The Problems are the Path: Opportunities in Commercial Real Estate

Year end pressure to sell is compounded by high interest rates and the desire to eliminate costly unprofitable investments appear in the large commercial projects and the smaller projects.  It takes some research to find an opportunity among the offerings. 

Hedge Funds, the so called Smart Money of sophisticated investors, have expanded on their bets that interest rates will go higher than they are now.  That bet is levied via short positions in Government Bonds.  A short mean they sold something that they bet will go down in value as interest rates go up.

That bet will be a financial reward to hedge funds, but will turn to be a liability and loss to Commercial investors who own commercial property with variable rates or mortgages that are maturing within a short time frame, say 6-months or less.

It is well publicized the Billions of dollars in debt that will mature next year for the Office building across America.  There is little in the news that deals with all the smaller transactions that have the same difficulty. What compounds the maturing debt in the smaller transactions of less than $10 million is the ownership by Private Equity.  The Wall Street Journal recently had an article on We Work.  We Work was an idea created to take advantage of empty office space to provide an environment to entrepreneurs looking for office space to create business models in high tech and related industries.  All was well for the idea.  Interest rates were low, ultra-low.  Investors were seeking anything that would give a return that would make up for the loss of higher interest rates.  The offer of forecasted return by real estate was readily accepted by many large investors.  We Work boomed.  The money flew in and the money flew out!  in the end the founder of We Work was replaced for his extravagance.  We Work eventually failed as entrepreneurs found working from home a far cheaper way for their business work than paying for office space and commuting during the pandemic.  We Work buildings went the way of  many office buildings in America.  Vacancy to a point cost of carry became a negative.

That scenario is the same for the smaller commercial properties.  Private Equity funds found ready investors among individuals and smaller institutional type investors as pensions and trusts to fund dreams of high returns secured by real estate.  The process is simple.  Raise millions of dollars to buy small commercial projects; such as, office buildings and apartment buildings.  Place each investment in a pocket in the master Limited Partnership, management by a corporation to protect the managers.  Each pocket would be a Limited Liability Corporation to protect, or at least try to protect the Master Limited Partnership, the Private Equity Fund, from foreclosure risk.  Buying property would be financed by a mortgage that would be financed by another Private Equity Fund.  The financing would be at higher rates due to the fact many traditional lenders would not want the risk associated with a single property within a Limited Liability Company.  Traditional lenders want security.  Private Equity Lenders want high returns to their investors.  The risk is managed by short term borrowing or notes. Their investors were also seeking high rates of return to replace the low yields available by risk less returns in a low interest environment of the 2020 era.  The short term notes rolled and returns came to investors and managers.  All were ecstatic and more money came in.  Investment Managment Funds search for more and more investments.  Eventually the choice became thin and thin until more risk was taken.

Commercial properties are different from residential in one big way.  Residential have State of California requirements of FULL DISCLOSURE.  Commercial real estate does not.  Buyers must perform their own inspection, most of which is a contingency after an offer is accepted.  Buyers cost are their own cost. Discoveries that would cause a increase in cost to buyer are then accepted or the price is adjusted. If not accepted buyer and seller go their way.  Seller deposit is returned and the cost of the investigation is the buyer's sole expense.

Small Businesses are the heart of America's Economy.  That is why their is a Small business Association formed by the U.S. government with various loan guarantees to help small businesses in America form and thrive.

It is those Small Businesses that buy, develop, manage and sell small commercial properties and residential properties in America.

Opportunity lies with those Limited Partnerships formed during the low interest environment.  Does management have sufficient experience?  Was the property on the edge of profitability?  Were permits taken for all the improvements?  Was there an "Oh Oh" moment when a wall was taken out and Black Mold was found?  Is the "Oh Oh" moment the realisation that the higher interest rates threaten profitability or create a loss?

To all those questions lies opportunity.  Opportunity exists when fear is high.

WeWork filed for Bankruptcy November 6, 2023!

As before, call or write for any question you may have and think of me of your "in the know real estate agent".