Delaware Statutory Trusts And The Woes Of Commercial Real Estate

Delaware Statutory Trusts And The Woes Of Commercial Real Estate

Wow!  That even rhymes.  How clever am I?  Gotta do something to get your attention.

For years, we have been telling income property investors it is time to get defensive because, “the times they are a changin.” (Bob Dylan).  Unfortunately, it sometimes feels as if we are simply “a voice crying in the wilderness.” (Book of Isaiah).

We believe change is coming in terms of commercial property usage and concomitant obsolescence.  These changes could be exacerbated by higher interest rates, lower valuations, and a financing environment that is best described as a ‘new ice age.’  How’s that for a start?

Commercial real estate has certainly seen its share of ups and downs the past couple of decades.  However, this time around things may be different, and not in a good way.

This convergence of lifestyle and workplace change along with inflation and higher interest rates coming in its wake is reminiscent of the tidal wave of social and economic change that rocked asset values in the ‘70s.

Back then, technological change allowed businesses and workers to leave the inner city and migrate to the suburbs.  This time around urban flight is catalyzed by the pandemic and progressive government failure.  Literally overnight, office towners emptied out and in so doing, fell out of fashion from an investment standpoint.  They are now beginning to fall like dominos in some of the nation’s biggest markets.

Simultaneously, what I believe to be pro-crime policies on the part of the progressive governing class have potentially degraded the quality of life in many of these same urban areas.

It seems as if they have turned the “broken windows theory” of policing on its head in the conscious attempt to encourage further crime and disorder, resulting in even more serious crimes.

In any case, it clearly seems to be accelerating the obsolescence of both office and retail property types as workers seek suburban safety along with the ease and anonymity of shopping online.

Last time I checked, you didn’t have to leave your car windows rolled down and doors unlocked to avoid being vandalized when shopping on Amazon.  You may not be able to try things on before clicking buy, but at least you’re not going to get mugged walking out.

Considering this, it is unknown how bad any commercial property downturn could be.  However, the deeper problem might be that given these structural changes in the way we work and live, once bottoming, values might not rebound as in the past.  This is food for serious thought when selecting replacement properties in 1031 exchange.

New technologies that are changing the way people live and work are threatening many landlords now.  Unlike past downturns, having left downtown, workers may not be inclined to rush back in.  No disrespect to Sam Zell intended.

Retail property owners have struggled with the rise of e-commerce for years.  This has pushed down the value of store fronts across the nation and still threatens many shopping malls.

According to UBS Group AG, store closures increased significantly this year.  They are projecting that around 50,000 retail stores in the U.S. will close over the next five years.

However, all is not doom and gloom.  With the housing shortage still acute, multifamily rents could begin to stabilize in the not too distant future.  Furthermore, recession often causes renters to take a step down in housing.  This could be good news from a demand standpoint for Class B and C apartments.

The majority of new supply scheduled to arrive on market in the near future will be at the highest price point.  This may have less of an effect on working class apartment communities.

As more Americans reach retirement age, they are opting for higher end senior living communities as well.  Newer, private pay facilities offer many more amenities from a lifestyle standpoint than in the past.

As people live longer, residents are seeking a more active, low maintenance, carefree lifestyle that is community oriented, which is what the best senior living facilities are all about.  Even Bidenomics may not be able to derail this trend.

Of course, self-storage has been a go to in both good times and bad for many years.  We have been and continue to be bullish based on its strong history and proven track record performing well during both economic bull and bear cycles.

In an era of increasing risk and expected valuation loss, storage properties have displayed one of the lowest credit risk/expected loss ratios of any CRE (commercial real estate) type as well.

Finally, its low per unit rental price point makes it available to an extremely broad and diverse customer mix.  In cuts across most socio-economic boundaries and can be used to house literally anything.

We have quoted Jamie Dimon, head of JP Morgan Chase in the past.  Income property investors would be wise to interpret his recent pronouncement regarding the failure of SVB, Signature Bank and First Republic Bank that “This part of the crisis is over,” with emphasis on “this part.” There may be more to come.

Real estate is historically a cyclical asset class, most investors know this.  Clearly, it is now in a down cycle.  It only makes sense to invest as conservatively as possible and keep your powder dry hoping for the cycle to turn back up again.

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