Current Economy's Impact on Commercial Real Estate | Investors Round Table

In this episode of the Investors Round Table, we delve into the pressing economic conditions shaping the commercial real estate landscape. Logan, Matt, and I will break down how interest rates, inflation, and broader economic trends are influencing investment strategies, capital deployment, and deal structuring.

Whether you're a seasoned residential investor considering the move to commercial properties or a real estate professional guiding clients through this transition, you'll gain valuable knowledge and practical advice. We'll cover crucial topics such as adapting your mindset, building the right network, and mastering the nuances of commercial deal analysis and execution. By the end of our discussion, you'll be equipped with the tools and understanding necessary to confidently take your first steps into the world of commercial real estate investing or to guide others through this transformative process.

Get commercial real estate coaching, courses, and community to jumpstart your investment journey over at CRE Central: www.crecentral.com

Key Takeaways:

• Be conservative in your underwriting and investment strategies:

  - Bring more cash to the table with higher down payments and cash reserves. - Don't be overly aggressive with rental increases. - Focus on assets that can provide solid, risk-adjusted returns.

• Explore creative financing options:

  - Utilize seller financing and lease options to structure deals. - Negotiate contract periods to lock in prices and wait for better financing. - Consider partnerships and strategic alliances to balance risk.

• Monitor macro trends and be adaptable:

  - Stay aware of demographic shifts, labor market changes, and technological advancements. - Understand how these factors could impact future vacancy, occupancy, and productivity. - Remain flexible in your approach and be willing to adjust your investment strategy as conditions evolve.

• Prioritize liquidity and operational efficiency:

  - Ensure you have sufficient liquidity to weather potential economic storms. - Focus on tightening up your operations and management to maximize performance.

About Your Host:

Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.

Episode Transcript:

0:00

Are you looking to take the next step toward investing in commercial real estate? But don't know where to go? Series central offers a comprehensive education and coaching platform designed to help you get started. Our online courses cover a wide range of topics, from the fundamentals to advanced strategies, ensuring you have the knowledge and skills needed to thrive in this competitive industry. As a member, you'll gain access to our exclusive online community and monthly group coaching calls, providing you with valuable networking opportunities and personalized guidance from experienced professionals, whether you're a beginner or looking to take your career to the next level. Cre Central has the resources you need. Visit www.crecentral.com to learn more. Welcome back to the commercial real estate investor Podcast. Today, we are back with another bro investors roundtable. Live today we're gonna be diving into the current economic climate. What is going on in the world? We just had a Fed rate drop last week of 50 basis points. Question of the day, where do you see opportunity in today's economic climate? We want to know drop in the live chat let us know what's going on the world. Logan, Matt, what's going on, guys? I'm going to kick it over to Logan first on interest rates and inflation. You know, with rising interest rates like financing deals, is entirely different than was a couple of years ago. So Logan, how have you adjusted your investment strategy, and honestly, just how you're looking at deals and getting into deals with the rate hikes and now rate drops? Yeah.

Logan 1:39

Well, first off, I want to make a point. I'm not going to get too in depth on this, because I could spend 30 minutes talking about this. But just because interest rates have dropped, do not mean that cap rates are going to change tomorrow. Okay, let's take an example, the single net tenant Net Lease market right now has 12 months of inventory on the market for an average of 6% cap rate, just because the Fed cut rates. Do you think that deals are going to start selling at a 5% cap rate? Those are already priced at a 6% cap rate. So why? Why would they move down? Okay, so there's typically a nine to 12 month lag between interest rate movements and cap rate adjustments, and there's a whole lot of data from Dr Peter Linneman and Dr Matt lariva, who actually have done statistical regression analysis on this data, and the correlation is to capital flows, not from interest rates. Okay, sure, capital flows and interest rates are correlated as well, but a great example is until capital flows in and buys that six per all that 12 month of inventory, 6% cap rate deals, it doesn't matter what the interest rates are going to be doing. Now, the interest rates may drive them to make more movements now, sure, but the whole market's not going to reprice. Okay? So that's, that's number one, the the second point being, I think that many folks that were doing deals in the past 12 to 24 months got Okay, taking lower leverage and just changed their financing structure. You know, in regards to doing real estate, I think a lot of people also change their modality, meaning, I've had number of clients over the past 12 to 15 days say, Hey, I'm not really interested in doing value add. At this point, I'm looking for something more stabilized. That's interesting to me. I've also had a capital markets expert on my LinkedIn live last week talking about how floating rate debt could be more attractive now. Think about it. Floating rate debt now could be more attractive as rates are going down for a lot of people, which could create this really interesting opportunity for people to go get variable rate debt without CAP. CAP rate. No, you have to buy those cap rates, maxes or whatever, or minimums. And that could open up a lot of financing structures for for these deals. But at the end of the day, most of the transactions that we are working on take the community and regional banks to be willing to lend. And here's the crazy part about that, guys, is I do deals with banks that literally have three or four people on an investment committee. It doesn't matter if, if all markers turn to everything looks great in commercial real estate. If one guy had a bad fishing trip over the weekend and he didn't catch his, you know, 12 pound bass, he's not approving that deal. So there's a lot of different components, I think, right now into looking at deals, but I just want to make that point that there's a major lag between interest rate. Rate movements and cap rate adjustments, as well as cap rates and interest rates aren't always as correlated as as we think they are before we before we talked about anything else.

Tyler Cauble 5:11

Yeah, I would agree with that. I mean, I think one if you're going to take anything away from the last 24 months, it's that being more conservative in your deals is not a bad thing, sure. Maybe you're not going to absolutely juice every ounce of IRR or cash on cash or whatever return on investment metric you want to use from every single deal that you do. But there's something to be said about risk adjusted returns. You come in with 50% leverage. You've only got 50% debt. Maybe that makes your cash on cash returns drop by 20% but at the end of the day, isn't it kind of worth it to have the financial stability that you get out of only having 50% leverage? Because guess what, that bank is not going to look at your loan as a remote top priority of something that they should be working on in case anything goes wrong with with our economic environment. Matt, I mean, talking about, you know, financing options and dealing with lenders. I mean, I know you deal with a lot of buyers on the legal side of things. I mean, you've got to be seeing some creative financing coming through and across your desk. How are, how are investors structuring some of these deals to continue getting them done? Because one thing that we've noticed, trading hasn't really slowed down a lot. Yes, you could look at some of the bigger, you know, maybe institutional stuff, or maybe a lot of your single tenant Net Lease deals aren't transacting. But from a local perspective, like here at the Kabul group, we've done significantly more this year already than we did last year.

Speaker 1 6:47

Yeah, I think it's very area specific, too. There's a lot of interesting conversations happening with banks, and I think they're very different conversations than what were happening a few years ago. There's a lot of conversations about debt covenants and debt service coverage ratio is not being met. And you know, banks are actually looking, I've got a couple banks that we work with where just a couple of years ago, a few years ago, they were giving out construction loans, development loans, commercial loans, and basically just maybe driving by the property and then giving the thumbs up and lending the money. And now they're, they're really, okay, we want you to update your financials. We want you to update your, you know, financial statements in rent rolls and everything. And they're really scrutinizing these properties. All of a sudden, it seems like there's a, there's a need for liquidity for a lot of these, these banks, and that's really changing the conversations quite a bit, and it's not really clear. You know, what the lending options are going to be in six months from now too. You know, we may have better interest rates. And I agree with Logan, too. I don't think that the interest rates changes necessarily means any impact on cap rates at all. I'm not convinced that just because the interest rates drop, that we're going to see prices improve. I just don't think that's necessarily connected. So there's a lot of unknowns. There's been some more as far as creative structuring goes, I've always been a big fan of seller financing. I've seen a lot more conversation around seller financing lately, because you just don't have to be as concerned about the banks if you're doing the seller financing. I've seen interesting strategies with lease options lately, where more people seem to be using lease options because it allows an opportunity to sort of hand off control while maybe providing an option to buy when interest rates are better. So I'm actually working with a tenant right now who's interested in buying my building that she occupies office space with a lease option. And I don't think that was a conversation we would have had a couple years ago. There's also an interesting dynamic going on right now with with people, you know, the bonus depreciation cost segregations have been, you know, really popular last few years, but there's some interesting conversations going on when people need liquidity, where they're sort of trapped in these deals, where, if they sell them and They have to recapture their bonus depreciation. It's a very ugly looking outcome right on the cell, so I've seen that forcing some seller financing conversations right there. Because you know when they you know if they were to sell and recapture and pay taxes, maybe they would have to pay $300,000 in taxes on a $500,000 gain, right? Whereas, if they do a seller finance, they might can push some of those taxes off and and do a seller note. So there's all kinds of interesting things happening right now. Yeah,

Tyler Cauble 9:51

I like seller financing from from both sides of it. I've got a deal that I sell or finance myself here this past year, and it's great. I'm getting, like. 2200 2400 bucks a month on a deal that I owe nothing on and I don't have to do anything with. And it's kind of tough to argue against that, right? I mean, does it get taxed differently? Sure. But also, again, risk adjusted, I don't have liability for anything. I don't have to worry. I mean, I kind of got to worry about the taxes getting paid, because that's, you know, in their loan covenant, so they have to pay the tax. To pay the taxes, but I don't have to pay the taxes. I don't have to pay the utilities. I don't have to worry about if a tenant is taking, you know, occupancy or not. It doesn't matter to me. So I really do love the seller financing strategy. You know, one thing that I was having is you guys were both talking is, you know, next time and the next economic cycle. It's always interesting living through these types of moments, because now we get to look back 2020, I mean, the amount of money that was printed by the government to keep the country running. That's obviously what sparked so much inflation. And hard assets like commercial real estate, even gold, right, perform incredibly well in high inflationary environments. So just keep an eye on what might cause inflation to continue to rise, because hard assets are going to be great investments to have during all of that. Now let's talk about getting into recessions as we're talking about hard assets. Because I know, you know if, if recessions are coming, people are scared to have any types of assets. So Logan, I mean, are you? Are you starting to hear from investors, like any, any hesitation, or just talk of a recessionary environment? I'm starting to hear rumors of it. But to be fair, we've been hearing that for 24 months. Yeah.

Logan 11:43

And I think many people say, well, the Fed cut 50 basis points because they know something that other people don't. And I don't think that's true. If you look at where we're at from a federal funds rate perspective, we are now at 4.75 to 5% okay, well, if you look at where they believe inflation is, somewhere closer to that two and a half to 3% rate, we're still highly restrictive in regards to the amount of the federal funds rate, where we're at. So I heard an economist speak the other day. It said, you know, something along the lines of, if somebody robbed your store and you knew it was between 8pm and 8am right? How are you gonna and you've got it on video. You've got your whole store on video. What's the best way to find out when you were robbed? Well, you would go to the middle. So you'd go to, you know, 4am right? And you'd see if you'd been robbed, if you had then you'll go 4am backwards. If you hadn't, you go 4am forwards. Same thing right after that, and you start in the middle. Well, one thing that people keep talking about is, what is the neutral federal funds rate? Well, I think that their thought is that somewhere between 2.9 and 3% so you know, we have some ways to go, and we're not being extremely restrictive. We have to remember, we went through the highest and fastest rate hikes in history. It's going to take time for us to get down. And they're not going to come out and say, Hey, I'm cutting, you know, we're going to cut rates 150 or 200 basis points. Now maybe they should, maybe they, maybe they should right. Because if they're trying to find that neutral rate a little bit faster, however, they need to have, you know, quivers in their in their tool belt, or their quivers in there, so they can shoot those arrows right. They can continue to reduce that now jobs report, look the the difference between when unemployment is rising because there are no jobs versus when the labor supply actually increases, are two different things, and that has to be really thought through. And what we're seeing right now is the labor participation rate just continuing to rise, not necessarily jobs not being out there. Okay, so that's that's a big component in regards to that. Now let's set the stage. Right? We we were, you know, from a Green Street property price index for commercial real estate, right? We were at 135 pre covid. We plummeted during the beginning phase of covid in response to the Fed cutting, you know, they kept their interest rates to negative, basically. And we peaked at 155 in May of 2022 we then troughed back at 121 in January of 2024, so this year, and did

Tyler Cauble 14:34

we lose Logan? So right now, I

Logan 14:35

think we lost, you know, look, we are in a component. We're in a period of time. Sorry, where'd you guys lose me at

Tyler Cauble 14:43

it was like, just keep going, yeah.

Logan 14:47

Well, we're in a we're in a time period now where interest rates are being signaled that we're going to be decreasing, and property prices are at at a level pre covid. We're at 125 which creates. Creates an opportunity. Yes, financing is still a little murky, but if you can figure out with a creative financing structure or some other type of financing structure, you can get a good basis right now and continue to rise this thing, ride this thing out. One strategy I have heard that people have been doing, and not everybody can do this, but let's say there's a commercial deal you want to go buy, and you've got the cash and you've got the rack track record to get it done. Well, I've heard family offices going in and negotiating six to eight month contract periods because they're going to buy it all cash, or they're going to say they're buying it all cash. They show that they've got the cash, they've locked up the price today and they're waiting for interest rates to drop so they can put a loan in it, you know, on it in six to nine months. That's a really interesting strategy that I think a lot of people should be thinking about right now. Not everybody can do that. I understand, but maybe you can just negotiate seller financing for a year right now and and get somebody to do that in 12 months, you go out and get new financing. So yes, the recession talks are there. However, I do not see a ton of markers right now from where I'm tracking. Richard Duncan, dr, Ed yardini, all these different economists. I do not see a massive recession coming. And I actually think that with where the federal funds rate is going at least in the commercial real estate market. Our rolling recession is going to be done here soon. Bob knackle, Kyle Matthews, couple of the biggest real estate guys in the country, saying transaction volumes are going to be the highest level that they've ever seen in 2025 and maybe into 2026 it all tracks very closely to the 18.6 year real estate cycle, and it's always that right now, I think it's a very good time to be operating in this space. Now, there will be a time where, where something breaks, because you talked about the liquidity that was injected into the markets that's still floating out there. I'm seeing, you know, major trillions of dollars, you know, being reported that are still on the sidelines. Well, what happens when more competition goes after asset prices or assets prices go up? Right? It's the same thing with banks and financing, though, when they start to say, hey, we've got our new quota for the year, we need to outlay this amount of capital, and we're going to start chasing deals, and that's going to make financing a little more robust for investors as

Tyler Cauble 17:25

well. That's right, definitely a good time to be holding real estate. You definitely want to be buying real estate before interest rates start to drop, because as interest rates drop, prices are going to go up, because you're going to have, you're going to have more capital going after these assets, which is naturally going to drive up demand, and therefore pricing. The Marine from Texas is dropping into the live chat saying, Hello, what's going on, marine? Good to see you. If you're joining us live. We got a fair amount of y'all on YouTube and Twitter right now. Question of the day, where do you see opportunity in today's economic climate? We want to hear from you. Let's have a discussion around that. Drop that in the live chat. You know, Matt, I mean the looming threat of a recession. It really does affect investor confidence, capital deployment. But you know, the thing that I've always found interesting, just like Logan just said, there's still trillions of dollars on the sidelines that people want to put into play. They'd rather be getting a 345, percent return than zero. And you know, it depends on the market too, right? I mean, Nashville, even in 2008 worst economic recession we have seen in 100 years, Nashville's real estate market still increased by 1% right at the height, at the height of this. So, Matt, I mean, how does, how does economic uncertainty like what we've been dealing with for the past couple of years, and what may still be ahead of us. How does that affect or change your approach to structuring your deals, or even, like, what types of assets you like to buy?

Speaker 1 18:52

Yeah, and and, real quick, my point of view, I think he mentioned rolling recession. I think we've got the 2008 recession that you know, is recent memory and a pretty scary event. It doesn't have to look that way, right? I mean, we could see we just had an $800,000 job revision down, and we've already, over the last couple of years. I mean, there's been more than 20% reduction in prices and a lot of asset classes. You know, the commercial office space in certain areas is hovering around 20% vacancy like basically historical peaks has been. And so I don't you know, there's not necessarily a causation. You know, if we have jobs losses and if we see a stock market correction, for example, that doesn't mean that commercial real estate has to plummet with it, right? I think there's a reasonable chance that we may have already weathered some of the real estate recession. And commercial real estate and in a lot of recessions, there are some some assets that are going up while others are going down. There are some assets that are coming out of a. Recessionary period, while others are going into it. And so I think that's possible here. I think you do got to be cautious. And from my perspective, I'm not really changing my personal approach, probably because it's been fairly conservative. I like to buy things, and especially now, want to buy things that are below replacement costs, that are affordable rents. I'm really not. I would not be wanting to mess around with Class A or luxury apartments right now, or, you know, luxury retail, those sorts of things. I wouldn't be wanting to get into deals where my financing was speculative in a year or two down the road, unless it was just a solid, really solid asset, and I had a cash alternative, basically, just more conservative approaches to things, a very solid deal with, with very limited downside, is what I'm looking for. And then if I can find a solid asset with solid financing, especially so seller financing, for me, that's the way to go. And I'm staying out of, you know, I'm staying out of luxury, staying out of class A staying away from downtowns only in areas where there's expected increase in demand, that's another big thing right now, you know, I'm staying away from places like Austin and in, you know, these areas where there's a lot of supply, it's not really clear that there's going to be increased demand, supply ratio. I'd rather be somewhere like Tennessee, right outside of downtown Nashville.

Tyler Cauble 21:31

Yeah, and, I mean, here's the thing, get creative with how you're structuring these deals, right? I mean, we talked about this a little bit earlier. We just went under contract last week on 105 self storage units with a couple of smaller flex buildings. And it's, it's a good deal, right? But here's the thing, my partner owns a moving company, and so he has a captive audience of people that will be needing self storage in perpetuity. So we're able to go out there. He's selling it in a different in a different way, right? So it's no longer on market self storage facilities. It's a totally it's a captive audience, so we're able to increase the cap rate on that property significantly. So think through that, like, who are the strategic partners that you could jump into these deals with? That totally changed the game, because now we're able to go for owner occupied financing terms entirely different type of deal, right? It makes our lives significantly easier. It allows us to kind of balance the risk in a deal like that, right? Speaking of risk, the labor market and supply chain issues, you know, I know that supply chain has gotten better the labor market. Maybe I don't really, I think, I guess it depends on what sector of the labor market you're in. To me, it just seems like that keeps getting worse. You know, we saw a report this past week that the US is slowing down significantly in terms of births, which means that, you know, hey, 3040, 50 years from now, we're probably going to have some problems. I mean, Logan, you know, construction is an issue with that. I mean future vacancy, occupancy, all of these issues could come up in 3040, 50 years. Is that on your radar? Is that something you're thinking about today?

Logan 23:18

Yeah, I mean, demographic shifts and trends are absolutely on the radar. I saw that Marcus and Millichap put out a great little video specifically on this, and cooled some of my fears around this. Saying, yes, our birth, you know, you the average rate of getting married used to be at 25 now it's 29 average. You know, kids per family definitely going down, however, the Gen Z population, so I forget the exact ages, right? But is a large population, and they will be entering into some of their largest wealth building and income, teen to 20 years, right? Because, let's say somebody's 35 or 40 right now, 45 to 54 is the top earning age for most, for the for the demographics, and so if we have a large population getting ready to be top earners, I think that's going to fuel the economy and the demographic trends for quite some time past that, absolutely, I have some some concerns in regards to that, and I think that China has the same exact concerns. And how that

figure out is, how does AI actually replace a lot of that productivity, right? I mean, we are at the very, very early stages. It frankly scares me when I hear some AI folks talking about it, because what the capabilities could be in the future, whole nother rabbit hole right there. However, if you can, like I saw Chipotle, they now have the, you know, the avocado per you know, robot that is making the guacamole. They have the person, you know, doing the tortilla chips. They can fry a batch of tortilla chips in, you know, in like, 37 seconds, or something at Chipotle, right? So those things you wonder, how, what, what impact or offset from a productivity standpoint, that may have and AI could fill in a big gap in regards to some of that productivity, but definitely on my mind, but probably later in the years, where I might not be so worried about it as I am right now.

Tyler Cauble 25:29

That's right. Robert mindanas jumping in. Robert's actually in my Siri accelerator mastermind, Robert, what's going on? Man, he's saying in our area, we have seen a 50% reduction in the industrial construction starts here in the Inland Empire. I mean, honestly, in my opinion, that sounds like a great opportunity, right? Because if you see a significant drop of construction in any given area, that means you're about to have higher demand and under supply. Again, it just always, almost always happens, as long as you're in a strong area which the Inland Empire is. So at some point, existing flex space, existing distribution centers, existing industrial real estate, is going to start going up in price because you can't deliver enough new construction to satisfy the demand that's in that market. So I think that's really interesting. AM, is saying Always a pleasure listening to the guys? Yeah, we love being here. It's always fun. Appreciate it. Am, thank you so much, Matt. I mean, what ways do you see investors managing their operational risks when it comes to supply chain disruptions, demographic upsets, potentially? I mean, I know that's probably just, hey, don't invest in certain cities. But what tactics do you see people deploying to manage these types of risks?

Speaker 1 26:41

You know, it's pretty basic and simple, but the biggest conversation I'm hearing is about liquidity. You know, do we have enough liquidity? Because at the end of the day, you can weather almost any storm or manage any risk if you have cash, right? And so that's one of the things that the conversations I've been hearing more of is, is more conservative conversations around that, right? Because I think everybody was really kind of stretching and leveraging a little bit more, and now the conversation is more about, are we liquid enough? How strong is our portfolio, right? Is this, is this asset really cash flowing enough to justify the equity that's sitting there, I would say that's probably the most important thing. And then it's also a good time to pay attention to how good are your operations, right? Because that's another story I'm hearing. Hearing a lot about when the market was going crazy. It almost didn't seem, you know, like in the Smoky Mountains, for example, there's some operators who are still killing it because they just really are locked and loaded and they understand their business. And there are others that are really struggling. And so for me, those are the two areas of focus for my myself and the people I'm talking to, liquidity and just getting your your operations nailed down.

Tyler Cauble 28:00

Yep, that makes sense. I mean, for the audience, for those of y'all that are listening, I think your action items coming out of this conversation to just better account for these challenges moving forward, just be more conservative in your underwriting. Bring more cash to the table in terms of a higher down payment. Bring more cash to the table in terms of your cash reserves. Don't get so aggressive with your annual rental increases. And look, I mean, if a deal comes in at better than an 8% cash on cash return, probably worth buying today, because we all know with inflation, it's going to continue to go up, and it might not be gangbusters now, but you start to see the inflationary effects on it. As long as you're conservative, you're not gonna have to worry about too much moving forward. Logan, Matt, appreciate you guys joining me. If you are listening or even watching live, don't forget to like and subscribe. Leave us some comments. We want to know. What do you guys like about the investors round table? What would you like for us to have a discussion around leave those in the reviews, and we'll see y'all in a couple weeks. Are you looking to take the next step toward investing in commercial real estate, but don't know where to go. Series central offers a comprehensive education and coaching platform designed to help you get started. Our online courses cover a wide range of topics, from the fundamentals to advanced strategies, ensuring you have the knowledge and skills needed to thrive in this competitive industry. As a member, you'll gain access to our exclusive online community and monthly group coaching calls, providing you with valuable networking opportunities and personalized guidance from experienced professionals, whether you're a beginner or looking to take your career to the next level, cre Central has the resources you need. Visit www.crecentral.com to learn more you.