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The Looming Crises in Commercial Real Estate:

Where Will Opportunistic Investors Find Great Buys in Real Estate?

Part 1: Short Term Rentals

When the Covid crisis first hit, and the economy first shut down, my brain immediately went from apprehensive on the future of my own businesses, to thinking about how the shut down will trickle up through the economy, to thinking about which real estate sectors will be hurt the most.
And then…to where there may be opportunities. Big opportunities.


I’m clearly not the only one who thought this way, as the stock market immediately rebounded from the lows; buyers swooped in to acquire shares at deeply discounted prices. I believe these actions were fueled by the lessons learned from the 2008 Great Recession. Many people had the mindset of wanting to identify great buying opportunities, and take action, this time, unlike the last.


This article isn’t about stocks, but I do believe the pendulum swung way too far, and that the bottom will fall out of the stock market again. The economy is deeply troubled, and will continue to be, and the current valuations make no sense.


What I do want to outline is the process that I believe will unfold over the next 12-24 months in the commercial real estate market.


When the economy shut down due to Covid, my hypothesis became: Owners of short-term rentals would be the first to get hurt, and will lead to short sales and foreclosures of what may be very attractive assets. My logic:

  • Many first-time investors have leveraged up, buying multiple properties at prices that only make sense if they can keep them highly occupied as short-term rentals. They are running hotels, except without the economies of scale that an actual hotel provides.
  • If they had to convert to long-term rentals, they would not be able to cover their debt obligations.
  • Many of the short-term rentals in San Diego are in neighborhoods that make very little sense to me. It is one thing to rent a house in La Jolla for a vacation, but I was seeing them in lower income neighborhoods, without walkability or nearby amenities. And many of these short-term rentals were performing very well.
  • The primary driver of short-term rentals is the discount from traditional hotels, plus having a kitchen and often multiple bedrooms.
    • But with hotels at low occupancy, rates have dropped, making the arbitrage less attractive for vacationers – so I believe they will return to hotels, not homes
  • A concern about cleanliness – would you put more trust in a hotel staff’s cleaning crew to disinfect a room after each stay, or a homeowner / AirBnB host?
  • These owners are highly leveraged, and are more likely to let the properties go into foreclosure; the banks are less likely to work out forbearance agreements for 2nd home / investment properties. The banks will have much bigger problems looming in other real estate asset classes.

A recent article in CNN gave some anecdotal evidence that this scenario is already playing out:
https://www.cnn.com/travel/article/vacation-rentals-coronavirus/index.html

To be clear, many or even most short-term rentals should do fine once the economy opens up. But if overall travel, after the “new normal” is established, is down say 10%, or 20%, that will hurt the worst properties. But targeting the worst vacation rental could still be a great buying opportunity.


The Opportunity
This will not be a 2008 scenario. Opportunistic investors will need to seek out the opportunities, create their own opportunities.


How these will hit the market: Through Short Sales and Foreclosures. Owners / Operators of multiple short-term rentals, unable to meet their mortgage obligations, will eventually need to put them up for sale. If they bought at the peak, they may sell for a discount to the mortgage principal.


When: In the next 6-12 months. Currently, lenders are offering forbearance on debt obligations, and owners are still hanging on. Give this a little bit of time. But…I’m predicting this asset class will be the first down leg in the commercial property downturn.


The reason short-term rentals will fail first, is that lenders will have bigger problems looming. Large retail centers, malls, hotels, and office buildings will be a bigger priority for loan modifications and work outs. The traditional short sale / foreclosure process will hit the short-term rental asset class first.


How Investors Can Take Advantage: Do not wait for the properties to be listed for sale. That is what everyone does. Here’s the playbook:

  • Create a list of your favorite properties. Go on the short-term websites and grab as much data as you can. Addresses are often obscured, but not on all sites. You’ll have to be resourceful. No one said this is easy, are you going to be the one who does the work?
  • Pull public data on the mortgage principal, and compare it to the value of the property. The highest-leveraged properties will be the most likely to go to short sale or foreclosure.
  • Reach out directly to the owners. You want to be the one they call when they decide to sell, or are forced to sell
  • Uncomfortable doing all of the above? This is what brokers do. But once a broker has a listing, their goal is to sell for the highest price possible – the opposite of your goal. Consider forming an alliance with a broker, who will do the leg work to find you the opportunities
  • Be disciplined in your underwriting and execution.

Who should pursue this asset class: Smaller investors, looking to pick up a 1 to 3 properties. This will be a difficult model to scale. If you own apartment buildings, buying a single unit or two may not be very attractive. Those investors will be pursuing the asset classes and strategies I will outline in future articles. But if you’re starting to build a portfolio, this is a great place to start.


Word to the wise: These opportunities will arise because the assets did not pencil as long-term rentals, the buyers assumed the world would not change and short-term rentals will be a going concern. Now the supply / demand for vacation stays is different. And cities have been introducing regulations limiting short-term rentals. So be sure your acquisition pencils as a long-term rental. If you can convert it back to short-term in the future, that will be extra profit for you.

This is a sub-series within my “Investment Strategies for a Post-Peak Economy” series of blogs.

I will examine each of the following asset classes in real estate: short-term rentals, hotels, retail centers, office buildings, multi-family, and the residential for-sale market. I will skip industrial and land asset classes, as I believe those are very site-specific and not subject to the same overall market dynamics.


I welcome feedback, and please share intelligent articles you come across on these subjects. I’m still studying this and welcome intelligent dialog.


About MV Properties and Keegan McNamara:
MV Properties exists to serve our clients in building their wealth through real estate investments. We guide our clients through creating customized real estate investment strategies. We analyze our clients’ portfolios, looking at return on equity (ROE), debt strategies, and tax efficient planning, to develop a plan specific to each clients’ needs.  We let the numbers tell us the strategy, as each situation is different.


Keegan McNamara is a real estate investor, developer, and broker. He owns MV Properties, a residential brokerage and property management firm, and McNamara Ventures, a development and investment company. Keegan can be reached at keegan@mcnamaraventures.com

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