Nikita Zhitov is a commercial real estate investor, developer and client CityPlat, LLC.
In commercial real estate, we always look ahead. Where are trends leading the market? What can we expect in the coming year? While some of these things are important to understand, the key is knowing what’s worth your time and attention and what’s not. It’s easy to get distracted.
CRE is a long-cycle proposition. The smartest investors are those who can stay focused and ignore what is beyond their control. As we look ahead to 2023, with a volatile economy and the lingering possibility of a recession, it’s important to stay focused and keep the noise at bay.
Our company has built a multi-million dollar commercial real estate portfolio by adhering to fundamental, time-tested principles and practices designed to support revenue, value and growth in nearly all transient market conditions.
So is a recession coming? My advice is to be prepared. Here are five 2023 guidelines – and potential challenges – that are top-of-mind:
1. Ask in the south and west
While the migration continues to the south of the United States, pay close attention to local economies and trend indicators. In some areas of rapid growth, supply simply cannot keep up with demand. The development boom is sometimes met with resistance from local communities and government, and infrastructure for basic services can lag behind. Investment in these regions remains strong, but keep in mind that associated growing pains often drive up costs for CRE.
2. Adopt reuse and redevelopment
Lifestyle changes due to Covid-19 have impacted the market value of one-time premium real estate, particularly downtown shopping malls and office buildings. Over the past three years I have liquidated most of our offices and instead focused on small to medium industrial/warehouses and small retail spaces. I expect more properties to be repurposed and redeveloped, such as urban industrial space being converted into retail space and office space being converted into multi-family housing.
3. Long-term exits
Since most recessions last an average of two to four years, I wouldn’t get into a project with an exit plan in less than four years right now. I also wouldn’t go into debt that expires in less than four years. Even if there are willing buyers lining up, it can be extremely difficult for them to get reasonable financing in the event of a recession. Be prepared to hold assets for a longer period of time, especially now. After all, it is the best way to build wealth and grow wealth.
4. Historical Values
Use only past and current market performance as a basis for valuation. Pro formas can be misleading and shifts in the financial markets, such as rising interest rates, must be taken into account. However, these challenges can motivate you to become a better negotiator and a more disciplined investor. Limited financing options force you to explore non-traditional strategies, such as my preferred alternative: seller financing. In short, be realistic with your projections and know your numbers inside out.
5. Debt vs. Cash reserves
Too much debt and not enough cash reserves are the two main reasons why companies fail in a recession. I recommend having no more than 50% leverage and having enough cash in reserve for one to two years of debt service. If you have to sell half of your assets to pay off the other half’s debt, do so. You may miss the opportunity to sell at the top, but you can sell close to the top. In the event of a recession, cash will be critical as bank funding dries up. Being prepared is always better than a liquidation sale.
By focusing on long-term goals, sticking to the fundamentals and maintaining a conservative financial position, you can maintain the value and performance of your portfolio, especially during periods of unpredictability. I’ve seen firsthand how commercial real estate investments can provide some of the best returns on investment of any asset class over time. With the right strategies, yours can too.