RCLCO: Real Estate Cycle Planning as Important as Ever
The current economic expansion became the longest in U.S. history as GDP grew for the 121st consecutive month. That makes this a good time to plan for a downturn, said RCLCO, Washington, D.C.
RCLCO Managing Director Charles Hewlett said the firm’s latest sentiment survey found decreasing pessimism among real estate market participants as improving stock market conditions and “resilient” underlying real estate fundamentals have given reason for moderate optimism. “But that does not mean that we should defer planning for the next downturn,” he noted.
Though real estate currently benefits from an expanding economy and operating fundamentals remain strong, growth rates have tempered, RCLCO’s Real Estate Cycle Planning for Your Company Is as Important as Ever report said. “[This], combined with capital market risks, indicates that real estate may be nearing the end of the ‘late stable’ stage of the market cycle and heading into an ‘early downturn’ phase,” Hewlett said. He called this consistent with the opinions of Sentiment Survey respondents.
“After flirting with inversion during the early part of the year, the yield curve has maintained an inverted form over recent weeks, hinting that there is risk of recession within the near- to medium-term,” Hewlett said. “When it occurs, real estate will experience some pain, even if not to the same degree as during the last downturn. Absorption may no longer keep up with deliveries of new multifamily and industrial buildings and office and retail assets may struggle to maintain occupancy in the face of changing demand characteristics.”
At the moment, there is more capital in the system than there are good real estate opportunities that meet return expectations. And Hewlett said asset-level capital stacks were constructed more conservatively during the cycle’s upturn phase, so RCLCO does not expect to see too much stress in the system when the downturn comes.
Though the firm does not expect to see a repeat of the dislocation seen during the Great Recession, “there will still be opportunities in the next downturn,” Hewlett said.
RCLCO recommended market participants keep some “dry powder” available for opportunistic buys during a downturn. And the report said investors should pay equal attention in the expansion’s late stages to “eyes wide open” underwriting and to creating income and value through operations. “Real estate investors should underwrite with realistic assumptions about future income and expense escalations, and test for downside protection to make sure they are comfortable with the results,” Hewlett said.
