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MortgagePoint » Your Trusted Source for Mortgage Banking and Servicing News 54 May 2024 F E A T U R E S T O R Y I t is a hard time out there for real estate professionals. The main impact of the Fed's interest rate hikes is that capital is harder to come by. That has resulted in credit standards tightening, and fewer transactions being conducted in the mar- ket. According to CBRE, commercial real estate volumes were down 54% through Q3 2023). As has been reported thoroughly, this will be a problem for people who are not well-positioned to weather this storm. In 2021-2022, many investors pur- chased properties at high prices, using two- and three-year bridge loans. They underwrote these deals with aggressive rent growth and price appreciation assumptions, which matched with cheap capital, and allowed for record prices. Now, they must find a way to meet their obliga- tions, which they took on by promising to achieve these aggressive assumptions. When their two- and three-year loans come due, they will have to refinance or sell their properties in an environment where capital is scarce and expensive (if available at all). Meeting their mortgage and investor obligations will be difficult for these aggressive operators. Some will make it ... yet many will underperform, and when their high-leverage debt obligations come due, they will have no choice but to recapitalize by paying down their exist- ing loans or selling at prices in line with a more capital-starved market. When this happens at a large scale across the market, it is called "deleveraging." After deleveraging has happened and leverage rates in the market grow in line with current growth expectations, reflation, and price appreciation can once again proceed. There are many buying opportunities in a deleveraging, however, the capital to allow for this deleveraging will have to come from somewhere, and it will not be traditional banks. It typically comes from prudent investors who are well-posi- tioned to take advantage of an environ- ment like this. There are many of these investors out there who have low leverage, cash-flowing properties with low interest rate debt locked in place. Many of them are buyers, but they are underwriting deals based on the new interest rate and pricing reality in the mar- ket. This is a reality that many sellers are unwilling to accept unless they are forced to. Biggest Risks in the Current Market I f you are a buyer in the current market, the good news is that downturns are typ- ically the best time to buy if you are able to hold onto your property until more nor- malized market conditions have returned. However, holding on until the market has stabilized is not a foregone conclusion. Here is a list of risks to consider: » Property condition: Issues such as structural defects, environmental haz- ards, or unexpected maintenance costs can pose significant risks. Many current sellers have begun a renovation, but have run out of money prematurely as inflation has caused cost overruns and capital is less available to fund short- falls. These sponsors may skip steps and cover up shoddy work. Thorough due diligence, including property inspec- tions and assessments, and adequate cash reserves are crucial to identify and address potential concerns. HOW INVESTORS CAN THRIVE IN CRE AMID CHALLENGING MARKET CONDITIONS Derrick Barker of Nectar discusses the state of the commercial real estate sector, and steps that investors can take in order to weather market volatility. B y D E R R I C K B A R K E R D E R R I C K B A R K E R is Co-Founder and CEO of Nectar, a platform that provides liquidity to property owners with cash flowing assets. He started buying real estate from his dorm room at Harvard. After Harvard, he spent three years trading complex securities at Goldman Sachs, while simultaneously building a 500-plus unit real estate portfolio in his hometown of Atlanta. He left Goldman Sachs to focus on real estate full-time, eventually growing his portfolio to more than 4,700 units, and $400 million in asset value.