PERE Special Report: Prepping for the Next Global Financial Crisis

By Mike Ratliff, Senior Associate Editor

With high flying fundamentals in core markets, it’s quickly getting to be that time of the cycle when smart investors begin to examine and refine their commercial real estate holdings in preparation for the next recession. While that day will certainly come, the exact time frame and strategies involved in mitigating risks and maximizing ROIs are up for debate.

Right to Left: Scott Stuckman, USAA Real Estate Co.; Jonathan Schultz, Onyx Equities; Jon Peiper, Mitsui Banking Corp.; Mary Ludgin, Heitman; David Hatcher (moderator), Real Estate Capital News.

A panel discussion at the PERE NY Summit 2014 this month examined the lessons learned from the recent global financial crisis, and how to prepare for the next.

“There will be a market correction at some point, likely triggered by a recession,” said Mary Ludgin, managing director & director of global investment research at Heitman. “We are 64 months into the recovery. The time between recessions since World War II is 66 months on average, and we are clocking in on that. We should see a longer time frame than that because the past recession was as deep as it was.”

When it comes to ever popular baseball analogy, Ludgin estimated that we are in the seventh inning, perhaps taking a stretch.

“Though we might be getting extra innings, we should still be organizing our portfolios with the idea that recessions are inevitable,” Ludgin added.

Continuing with the sports analogy, Scott Stuckman, managing director at USAA Real Estate Co., took things a bit deeper. He said that you could view the industry like a baseball league, with different innings in different ballparks—e.g. different markets, and different product types—making the industry hard to read.

“So much of the value we have gained is driven by capital, not exuberance by tenants taking more space,” Stuckman said, adding that he is seeing a confluence of multiple foreign buyers from all regions of the world flocking into the U.S. in unison for the first time in his career.

“So instead of baseball, perhaps I should say it’s more like cricket,” Stuckman said. “Nobody really understands what is happening, and you don’t really know when it is going to end.”

Jonathan Schultz, co-founder and managing principal of Onyx Equities, believes we are earlier in the recovery. He cites frothy debt markets that are as hard charging as he has ever seen. That said, he did acknowledge that lackluster job growth should raise some concern.

“As a real estate investor, job growth is one of the number one things we look at in the markets where we purchase,” Schultz said. “I don’t see much job growth except for very specific places and very specific sectors. Healthcare and tech seem to be the two main growth industries at this point.”

Schultz is also keeping a close watch on loan maturities, with roughly $400 billion in CMBS coming due in 2015, 2016 and 2017. This batch is roughly twice the size of the previous set of loan maturities, meaning there are roughly twice as many loans with DSCRs close to or at 1.0 compared to the 2008 to 2011 maturities. Therein lays the issue.

“These building are not necessarily bad buildings,” Schultz continued. “Some are over 80 percent occupied. As far as paying attention to where the next opportunities are, it is going to be about where these loans are coming due and or maturing, and they tend to be the suburban markets more than the cities.”

Stuckman said that his firm shies away from CMBS.

“As a general view, we skip the CMBS. It is the cheapest drug, but there is no way out,” he said, adding that USAA Real Estate Co. never used CMBS debt and never experienced a single foreclosure, workout or lost property during the recession.

Instead, Stuckman said that his firm is keeping an eye on “necessity real estate” in urban infill locations. This would be assets like grocery stores and fitness clubs, not the type of retail that could be hit by ecommerce.

One key to coming out on top of the next downturn is to have the resources set aside to make a move.

“One of the lessons learned from past cycles is that you have to start buying early, even while the knife is still falling,” Ludgin said. “Have capital ready to buy assets poised for recovery. Recessions shake loose assets you won’t be able to buy at other points in the cycle: they are when you’ll have a chance to get a piece of Class A regional mall, for instance.”