Real Estate Valuations Post Covid
Let’s say someone bought 10 units in 2019 for 1.2 million dollars. Each unit renting for $1,000 a month. He made 10k in gross income and after expenses his net operating income was 6k a month. The mortgage payment was 5k, leaving him with cash flow of 1k a month. OK, so a fairly good deal, certainly many investors would have done that deal in 2019 as the commercial property market was hot.
Then covid hits and 2 renters move out. A third renter has asked for forbearance and a fourth renter is not responding to calls or answering the door. So instead of making 1k a month our investor is now losing 3k a month. He is paying handsomely to own this investment property.
What is the property worth? He paid 10x gross income for the place in 2019. Is it worth 10x gross losses now? Would the owner have to pay someone 360k to take the place off his hands?
What was once an asset is now a massive liability. This is the problem with commercial real estate. The values were inflated because of easy lending on deals and an economy based on government spending, not real, lasting jobs or even a real economy.
The government could theoretically keep asset prices propped up, but unless they get massive amounts of money to every renter – and do it forever – the prices of commercial real estate must fall.
I think many are salivating at the prospect of getting great deals. But if the average renter can’t get a job much less pay rent, the entire valuation structure must be reconfigured. A new buyer could say 1k is too much in rent, but the market will support 500 a month in rent. That halves the value. Our first investor is not going to pay 600k to get rid of this liability, he’ll let the bank take it over and deal with it.
Since so many properties changed hands in the last few years during the bubble phase of commercial real estate, there has got to be thousands of real estate investors looking around, biting their nails, nervously chuckling, thinking “buy real estate at any price is the road to riches, that’s what the internet said”, or “hold for the long term”, or “cash flow is king”.
The Fed blew this massive bubble and people bought it, coming up with all manner of excuses to justify valuations. The air is coming out now and there is no way to know what renters will be able to pay going forward. There is no telling what commercial real estate will be worth.