“Ch-ch-ch-ch-changes,” David Bowie used to sing. We have heard many times that change is inevitable. This is especially true as we are in the longest economic recovery that the United States has ever experienced at 126 months. Most economists and businessmen have expected a slowdown in the economy for the past several years, but our economy has continued to grow. My crystal ball is no better than anyone else’s, but I expect a strong economy until the summer. Trump will do everything within his power to keep the economy going strong to help his reelection prospects. But, as we approach the election in November, I expect that businesses and consumers will slow their spending, which could result in the beginning of a recession.
We must remember that recessions are a normal cycle within our economy and do not typically last more than 22 months. Most economists are predicting a mild landing for the US economy. The last recession was unusual in its severity and length.
The point of my article is not to pinpoint when a recession will occur but to help our Members and Guests prepare for one. Those of our ranks who have been in the business for less than eight years have never experienced a downturn in the economy. During a recession, some real estate professionals prosper, and others flame out. What can we do to enhance the chances that we prosper as opposed to go up in smoke? Within the Society, we have real estate brokers earning an income from commissions, we have real estate investors who live off their investments in income properties, and we have developers who are active in development of all real estate product types. We also have hybrids of this with a mix of the three.
Transactional Real Estate Brokers: I can personally attest that my brokerage income can drop off a cliff during a real estate downturn. The exception is when the lenders are aggressively dumping properties. But lenders do not always cut prices to meet the market. During the downturn of the late 1980s and 90s, the government entities controlling foreclosed real estate dumped the properties, and transaction volume was at a high level. I was able to earn significant brokerage commissions during that downturn. But in the last recession, commercial lenders were not as aggressive in their pricing. I had many clients with lots of cash on the sidelines waiting for opportunities that did not occur. Ironically, there were fantastic opportunities in the single-family arena but not as much in the commercial world. What can we learn from past cycles to help us prepare for the future slowing in the economy? It never hurts to stay liquid. Budget properly so you have ample cash to carry you through a decrease in fee income. Counsel your clients. Set a meeting with your clients and offer to analyze their portfolio to give them wise counsel on how they can weather the upcoming change in the real estate cycle. Based on their portfolio, should they plan on holding their assets, or does it make more sense to sell some of their assets now, before the slowdown? If they should hold, what does the debt look like on their assets? Loan maturities during a downturn can be problematic. Many lenders are still aggressively making commercial real estate loans, with very attractive interest rates and terms. I am seeing more offerings of limited or no liability on loans and assets that previously would have required 100% recourse. Does it make sense to refinance now, ahead of a slowing economy? Or perhaps even consider paying off existing debt. The above advice to transactional brokers can enhance the brokers income via consulting fees, refinancing fees, and brokerage fees. But more importantly, you can provide a valuable service to your clients by giving them prudent advice on how they can enhance the income from their real estate portfolio during a downturn.
Real Estate Investors: The common advice that is applicable to Transactional Brokers, Real Estate Investors and Developers is to stay liquid. That may mean selling an asset prior to your projected holding period. Cap rates are still extremely low. There should still be time to market a property now and achieve historically low cap rates prior to a slowdown in the economy. It never hurts to take a profit, especially if it safeguards you and your investors from undue risk in a slowing economy. Capital gains rates will probably never be as low as they are now. Analyze your upcoming lease terminations. Does it make sense to negotiate early lease renewals before the market changes? As we head into a slowing economy, stay in close communication with your tenants so you can detect any issues in their business. Avoid that unexpected call from a tenant that they are shutting their doors when you had no advance warning their business was in trouble.
Real Estate Developers: For the third time, I emphasize staying liquid. What if the investor or developer does not have the financial ability to increase liquidity before the next downturn? Consider bringing in equity partners now, before the economy slows down. If you do not have the expertise, hire an S.E.C. member to analyze your portfolio to identify the positive attributes that will attract investors to your deals. Review your development and construction schedules carefully. How will your construction schedules match up against a slowing economy? Communicate with your construction lenders. Can the loan be restructured in light of the coming slowdown? Is it possible to get out of your construction loan earlier than anticipated and convert to a permanent, non-recourse loan? Is it better to stop development midstream or curtail certain aspects of your development plan to better navigate through a slowing economy? If you are looking at new development deals, pass on any deal that does not make sense during a slowing economy.
Summary: Another thing to watch as the economy slows down is your health. When we are under stress, it can severely impact our health. Recessions can generate huge amounts of stress. Practice good eating habits, exercise regularly, get enough sleep, and maintain a strong spiritual base. Hopefully some of these suggestions can help you and your clients prepare for a slowdown with minimal impact on cash flow, net worth, and health.
Steve Fithian, CCIM, CPM, S.E.C. President
