How are real estate companies adapting to this situation?
They are trying to survive. On the residential side, foreclosures are at an all-time high and credit is tight. Would you go into a business where you build a new house on speculation and hope to find a buyer for it, then hope that buyer can find financing to purchase the house? People became much more conservative because their incomes have been cut and their job situation has become more uncertain. Thus, the universe of prospective buyers out there has shrunk significantly.
It’s not much better for commercial developers. Retail has become so fragile that anchor tenants of a shopping center could file bankruptcy and go out of business at a moment’s notice. So where does that leave the developer who was counting on that rent to pay his debt service?
That’s another hazard that the real estate industry faces, particularly on the commercial end.
Apart from the real estate industry having its own challenges, who pays the rent and what impact does the economy have on those who are paying the rent? It’s a ripple effect. If you look at the larger developers of retail properties, the name of the game is to pay down debt and hoard your cash.
What must be done to survive?
Taking steps to try to preserve revenue to the greatest extent possible, while enhancing revenue wherever possible. Also, manage operations more efficiently. That means cutting expenses, because profit margins are down. Many developers don’t have a positive profit margin anymore. The endgame is making sure you have enough revenue to survive.
For the small developer, it could mean selling lots for no profit; it could mean selling lots at a loss just to get out from underlying debt service.
For commercial developers, it could mean putting tenants into space at less than market rates. The irony there is no one knows what market rates are anymore because the economy is in such a fluid state right now. You have to ask yourself: Am I better off with 100,000 square feet of empty space, or am I better off with 100,000 square feet of space leased at half of what I think market price is?
What lessons can other industries learn from the challenges the real estate industry faces?
Borrow prudently. Don’t overleverage. Make sure you have money for a rainy day — a rainy day could last a long time. Many problems the real estate industry faces now are a result of overleveraging. When that overleveraging is coupled with depreciation in underlying value, that’s not a good combination.
Robert A. Ranallo, CPA/ABV, JD, CVA, CFF, is a partner with Skoda Minotti. Reach him at [email protected] or (440) 449-6800.