Coronavirus and Its Impact on Commercial Real Estate Investments
Uncertainty in the economy reminds all investors of the importance of diversifying their investment portfolio. It also represents a time to remember that the landlord-tenant relationship isn’t one-sided. It is a dynamic one where both parties need to work together so that everyone wins. This concept, while always important, is even more so in times of financial or market stress. Effective and frequent communication is the key. It is also a time where good real estate operators can show their skills by aggressively refinancing their assets to benefit from historically low interest rates. Additionally, turbulent times and “Black Swan events” will clearly identify any weaknesses in a real estate operator’s underwriting assumptions, disregard for market fundamentals, or ventures too far on one side of the risk-reward equation. Lastly, it is NOT a time to panic. After every economic upheaval, real estate values have increased significantly, and at Kenwood, we expect to see that unfold once more, after the coronavirus crisis passes.
The business climate has shifted dramatically since March 1 when coronavirus first presented itself in the US. Restaurants (except for carryout), health clubs and indoor malls have temporarily closed. Thousands of workers are now not collecting paychecks, and hundreds of businesses have adjusted their staff to work remotely while receiving little to no revenue. We have seen numerous public companies pull their earnings guidance and have witnessed multiple 2,000-point swings both up and down (although mostly down) in the Dow Jones Industrial Average in March. All of this is unsettling. However, from uncertainty, there is always opportunity. At Kenwood, we have seen two prior major economic upheavals over our 24-year operating history, and we will get through this one as well. Below are our thoughts on the economy, effective real estate strategies and how we foresee the real estate markets performing over both the short term and long term.
During the last two economic down cycles, 2008–2009 and 2000–2001 (dot.com bubble), real estate investments provided long-term investors with many advantages over their stock equity investments. Real estate values did not experience the extreme volatility witnessed back then and similarly over the past 30-plus days. Most recently, stock volatility has been unprecedented. When the Dow Jones Industrial Index or the S&P 500 experience a 5% to 10% decline in one day, we remind ourselves that real estate investments provide diversification and why it is such an important component to include in an investor’s long-term strategy. Real estate is far less volatile and still represents a “hard” asset whose value should never go to zero, which we know stocks can do (e.g., MCI WorldCom, Enron). The land itself still maintains a much needed limited resource and is a highly functional component of every real estate investment. Moreover, once the initial crisis passed and the recoveries from 2002 to 2007 and from 2011 to 2019 were at hand, our properties experienced significant valuation increases.
In this environment, successful real estate operators need to be in regular communication with their tenants. Letting them know that their landlord is stable, available, and open to working with them during this crisis will foster and build long-term relationships that will be remembered when future renewals are negotiated and long after coronavirus is in the rearview mirror. Our portfolio consists of more than 43 tenants who have been in their property for more than 10 years and more than 28 who have been in their property for more than 15 years. Our long-term ownership platform is ideally suited for these unprecedented situations. Effective communication has always been one of our strengths and we will utilize that history throughout this period.
Across our portfolio, our level of leverage is relatively modest. Where we can, we will look to refinance our properties to take advantage of these incredibly low interest rates. We may be experiencing a 100-year low point in interest rates. We took a similar strategy after the financial crisis when we secured new loans for acquisitions and the refinancing of existing loans. That was possible in part due to our real estate operating history. We have never lost a property to a lender or had to renegotiate an existing loan. We intend to utilize this strength to improve our loan positions wherever possible.
This generally lower leverage and conservative philosophy has guided Kenwood well through its history. It’s why we avoid acquisitions that would require us to utilize an interest-only loan as the only avenue to produce reasonable returns. Real estate investments can be risky. Understanding those risks, managing them, and recognizing that unexpected events, even so-called “Black Swan events” like coronavirus, can occur. This is why investing with an experienced real estate operator is so important. It is why Kenwood spends a significant amount of time underwriting, testing and re-questioning our underwriting model assumptions with every potential investment. We recognize that we don’t just take risks. We take very calculated risks whenever we move forward with any investment.
We believe that interest rates will remain low, very low, for the foreseeable future. This will not only assist with refinancings but will positively impact property values. Since leverage is an important component of the real estate capital stack, lower interest rates have traditionally created cap rate compression, which in turn increases property values. We expect this to happen again as we move past the coronavirus outbreaks and the economy becomes more stabilized.
We stand by to support our tenants through this crisis. We want them to feel that we are all in this together and we’ll get through this together. This will continue to help build the long term tenant relationships that we seek. Developing strong tenant bonds also benefits our investors by reduced vacancy loss and lower tenant transaction costs. This is the time to distinguish Kenwood to our tenants and by extension to our investors. Our stability, long term value investing approach and commitment to tenant satisfaction, which represent three of our core values, will produce the measured returns that our investors have experienced and will continue to enjoy and will remain our “North Star” even in challenging economic times.