Recession Planning for CRE Investors

1. Build a cash reserve. Now may be the time to forgo owner distributions to build a cash reserve, also known as a rainy-day fund. One of the biggest mistakes investors make is not having sufficient cash reserves when times get tough. They like the cash flow being generated during the good times and are happy to pocket it for other purposes but they conveniently forget the negative consequences of rising vacancy on the property’s cash flow. Do you have sufficient reserves set aside for tenant improvements and leasing commissions should the downturn cause abnormally high vacancy at your property?

2. Change the term of your loan. Is your loan coming due within the next couple of years? During the Great Recession, many investors lost their properties, not because they were delinquent on their mortgage payments but because they were unable to refinance their existing loan at the same loan amount. Or it could be that the property owner fails other financial ratios the lender uses to assess an investor’s financial strength and liquidity that prior to the Great Recession they would have had no problem passing with flying colors.

I had a client who built a Class A multi-tenanted office building that at the time of construction was worth about $5 million. The ten-year loan came due at the height of the recession. The property’s vacancy rate at that time was nearly 40%. In order to refinance he needed to pay down the existing loan by about $1 million. But he didn’t have the money to pay down the loan and he couldn’t refinance the property. So even though he had paid every mortgage payment on time for the ten years of the loan, the lender ended up foreclosing on the property.

So how do you avoid that from happening to you? Is your loan coming due during the next few years? If so, you may want to consider refinancing now with a loan term of five years or longer as historically economic downturns don’t last for extended periods of time. If your property’s occupancy rate plummets as a result of the coming recession you won’t have to refinance at the peak of the recession.

3. Another reason to refinance your property is to improve the property’s cash flow. If the last time you financed your property was more than 3 years ago, it is likely the current interest rate is higher than what you could get today. A lower interest rate will reduce the mortgage payment and make your property that much more resilient to a market down turn.

4. Do your capital repairs now. Are there capital repairs that likely need to be completed over the next 3 years at the property? Are you putting off re-painting the exterior, or repairing, resealing and restriping of the parking lot or replacing the roof? Maybe now is the time to make those needed repairs when the property is flush with cash instead of waiting to do the work when the recession hits and cash flow is limited at best.

5. Do a vacancy breakeven analysis on all your properties. Based on your current rent roll and operating expenses, what vacancy rate will result in the property’s cash flow before debt service equaling the mortgage payment? At the height of the Great Recession, apartments averaged a 10% vacancy rate, industrial properties averaged about a 15% vacancy rate and office and retail probably averaged around a 20% vacancy rate. How well does your property do with these vacancy rates? If it can still breakeven with these types of vacancy rates you’re probably okay. If not, now’s the time to make the changes necessary so it can. Do your own breakeven test. If you would like a formula to fill out to accomplish that, let me know.

by: Doug Marshall’s Blog Marshall Commercial Funding Blog

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