’t take borrower resignation or capitulation. If you are willing to pursue future foreclosure of the asset, this can be a good strategy;

• Banks are starting to take large reserves on their balance sheets in anticipation of loan defaults. Oftentimes, property sales follow the same or the following year.

• Each property type has its own key metrics, but increased vacancy and/or lower rents are an initial sign of problems. This leads to an inability to service debt, which can lead to the sale of the assets.

Are there any CRE safe havens during disruptions and downturns?

Despite the volatility, commercial real estate, particularly rental apartments, remains one of the most resilient asset classes during periods of disruption. Multi-family is the safest CRE alternative.  Housing is a fundamental need. During downturns, more people tend to rent rather than buy. These and other factors make multifamily housing a defensive investment that can weather economic storms better than other CRE sectors.

One thing to keep in mind is that once disruption occurs and people start to sense distress in the real estate markets, foreclosures and distress or liquidity-generating sales usually don’t occur as fast as people think they will. So, stay aware, be patient, and be poised to play defense if necessary and offense when the time is right.

About the Authors

Bradley Griggs, Co-founder & Managing Partner

Blake|Griggs Properties

Mr. Griggs has developed more than $3.5 billion of real estate investment totaling over 7,500 apartment units, 40 extended-stay hotels, and 2,000 for-sale residential homes. He has been a senior executive at public and private real estate companies.

Connect with Bradley on LinkedIn

Brad Blake, Co-founder & Managing Partner

Blake|Griggs Properties

Mr. Blake has been involved in the development and management of more than $2 billion of multi-family, mixed-use, and retail projects over the past 35 years. He has started two private real estate companies and been the Chairman and CEO of a public REIT.

Connect with Brad on LinkedIn