The illiquid nature of commercial real estate makes it inherently less volatile than stocks, bonds and other equities that are more subject to ebbs and flows in the market. That said, no investment is foolproof – commercial real estate included. This is particularly true for long-term real estate investors. Anyone who invests long enough will experience the peaks and valleys associated with the natural maturation of any real estate cycle. They might also experience unexpected downturns, such as those recently brought on by the COVID-19 pandemic.
Whether you are a seasoned investor or someone investing for the first time, it is important to be prepared for inevitable market downturns. At Smartland, we are acutely focused on recession-proofing our real estate portfolio as a way of protecting investors’ capital. Here are several strategies we deploy to do just that.
Identify Efficiencies that Minimize Unit Downtime
In the early days of Smartland, we invested almost exclusively in scattered site single-family residential homes. We purchased single-family homes in different neighborhoods and markets, and then renovated these properties before leasing and holding for the cash flow or selling to investors or homeowners. We did this thousands of times and through that process we learned just how inefficient scattered-site residential can be. We identified the top ten inefficiencies, which then led us to multifamily where we could invest in units at scale.
Before investing in private equity real estate, it is important to understand the risks as well as the rewards.
By investing in multifamily, we applied what we had learned investing in thousands of single family homes, identifying execution efficiencies related to renovation. We could buy materials at scale – paint, flooring, fixtures, and negotiate discounted bulk purchases with large distributors like Home Depot. That way, when units turn over, we can move quickly. We do not need to worry about matching paint colors since we use the same paint color in all units. These types of efficiencies allow us to make units “rent ready” faster and with less downtime and less downtime means more cash flow, and more cash flow creates a more recession-proof portfolio.
Renovate Units Properly
Some value-add investors will put band-aids on certain problems which, in our opinion, only leads to more work and expenses down the line. They prefer to do the minimum necessary to increase rents as quickly as possible. They focus on esthetics, which is good, but they go no deeper than that superficial level and as our goal is to increase rents quickly and keep them there for the long run, we prefer a more systematic, long-term approach.
At Smartland, we renovate all units properly. If this means gutting units to the studs, that is what we will do. We do not cut corners. By applying the Smartland renovation processes we developed in our single-family home business, doing the job right does not mean higher capital expenditures on the front end. Based on experience, we know that when we add certain amenities, such as light fixtures you can control using an app on your phone (our residents LOVE this feature) or by installing remote control speakers in every room of an apartment (this WOWs our residents), our return on the investment we make based on additional revenues we can get from rents outstrips the cost.
Furthermore, by gut-renovating units properly from the outset, we know our operating costs in the long run will be lower because we’ll be spending less time making costly repairs in the future.
Recondition Vendor Contacts
Many sponsors will purchase a value-add investment in which they oversee the initial construction, but then keep all other existing contracts in place. This might include the landscape or snow removal company, pool service company, property manager, leasing broker and more. When we invest in a property, one of our first priorities is to look over each vendor contract with a fine-toothed comb. We analyze whether these contractors are a good fit for our business model, and if so, whether the terms of the existing agreement are aligned with market standards. If not, we renegotiate all contracts to optimize service delivery and in turn, optimize returns for our investors.
Diversify Your Rental Portfolio
One of the best ways to hedge against a downturn is by diversifying your rental portfolio. This can be diversification by geography and/or product type.
At Smartland, we do both.
Our investments are generally concentrated in two areas: we make value-add investments in the Midwest market and oversee ground-up developments in the south Florida area. The former is a cash cow; the latter provides appreciation. If one market should suffer a downturn, the other can still carry the portfolio and vice versa. We invest in multifamily in both of these regions and continue to maintain a portfolio of scattered-site residential as a means of further diversification.
Consider Product Type
There are some commercial real estate product types that, frankly, outperform others during periods of economic uncertainty. As we have just witnessed during the COVID crisis, the value of multifamily assets remained strong. This was, at least in part, a result of the federal government issuing stimulus checks that presumably helped people pay their rent. Office, retail, and hospitality have not fared as well.
Multifamily also performed well during the 2008-2010 recession. Many people who were, unfortunately, forced to sell or foreclose on their homes turned to renting instead. Family members and friends move in to shared apartments together. Any natural vacancy caused by the downturn was absorbed by those needing to rent until they were back on their feet again. Ultimately, everyone needs somewhere to live and as such, multifamily tends to perform well regardless of downturns in the economy.
Implementing new technology requires an up-front investment, but once the technologies are up and running, can help to streamline systems and processes. For example, when the pandemic first hit, many people were hesitant to tour rental units. Tech savvy property owners were able to lease units faster by offering virtual tours or self-showings through the use of smart lock technology. All documentation could then be signed electronically, bypassing the need for a prospect to ever encounter a leasing broker face-to-face.
Risk-free real estate investments simply do not exist.
There are countless ways to leverage technology these days, well beyond property leasing. Software programs can be utilized to streamline repair and maintenance requests, for example, which translate into faster results and happier tenants who are more likely to stay put even when faced with a recession.
ID Amenities that Enhance NOI
One of the best ways to recession-proof your portfolio is by finding ways to increase NOI today. At Smartland, we are laser focused on delivering high-quality amenities for which tenants are willing to pay a premium. This includes technology such as smart locks, Nest thermostats, Bluetooth speakers, multiple USB outlets, EV charging stations and more. There are other low-tech amenities that we offer, such as large dog parks for tenants with pets. In our experience, a tenant is willing to pay the equivalent of 13-months’ rent over a 12-month period for pet-friendly units. By maximizing NOI today, we are better positioned to weather any cash flow disruptions brought on by a recession.
Another way to protect your real estate portfolio is by optimizing leverage. “Distressed” real estate is often in excellent condition but instead, has a distressed capital stack as a result of the sponsor being over-levered. By investing in a fund instead of investing in an individual deal directly, the sponsor has more control over how those funds are allocated and can optimize leverage accordingly. This is one of the primary reasons why Smartland has created a fund for investors rather than creating a syndicate to invest in individual deals.
Investors looking to hedge against stock market volatility will certainly want to consider investing in commercial real estate. But be wary of sponsors who promise to “set it and forget it,” as successful real estate investors know that real long term wealth generation requires ongoing, active management and attention to detail. Part of those management responsibilities entail looking at a portfolio holistically to ensure investments are made to protect investors’ capital in the event of a downturn.
Commercial real estate debt is serviced by the cash flow the property generates.
Recession-proofing your real estate portfolio is a good way to protect your downside. And if you protect your downside, and the upside will take care of itself.
Are you ready to recession-proof your real estate portfolio? Contact us today.