We are a mid-sized insurance group based in Beijing that have been holding on a couple of mixed-use developments in Florida. We keep hearing that the market is past due for a downturn and are trying to determine if we should sell these assets now or be prepared to hold on to them for four or five years. When do you think the U.S. commercial real estate will begin its downturn? How long do you think the downturn might last?
Either late this year or next summer of 2019, the U.S. real estate market will start the downturn or a new recession period. Normally, commercial market is a little bit behind residential, but I expect the prices of commercial properties in most U.S. metro areas will drop no later than the beginning of 2020.
Major market shifts are very difficult to predict accurately or see coming. Very few saw the financial crisis and Great Recession coming in 2008, and those who did and acted did extremely well. I think it is fair to say that most experts think that capitalization rates cannot move lower, so price appreciation can really only come from either increases in rents or increases in capital flows. Most believe that the U.S. economy remains strong, so slow and steady growth is likely for the next year or perhaps two years, but many see a very mild recession by 2020 or 2021. Very few expect a severe recession like we had in 2008, which dragged on for many years. Since leverage on assets is so much lower than in past cycles, given much greater lender discipline, the kind of downward spiral we experienced 10 years ago is unlikely in the next recession, which should be mild and not of long duration. That said, I do not see a lot more real appreciation on most assets, especially in places like Florida (though there are always special cases), but if you like the cash flow you are getting and not overleveraged with good long-term debt in place, you may be better off holding unless you have better investment opportunities into which you would deploy sale proceeds.
Get a survey of the market from a knowledgeable group. Look for an adviser with background. Talk to market brokers. Then test your property for downturn risk. What is the remaining term of your leases? Are the tenants credit-worthy? Does the property need work? Upgrades? Then, depending on the type of asset, you will have the ammunition to make a decision.
Generally speaking, many industry experts and observers believe we are at the tail end of this recovery cycle. However, it's important to remember that while this recovery has been long, it has been slow, implying that people are overly weighting the amount of time that it’s been since the 2008, 2009. So, there is likely still a lot of room left, and the economy in general is strong with coming superficial boosts from the recent tax reform. There is strong growth, low unemployment, interesting demographic trends, etc. The biggest risks to the U.S. are probably geopolitical over economic. In commercial real estate nationwide, there is less leverage in the system and spreads have been tightening for some time before a recent rise. LTVs and CMBS rates are at more conservative levels than 2007 highs, implying that we are not near a major blowout in the system. At a more micro level, there are different forces affecting different asset classes and geographies. In fact, New York City prime office prices have already started to decline, and the residential market here has been declining for a while. So in some sense there is price corrections and a “downturn” happening now. Florida in particular is a market experiencing population growth, has ease of doing business and is benefitting from recent tax changes. I am more bullish on Florida projects (location and product-dependent, of course) than most parts of the country. To answer your question broadly (and without knowing the specifics of the assets, which is crucial), I think a downturn will occur between two to four years from now. I think it will be much more subtle than the 2008 downturn, and won’t last longer than 18 to 24 months. Finally, whether or not to consider a sale now depends on your basis and short-term goals. However, prices are inflated at the moment, and if a good price can be achieved that hits exit return goals, I think it can be the right time to sell.
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