There are always distressed asset opportunities in commercial real estate. You just have to no where to look.
One of my favorite place to find commercial real estate opportunities is with CrowdStreet. CrowdStreet focuses on individual real estate opportunities in 18-hour cities where valuations are lower and rental yields are higher. They are always trying to source the best deals for their investors.
Reviewing Real Estate Opportunities So Far
Let's first review what I've discussed about investing in real estate during the pandemic.
On March 16, 2020, as someone interested in buying a home, you read How Does Real Estate Perform When Stocks Melt Down. From this article, you learned that real estate tends to significantly outperform when the S&P 500 is down between 10% – 20%. If you bought residential real estate in 2Q2020, you're likely doing well as demand for residential real estate continues to grow.
On March 18, 2020, you read How To Predict A Stock Market Bottom Like Nostradamus and decided not to freak out. Instead of selling stocks, maybe you even bought stocks. If you did, you're sitting pretty given the NASDAQ and the S&P 500 rebounded to all-time highs.
If you're still looking to build more wealth, your attention should now be focused on investing in lagging asset classes. In particular, I'm interested in investing in distressed assets in commercial real estate in hospitality.
According to Real Capital Analytics, commercial real estate valuations fell by 35% between August 2008 and June 2010. Despite the bull market in stocks and residential real estate so far, history could repeat itself. Therefore, we should be preparing now.
Today, the S&P 500 and the NASDAQ are at all-time highs. There is a tremendous amount of liquidity searching for investment opportunities.
Searching For Distressed Asset Opportunities
To help us get smarter about distressed asset opportunities, I've asked CrowdStreet, a site sponsor and one of the top real estate crowdfunding platforms to answer some questions.
CrowdStreet is focused on finding promising real estate investments in 18-hour cities where valuations are lower, rental yields are higher, and potential growth is stronger due to demographic shifts to smaller cities. The site is free to sign up and explore.
1) Where does CrowdStreet see the most opportunity in CRE over the next 1-2 years?
Best Geographic Opportunity In CRE
Even in the face of economic uncertainty, we remain confident in the long-term potential of 18-hour cities like Austin, Nashville, and Charlotte.
Prior to COVID-19, their job and population growth rates were above national averages. Further, these cities were supported by a diverse employment base.
Compared to metros that have a strong reliance on the service industry, these markets stand a better chance of bouncing back quickly, once the health concerns of COVID-19 are under control.
We also favor these metros because:
- They have a lower cost of living and more affordable housing compared to 24/7 metros like LA and NYC.
- Their job and population growth rates are above national averages, which indicates a market’s economic health and gives us some insight into employers’ confidence in the market. Employment growth can also be used as an indicator of future growth.
- They’re supported by a diverse employment base, often with companies relocating to the area and/or expanding their footprint. This means there is likely a lower unemployment rate.
- They have a growing millennial population since younger workers are relocating in search of well-paying jobs, affordable housing, and a live-work-play balance. As the largest cohort of the workforce, millennial migration greatly impacts the employment growth of an area as they move in.
- They are seeing an influx of institutional capital, such as investments made from pension funds, endowments, or foundations, etc. They represent where the ‘big money’ is moving.
Favorite Commercial Real Estate Asset Classes
Hospitality, retail, and office commercial real estate have been hit hardest during COVID-19. See chart below as of 4/16/2020 with the most pain in 2Q2020 so far.
Let's review our favorite asset classes today.
Industrial
Last-mile industrial properties are more valuable today than ever, thanks to the dramatic increase in online shopping we’ve experienced this year. While e-commerce accounted for 11% of all retail sales in 2019, according to a Mastercard study published in June, it doubled to 22% for April and May of this year.
We have witnessed e-commerce steadily gain market share each year over the past decade but the pandemic has greatly accelerated its rate of adoption. Amazon's stock performance is clearly an indication of e-commerce's growth.
We believe that heightened demand for last-mile distribution spaces will continue for years to come, especially in growing metro areas, as companies strive to ensure they are well-positioned for the future.
Medical
Thanks to the high cost of moving, highly specific, and expensive build-outs often required to bring a new medical office online, we believe medial buildings are attractive.
We suspect that most medical tenants will not break their leases and, instead, will opt to renew when the time comes. Medical was relatively healthy going into the pandemic, and should emerge relatively healthy out of the pandemic.
Multifamily
We like the prospects of ground-up multifamily development projects already in progress in key markets, especially those projects that will deliver late in 2021 or in 2022.
Further entitlements for new developments will likely be greatly muted over the next 12 months. This means fewer competitors when those projects that are already-in-motion hit the market in 1-2 years.
We also like higher Class B to Class A assets in strong locations within vibrant submarkets. These properties, while possibly seeing low-to-no rent growth over the short term, will likely continue to perform well and should see a rebound in rent growth as the economy moves into recovery.
Retail
We view grocery-anchored shopping centers as among the best investment opportunities within retail right now. According to a study published by the Hartman Group, grocery stores’ share of food spending rose from 50% in February to 63% in March and then 68% in April.
Food consumption purchased at grocery stores is still up in the mid-60% range, a level not seen since the mid-1990s. Even with some expected regression towards the mean whenever we exit the pandemic, we anticipate grocery store sales will remain strong for a number of years.
Self-storage
Self-storage proved resilient during the Great Recession. Given the greater adoption of self-storage over the last decade, we believe it will again prove resilient. So far, public markets agree.
Throughout the pandemic, publicly-traded storage REITs have been among the best performing all asset classes. According to multiple reports from Green Street Advisors, public storage REITs experienced only single-digit percentage drops, roughly in line with industrial and manufactured housing REITs.
In comparison, office, retail, and hospitality REITs all experienced drops of 30-50% over the same time period.
2) How is CrowdStreet positioned to take advantage of any distressed asset pricing / opportunities?
CrowdStreet sits in a unique position in the commercial real estate market. We maintain hundreds of relationships with institutional-quality sponsors who have a broad range of geographic and asset type specializations.
Because of our large network, we’re able to access and review hundreds, or even thousands, of high quality deals every year.
Distressed deals often happen quickly – getting access to these opportunities requires early looks from those in-the-know. You also need agile, reliable capital that can react quickly to these fast-moving deals.
Therefore, we recommend you sign up and get on our e-mail list and automatically get alerted on new deals, distressed or otherwise.
CrowdStreet’s proprietary network and processes, along with a seasoned team of investment professionals, allow our Marketplace to source, review, and share this deal flow with investors.
CrowdStreet is ideally positioned to give both sponsors and investors the speed, rigor, and agility that’s necessary for navigating this type of market.
3) Are there particular sponsors CrowdStreet has worked with who are experienced with distressed assets and have successfully exited?
Ardent. They started in 2009 looking at distressed deals and we are currently looking at their strategic fund.
4) What are the main things a sponsor and investor should look for before investing in a distressed asset?
Here are some key questions sponsors and investors should ask themselves:
- What has to happen for the asset to break even, and then to become profitable? Take a hotel deal for example, with historically low occupancy, these assets are hemorrhaging cash. How much does occupancy have to increase before the hotel stabilizes? What is going to drive this demand – conferences, sports arenas opening up, tourism picking up again etc.? How long will this take?
- How much in reserves will the asset have, and how much runway does it provide for covering expenses and debt service? Do you think 12 months, 24 months worth of reserves? Is this enough time to turn the asset around?
- What is the valuation of the asset and where do you need to get it to hit your pro forma? You’d probably want to see the stabilized asset hit somewhere in the ballpark of a 2018/2019 valuation 5 years. This is how you could back into the going-in basis.
- What does the leverage look like? Does it match your business plan in terms of timing?
- Who’s the sponsor? Distressed deals are risky, you’d want to work with a sponsor who has deep experience in the market and asset class.
- Does the asset and business plan still make sense? Was this a poor performing asset prior to the downturn? Will this become obsolete?
Make Sure You Have Cash On Hand
The current economic slowdown could ultimately lead to many loans becoming ”bad debt” as companies default on their debt. Current levels of distress could lead to a decline in new commercial real estate loan origination.
This means sponsors are more likely to sell their properties in a fire sale to stop the bleeding, rather than restructure their debt since loans may not be readily available.
Over the next 1-2 years, there should be more distressed asset opportunities in the commercial real estate space. Therefore, it's good to cash up in order to take advantage of potential good deals.
Take a look at the cash buildup at closed-end real estate funds. The one thing that is very different from this financial crisis, besides the much larger government support, is that institutions and people have lots of liquidity. When there is a rebound, I believe the rebound will be much faster than historical rebounds.
Hospitality Is My Favorite Distressed Asset
In my opinion, hospitality commercial real estate is the most attractive distressed asset. Travel is roaring back as pent-up demand gets unleashed in 2H2021 and beyond. The goal is to find that hotel in a good travel market that is undercapitalized. Therefore, the hotel needs to raise money at a big discount even though the good times are just around the corner.
To help me find these deals, I've signed up with CrowdStreet to send me e-mail notifications. Their investment team is looking for such opportunities as well. The only issue is that demand is outstripping supply. Many of these deals are fully subscribed after only 2-3 days.
Less Distressed Assets Today
I want to thank CrowdStreet for sharing their thoughts on the commercial real estate space right now. There is also going to be a lot of repurposing of space.
Just look at Amazon planning to turn abandoned department stores into fulfillment centers. That's great for both Amazon and mall operators. Offices will also eventually come back.
Human ingenuity and the desire for profits is what we should invest in. Search for distressed investment opportunities on CrowdStreet and other platforms today. Real estate crowdfunding accounts for roughly $70,000 of my estimated annual passive income of $300,000.
There are less distressed assets in 2022+ as the economy comes roaring back. However, they can still be found in the commercial office, mall, and hospitality space. You just have to look!
I say just play commercial real estate through REITs. More liquid and beat up right now. My top picks:
Hotels: Park Hotels (PK). Enough cash to last over a year and a half no revenue. Top hotels in the U.S. Trading at $10 vs 25-30 pre covid. That’s a 20% yield if divy fully reinstated in future.
Grocery shopping centers: Brixmor (BRX). 9.3% yield when dividend is reinstated next quarter. Rent collections of 85% last month are enough to cover the dividend. Located in suburbs, tenants doing ok.
Healthcare: OHI and MPW.
Net lease retail: STOR, WPC, SRC. Less risky bets.
Malls: SPG. I get it, retail apocalypse. But best of breed, way discounted in the $60s vs $150+ pre covid, huge dividend potential. If you have been to some of their top malls I think you will agree the good malls will survive. SPG is repurposing failed anchors, like JCP, into experiential tenants and apartments/hotels.
Those are just some of the REITs I’m buying. I’m already up big but they still have a long way to recover.
Great suggestions. Will check them out. Thanks
How confident are you in CrowdStreet? I am looking at dipping my toe into the water on my first commercial real estate investment through them. It’s in St. Petersburg, FL which is about 35 miles from where I live. I went an looked at the building today and like the area where it is located. I think the downtown area will eventually come back as the Tampa-St Pete area is an area that is growing and attracting others from the northeast. I know the money will be locked up for 4-5 years but since I’ve never done anything like this I still have some reservations. I’m thinking of between 2.5% to 5% of my portfolio. Any insight?
I like CrowdStreet because they enable the investor to invest directly with the sponsor. So you sidestep any platform risk with CrowdStreet. Of course, you must also then do your due diligence on the sponsor.
I met seven or eight people from the team at the end of last year and I really enjoyed hearing their strategies, investment philosophies, and expansion plans.
The most important decision is the investment opportunity. So always do your due diligence.
I limit my allocation to 10% of investable assets.
Nashville just raised property taxes by 34%. How does this change your outlook on that particular city?
How confident are you in CrowdStreet? I am looking at dipping my toe into the water on my first commercial real estate investment through them. It’s in St. Petersburg, FL which is about 35 miles from where I live. I went an looked at the building today and like the area where it is located. I think the downtown area will eventually come back as the Tampa-St Pete area is an area that is growing and attracting others from the northeast. I know the money will be locked up for 4-5 years but since I’ve never done anything like this I still have some reservations. I’m thinking of between 2.5% to 5% of my portfolio. Any insight?
A lot of good insights in this article. The pandemic has certainly induced changes in consumer behavior, but it’s important to distinguish between long-term structural change vs. short-term phenomenons. When we get an vaccine, I’d bet that the hospitality industry would quickly bounce back. People would want to go to restaurants and not cook at home as much — therefore, grocery store revenues should drop to pre-COVID levels. (Cooking at home was not a desire for many people, but a necessity.)
However, there would be some permanent behavioral changes such as more online shopping, especially as merchants have beefed up their ecommerce platforms during the pandemic, enhancing the customer experience. In this case, people might very well not revert back to old habits. Regarding the point about Amazon turning malls into fulfillment centers, I would say that’s an exception and not a trend. Fulfillment centers do not require as much floorspace as department stores/malls, which are designed for a good shopper experience while the former is designed for storage and access.
Sounds good. So what lagging assets do you suggest investing in? I’ve got to imagine many of us are already invested in the likes of Amazon and other internet companies by now. I’m not sure if I should be investing even more in tech/internet now. It feels like the risk/reward ratio is off.
Ten years from now I will be happy I bought Amazon at its current price. Just like now, I am happy I bought Amazon ten years ago at its then
current price, even if that price ten years ago seemed high at the time. It does not matter if the price is too high. It just doesn’t matter. Buy. Sorry about the typing.
Cool, I’m so happy I did too. Netflix too, but in 2006 when I got my MBA part time. Reed Hastings spoke at my commencement.
At age 71, I encourage you to enjoy more of your wealth.
I see Charlotte listed as one of the target cities. While I agree that since the recession the job economy of the city has diversified, it is still very heavily with financial institutions big and small. Wells Fargo is a significant employer in the area and they are basically going to be slashing roughly 20-25% of their workforce of 250k+. This will hit San Fran, Minnesota and Charlotte particularly hard (likely to start towards Q4).
Housing prices continue to be driven up in this metro and is outpacing what your typical household income in the city can afford. The city is notorious for over-leveraged people on houses, cars, etc. It is an extremely “plastic” city and suffered greatly during the recession due to this, many did not learn from their mistakes.
I personally believe that growth prospects of the city are near the end of their maturation. Neither of the health systems operating in the area are very well run, so you have providers and/or groups breaking off to form their own practices, joining “networks of practices”, or going to the RTP area to the univeristy systems. The other major banks/financial institutions in the area have likely learned from WFC, because hiring was extremely minimal even pre-Covid. My 2 cents from a former resident of the area of 15 years from late 90s to post-recession recovery.
Thanks for the color on Charlotte. The one thing I do know is the San Francisco market. And financials is not a big part of the economy. So many people are getting extraordinarily wealthy on tech it is nuts. I don’t have that large of a tech portfolio and don’t work in tech, so am not leveraged. But even I have made several hundred thousand dollars in my tech investments this year.
So I do believe money will seek assets like real estate and the Bay Area economy will hold up fine.
What lagging asset class would you invest in?
Thank you for the reply Sam.
This response may not be exactly what you were looking for. but I am not necessarily against CRE. I may feel we will see things return “normal” in the future, but CRE for retail/office space may not come back fully to what it was. I believe we will see a shift to moderate to large businesses move to the hotel concept of office space for employees, reducing their footprint. I think with retail, we are seeing the the true end of an era with “big” brick and mortar. These are of course my gut feelings and I could be early or wrong. I have no data to back up these assumptions. I know that I would not invest in CRE focused on retail, if big business begins shifting away from it and this sector relies on small businesses to fill the void, given the typical lifespan. Couple that with small businesses and entrepreneurs shifting to primarily online store fronts, which additionally provide them broader consumer bases.
To answer your question, in the short term I was/have been plowing money into Med Tech, Life Sciences, and Devices (especially during the dip). It could be that me working research, I gravitate towards this. When you look at the impacts of AI, wearables, device improvements around Cardiology, Vascular and Ortho there is a lot to be excited about. I think Livongo is a reasonable representation of innovation in these fields, though overvalued at this point in my opinion. They have been the poster child for diabetes management and will likely continue to see more and more interest with wellness programs active at employers and implemented at health systems as solutions. As we see further turnover with MDs to the younger generations, I believe these new chronic disease management and exacerbation prediction solutions will build even more steam.
Yes great call on the bottom, I definitely didn’t take into account how printing trillions of dollars would impact to stock market as well as certain sectors of the economy.
One question I have for you since you are probably the most knowledgeable dude on the planet when it comes to SF real estate is, what do you make of all of these articles and talk of the exodus from California and particularly the big cities like SF? I am reading that the combination of Covid19, uber-liberal politics, trying to increase the state taxes, and the ability to work from home has started a shift there. Do you think it’s much to do about nothing, a temporary blip, or the hard reset that will bring a price correction back to some level of sanity? People will always want to live there for sure, but curious what your vision is when you put the Nostradamus hat on.
I think the combination of the income tax increase to 13.3%, along with the proposals to further increase (to 16.8%) plus start a wealth tax, along with the inability to write much of this of for federal tax purposes and the new remote work possibilities will cause lots of wealthy people to leave. I just left due to the above and I was paying 6 figures in income tax to the state. Now zero. CA politicians think people will just keep paying so their only answer to a fiscal problem is to raise taxes. It certainly worked in 2012 but I think this time it’s different and you will see a marked exodus. Something like 10k people pay around 40% of the income tax in a state of 40 million people. Not saying it’s going to happen all at once but the state will begin to feel the effects beginning next year and will accelerate if the two tax proposals pass, which I would expect they will. This will not be pretty and I am certainly glad to be out.
Don’t forget, the people who have been coming into CA have lots of problems, and have a track record for leaving places that got worse. The government has ways told, and untold, of tracking your person and property. Interesting days ahead!
I’ve got an article coming up on big city real estate.
I haven’t been this excited in a while. The media always likes to scare and go to extremes. So a bunch of people I know are using the fear to buying more real estate.
The city gets better with less traffic and congestion, not worse. But deals, other than downtown condos, are hard to come by.
So many people are getting extraordinarily wealthy on tech it is nuts. I don’t have that large of a tech portfolio and don’t work in tech, so am not leveraged. But even I have made several hundred thousand dollars in my tech investments this year.
Let’s not talk about the thousands who have made much more with the NASDAQ up 25%.
I think MF REITS are trading mispriced right now. Or MF class B and C are way over-priced, or both. EQR for example (class A MF in top tier markets), trades at 20B market CAP, with less than 10B debt, and conservative operating income of 1.6 B. So cap rate of 5.3%. At the beginning of the year, market cap was 30B with similar income and debt, so cap rate of 4%. There is a 130 BP increase rather than the +40 Cushman cited for implied changes in MF pricing. I only see 4% CAP on class B small MF in primary markets. These should go for 6 to 7% if EQR is going for 5.3% (note, EQR has additional value as a property management and RE development component, so it is implied being traded at least 6% if you add the other business segments). So something is mispriced. I am loading up on EQR for weeks now, unless I am missing something?
I also am buying EQR. I think cities have shown resilience in the past and this looks like a great buying opportunity. $90 stock recently trading at $54. If I could go buy physical condos in these cities down that much I would be more than happy too.
Thanks for the suggestions! Will look into these.
I am using it as a hedge against discounts in Multi-Family never materializing. I hope to purchase at class B at >7% CAP, with down-payment from cash-out refi of existing properties (so ~3% borrowing rate), and a Freddie MF loan at ~75% LTV on the rest at currently 4.25% rate. So I’d be making 7% on 100% borrowed money at around 4% borrowing cost (add principal payments equals around ~6%). But currently, I am not seeing anything close to 7%, so I figure to hold the down-payment in EQR at 6% effective CAP. If MF deal never comes, I should be able to make a healthy return on the concentrated EQR holdings. As JB mentioned, basically EQR can be viewed as class A MF currently can be had for almost 40% discount. Am not seeing anybody selling MFs at this steep of a discount…. I don’t think there are any discount currently in the southern markets I am looking at….
Intriguing insights. I believe the 70% hit on the hotel sector because of the pandemic. Boy it must be hard for those working in the travel industry. I certainly have no desire to travel for a while. I haven’t followed the commercial real estate market much at all since my interests are in single family homes and condos. So I like that there are REC platforms to gain exposure to CRE without having to know all that much about it. Love section number 4 on important questions to research before diving into a distressed asset. Very helpful thanks!
Nice job calling the stock market bottom and analyzing how residential real estate performs in a down stock market. A lot of people were calling for doom in stocks and real estate in 1Q2020.
It’s very difficult to decouple with people getting rich off stocks and housing and then have CRE fall badly. As a result, maybe CRE won’t fall too badly at all? I don’t think CRE is going down anywhere near 35% as it did in the last reason.
Hotels seem like they are in trouble though. I’m not sure how they are going to survive if the economy doesn’t open up soon. Office is going to be stronger than expected due to long-term leases and a likelihood of repurposing office space.
Thanks. It is crazy how much money people have made in tech stocks this year. As you know, I live in San Francisco and literally Everybody I play softball and tennis with has made some money in tech.
I didn’t even know Tesla had $2000 a share until my softball buddy messengered to me.
I am pretty sure that there is going to be a capital rotation to laggard sectors. This is how it’s been ever since I’ve been investing since the 90s.
Capital has rent seeking behavior. It’s gonna always flow to where there is the most opportunity. Right now, it seems like hospitality commercial real estate is just trying to hold on for dear life. Because they know there’s gonna be a rebound and they know other assets are doing well, so the last thing they want to do is sell at a big discount.
The $1 billion investment by Silverlake and Airbnb was huge. And now, the call is that Airbnb will actually benefit because baby more people who want to do Airbnb then hotels post COVID-19.
Who knows for sure, but what I do know is that space will be repurposed, and there is just a massive amount of cash waiting to be unleashed.
To build wealth, we must always be on the lookout for opportunities.
I knowing about real estate and I don’t want to learn. What I do know is the smartest move I can make is to stay fully invested in Apple. Which co. Will take its place? None
Agree. I now have way more Apple stock than I realize. Literally don’t have to work b/c of Apple stock alone.
A SF realtor at an open house was saying her one clients are up over $1 million in Apple stock this year.. as they work for Apple. And Apple employs tens of thousands of people in the Bay Area!
Nuts!