What do real estate companies and executives need to do to prepare for 2023 and the expected economic slowdown?November 28, 2022 – Client Alert
A few of Greenberg Glusker Real Estate Partners answer a key outlook question: What do real estate developers, investors, lenders, owners, and operators need to do to prepare for 2023 and the expected economic slowdown?
“Things are all over the map in the current real estate investment environment. In general, I am seeing more activity in both the retail and office sectors over the past months, particularly the retail section.
Buyers with very low costs of capital are actively looking for deals because they are less impacted by the current high-interest rate market. They are being more conservative in their underwriting, but they are still very active. Buyers that are more reliant on conventional loans are slowing down and waiting for seller and buyer expectations to come into more equilibrium. One exception to that is a 1031 exchange seller with significant gain, in which case the pain from paying higher interest rates may be more palatable than the pain from paying significant tax. In those situations, I am seeing buyers look for shorter-term loans, preferably with no prepayment penalty, so they can refinance their higher-rate loans more quickly when rates start to drop.
Seller perspectives are also varied. Some are selling even if they believe that they’ve missed the top of the market because they prefer to get out now before prices drop even further. This is particularly true for those who are under financial pressure, such as an impending loan maturity or need to inject significant capital. However, many owners with positive cash flow and no sales pressure are hanging tight.”
Ken Fields, Partner, Greenberg Glusker
RETAIL LEASING CHALLENGES
“All retail parties need to be more realistic at the beginning of a deal in today’s world. That should include more discussion and thought around timing, including permits and materials and the cost of materials. Do contingencies need to be broader and/or expressly include more expansive force majeure language? How do you best prevent deals from falling apart during lease negotiation or after?
Timing and costs are two of the main issues in retail to keep a close eye on now and into 2023. From the beginning of deal negotiation to execution, costs to build are, in some cases, increasing dramatically, often giving rise to re-negotiations or even terminations. Additionally, the timeframe for getting construction, and even, use permits has, in some cases, doubled or even tripled. Pre-COVID, these issues, typically, weren’t being talked about, but now landlords and tenants need to be more attentive to these issues, in order to “get deals done.”
During the post-Covid era, I have seen increased friction between tenants, looking for the broadest use and exclusive clauses possible and landlords wanting to narrowly define one or both in order to not jeopardize future leasing activities. You want to grant tenants broad enough rights so they can be successful, while at the same time, avoid future vacancies due to the inability to grant a specific use especially given the fast-paced, mercurial retail market. Finding the right tenant mix is critical to the success of a center (including all of its tenants). Furthermore, declarations recorded against the center and existing leases with restricted use provisions (i.e. “no entertainment or amusement centers”) are, in some cases, outdated and severely “tie the hands of the landlord.” Does enforcing these provisions really help an adjoining owner or a tenant at the center or do they ultimately cause unnecessary vacancies that hurt all parties concerned?”
Barry Edwards, Partner, Greenberg Glusker
LANDLORD LITIGATION & DISPUTE RESOLUTION
“Tenant awareness is always important for commercial property owners, but especially during challenging economic cycles. Staying in touch and working with tenants when the economy turns down is best done before the amounts owed are so high that there is an incentive for the tenant to do something drastic. Bring your real estate counsel into the discussion early so that you can know what legal options are available to ensure that the path you choose is the one that makes the most sense for your property and business.”
Gregg Martin, Partner, Greenberg Glusker
CRE DISTRESS & RESTRUCTURING
“The real estate market, like all else in the economy, is cyclical. Real estate prices have had a good run for almost 10 years. Over the course of the last 2-3 years, much of the increase in prices, and corresponding reduction in cap rates, has been a function of both monetary and fiscal policy stimulus. That however has come to a conclusion. The increase in interest rates and the cessation of quantitative easing by the Federal Reserve has put the brakes on. Inevitably this affects the cost of refinance and the price buyers will pay for real estate. Added to this is the long-term effect of tenants’ repositioning themselves with smaller footprints due to modified post-Covid work-at home polices. In the long run as leases renew for smaller space, this will add to cash flow pressures. For owners who are appropriately leveraged, they will be able to weather the storm, but for those who have a high debt to equity ratio, they will need to either refinance at higher cost, take a lower sale price, or be ready to do a workout with their lender.”
Brian Davidoff, Partner, Greenberg Glusker