Over the past several months, many people have been grappling with news about the economy, trying to plan their next steps.
According to reporting by Bankrate, in January 2024, the Federal Reserve opted to keep interest rates steady, which was “the fifth time in the last six meetings that the Fed has left rates unchanged, though the central bank has raised rates a total of 11 times during this economic cycle in an effort to tamp down high inflation.” Capital markets were in flux in 2023, which put a significant downstream strain on certain industries, such as real estate and construction. It remains to be seen to what extent capital markets will be in flux this year. PwC, in its “2024 Capital Markets Annual Outlook,” noted that for 2023, “stabilizing inflation and interest rates in the back half of the year offer reasons for cautious optimism going forward.” The firm continued that while “the economy will likely avoid a near-term recession,” it “expects real GDP growth to slow from a projected 2.4% in 2023 down to about 1.4% in 2024.”
Of course, economics and politics are intertwined—as CNBC reported in January 2024, JPMorgan Chase CEO Jamie Dimon “said he remains cautious on the U.S. economy over the next two years because of a combination of financial and geopolitical risks.” The various geopolitical conflicts currently occurring can cause severe market volatility.
Yet, there’s debate on whether a recession is looming in the United States, with some experts being more optimistic than others. I predict that there will be a light recession in the United States. However, in my view, what is clear is that real estate investors, whether they own real estate investment firms or are operating solo, need to heed the current economic circumstances and carefully plan their next steps to minimize their losses if a recession does occur. Here are several best practices they should follow.
1. Avoid Debt As Much As Possible
Dimon captured it perfectly when he compared the nation’s debt to an addiction.
The business world, particularly the real estate industry, is no stranger to debt. Some real estate firm owners and investors take on excessive debt so they can grow faster. The problem, however, is that growth isn’t always sustainable—and in the event of a recession or other serious event, that growth might free fall. Too much debt can kill businesses, especially during downturns.
Granted, it’s not realistic for real estate investors to avoid debt altogether. Debt is often necessary to acquire real estate. However, real estate owners need to be disciplined in how they approach debt. A disciplined debt strategy can pay off in the long term. Specifically, I recommend that real estate investors avoid taking on more than 40% debt, be it in the context of an acquisition or across the entirety of a portfolio. If they absolutely have to, they can go up to 50% debt, but any more than that is heading into dangerous territory. A good rule of thumb for real estate investors is to keep their debt level to no more than two times their EBITDA. As for real estate investors who already have substantial debt, my advice is to prioritize paying off their debt. Less debt now means more flexibility later.
2. Pursue Debt Funds If Need Be, But Shop Around
With some traditional lenders tightening their lending standards and being more hesitant to lend nowadays due to increased interest rates, real estate investment firm owners and solo investors might increasingly find themselves having to consider nontraditional lenders, namely, debt funds. In fact, according to real estate information company CoStar, “real estate debt funds launched in 2023 are looking to raise over US$60 billion globally.”
But real estate investors should proceed with caution if they’re considering debt funds. Debt funds have to earn higher interest rates because they’re dealing with a higher cost of capital; as such, they can be opportunistic. To mitigate risks, I advise anyone in the real estate industry considering a debt fund to shop around and look for ones that are more established and relationship-based, as they’ll be more likely to work through problems with borrowers, as opposed to putting pressure on them. Moreover, debt funds can have wide ranges in their quotes, and it’s beneficial to compare quotes and negotiate accordingly. That’s a big reason why real estate investors should start researching debt funds sooner rather than later. If they have even an inkling that they might need a debt fund at some point, they should begin their search right then and there. Otherwise, they might find themselves having to enter a bad deal out of desperation.
3. Be Selective About Acquisitions—And Focus On Existing Customers
The more selective real estate investment firm owners and investors are about acquisitions nowadays, the less likely they’ll have to turn to a debt fund down the line.
In my view, it’s smarter to wait than buy property today, given the state of the housing market. Instead, real estate investors should consider putting more time, energy and money into managing their existing properties. By running their existing properties well and providing their tenants with great customer service, real estate investors can safeguard their businesses. When treated well, tenants are less likely to leave, and real estate investors are therefore less likely to find themselves in a lurch trying to replace those tenants. The real estate firms and investors who have happy customers are the ones who have a better chance of coming out on top—even in the event of a recession.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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