Six Threats to Real Estate Investment and What You Can Do About Them

1)  THREAT:  External forces that could tip the economy into recession.  A critical geopolitical event elsewhere, deteriorating debt conditions in Europe, an increasing debt to GDP ratio in the US, or further downgrading of our nations’ credit rating could al pus the US and global economy into a recession.

BEST DEFENSE:  Stick with the basics.  Invest in properties in good locations with good loan terms, stables leases, and reasonable return expectations.  Pick relatively recession-proof property types like apartments or grocery-anchored retail.  If you are involved in property management, do what’s necessary to retain good tenants.

2)  THREAT:  Washington gridlock and repressive regulations.  Whether it is increasing healthcare costs, the outdated 1980 Foreign investment in Real Property Tax Act, or the proposed risk retention rules affecting asset-backed securities, the cost of federal regulations is increasing borrowing costs and decreasing liquidity, particularly in the secondary and tertiary markets.

BEST DEFENSE:  Support real estate organizations working to reform or repeal onerous regulations.  Write your legislators and hold elected representatives accountable for their actions.  Use the ballot box to support candidates with a business vision and commitment to a more stable political climate. 

3)  THREAT:  A 2012 hiccup in property values.  With transaction volume and values flattening in late 2011, it’s possible that commercial property values will experience a slight decline this year, or at least increase more slowly than alternative investments.  On the other hand, slowing activity could indicate a further stabilization in the market, which could prevent overheating.

BEST DEFENSE:  Base your investment decisions on good research.  Analyze data on return expectations and lower your return estimates if the economy deteriorates.  Consider selling nonperforming assets, if you can get a fair price.

4)  THREAT:  Stingy capital and strict credit requirements.  Although US banks are generally healthy, there is an increasing lack of liquidity in European banks, insurance companies, and pension funds.  All the stress keeps lenders cautious and loan requirements stringent.

BEST DEFENSE:  Seek out equity and debt capital aggressively.  Act immediately to lock down money for investments in 2012.  Another option is to build up cash by selling a few properties or increase the leverage on existing loans.  This will put you in a position to self-fund investments.

5)  THREAT:  Increase interest rates.  The Federal Reserve has announced that it intends to keep the federal funds rate low at least until 2014, but it will eventually increase short-term rates to fight inflation.  Higher mortgage interest rates will follow.

BEST DEFENSE:  Lock on low rates now.  Despite the post-credit crunch trend toward deleveraging, smart investors should borrow as much as property cash flow will allows and lock in longer-term loans now.  Don’t wait until the note comes due.

6)  THREAT:  A value bubble in Class A properties.  Some investors – flush with cash and seeking the safety of high-quality assets – are already paying top dollar for prime properties.  If prices for such properties keep climbing, investors who fear they’ll miss an opportunity may jump too quickly and overpay.

BEST DEFENSE:  Stick to your investment metrics.  Determine your return requirements, benchmark your investment decisions, and trust your gut.

Source:  Ken Riggs, CRE, Real Estate Research Corp, Chicago.