Challenging Market Conditions Require Commercial Real Estate Owners to Find Creative Solutions
October 10, 2023
Tighter credit, lower asset valuations and changes in consumer demand will force property owners to reimagine how real estate assets are currently used and to deploy new tools to ensure real estate assets are being used for the highest and best use in a rapidly changing environment.
If real estate assets are showing signs of vulnerability like protracted vacancies, maturing debt with challenging refinancing terms on the horizon, or depressed valuations, early action may help provide breathing room in a more challenging real estate operating environment. Here is a snapshot of some things real estate owners should be thinking about to help navigate difficult times.
Pursue Zoning Changes
If existing zoning has become outdated and prevents repurposing real estate for new uses sought by the local market, owners should consider collaborating with local officials to discuss new zoning options for underperforming real estate. Such an exercise could include proposals to amend existing zoning ordinances to add new uses not previously permitted in certain areas. While a zoning ordinance amendment is a complex and uncertain process, a collaborative approach between property owners and local officials can produce mutually beneficial outcomes.
Increasing Working Capital Behind Real Estate Assets
As substantial amounts of commercial real estate debt mature in the coming years, the economy will look much different than it did when deals were initially underwritten. Credit will be harder to obtain, and lenders will likely require commercial real estate owners to show more comprehensive credit applications. Owners may need to address deferred maintenance and offer more high-end amenities to increase cash flow, all of which require capital. If real estate assets were already operating on thin margins, and debt is harder to obtain, it will be difficult to deliver these improvements. Partnerships and joint ventures may prove to be an advantageous option in these circumstances.
A joint venture is generally a new relationship between two entities. These relationships can help real estate owners who need capital to improve real estate and improve real estate performance. A joint venture can take many forms like creating new entities that are jointly owned among the joint venture partners with the partners bringing in additional working capital as contributions to join the partnership.
Alternatively, real estate owners who operate real estate through single purpose entities (SPEs) can consider selling interest in their SPE to raise capital for necessary improvements to meet market demand. Such a scenario may have an owner of an SPE in the form of a limited liability company (LLC) sell a portion of the LLC membership interest to investors to raise capital, which can then be used for real estate improvements to increase cash flow.
Be Proactive to Optimize Real Estate Sales
When a real estate asset is underperforming to such a significant degree that the strategies previously mentioned are not viable, then it may be inevitable that the real estate will change ownership, either by choice or by more severe circumstances like foreclosure. If a real estate owner is facing such circumstances, they must be proactive. Getting ahead of foreclosure will yield the best outcome for real estate owners. Owners in this situation must also consider the primary objective. Is future occupancy for a business the priority, or is satisfying outstanding debt obligations more important?
Maximizing Sale of Real Estate
If the primary goal is satisfying outstanding debt obligations, then taking steps to ensure a solid real estate sale contract is in place will help increase the likelihood of closing the sale and liquidating any remaining equity in the property. A comprehensive sale contract can also ensure the owner is compensated for the time that a property is off the market as due diligence is conducted and entitlements are pursued by potential buyers.
Sale-Lease Back Transaction
If real estate owners are more concerned with being able to continue occupying the real estate, owners should consider sale-leaseback transactions. A sale-lease back transaction lets the current owner liquidate equity through a sale of the property while continuing to occupy the property by making regular future lease payments to the new owner.
This is a very brief review of some of the tools and strategies that may help commercial real estate owners as the economy recalibrates and owners reimagine the highest and best use for different classes of real estate assets. Each approach will apply differently and may have dramatically different outcomes based on the circumstances of each transaction, but the key takeaway is that owners have options and should be proactive.
Please feel free to contact any member of the McNees Wallace & Nurick Real Estate Group for assistance with any real estate issue or if you have questions regarding this post.