Commercial real estate faces a reckoning in 2023.
Until the Federal Reserve started raising interest rates, investors poured money into commercial real estate at compressed cap rates, resulting in a lower return on investment. But as the Federal Reserve continues hiking interest rates to curb inflation, cap rates are rising along with them.
The result is that investors who purchased properties at low cap rates will be overleveraged when their debt comes due, said Victor Whitmore, co-founder and CEO of Precision Equity, a $170 million real estate investment firm.
“When they go to refinance that debt and interest rates are three to four points higher than they were, they’re not going to get the loan dollars,” Whitmore said. “People are being foreclosed on, but other savvy investors will understand how to take advantage of those ups and downs.”
Changes in working and shopping behavior resulting from the global coronavirus pandemic have taken their toll on retail and office properties, making multifamily real estate the safest investment, Whitmore said.
“Retail is at a crossroads — COVID had a huge impact on that,” Whitmore said. “Brick-and-mortar stores are closing and going bankrupt. When you’re talking about big boxes of 20,000 to 40,000 square feet or higher, those properties are really going to struggle, which impacts the whole economy. There’s less movement of money and less real estate taxes being paid.”
Whitmore predicts that many shopping malls — a sector he said is dying — will be repurposed into office space or multifamily communities. Even so, neighborhood shopping centers that offer dining and entertainment will continue to perform well.
“I don’t think retail has gone away, but the market is certainly shifting,” he said. “There’s a lot of competition with online shopping. Consumer preferences are changing. With inflation, people are spending less on physical items and spending more on travel, dining and entertainment.”
While it could be a good time to invest in real estate, novice investors should consider real estate syndication, where a group of investors collectively raise capital to buy commercial real estate or build a new project, Whitmore said.
Companies like Precision Equity take a value-added investment approach that focuses on acquiring underperforming multifamily assets in markets that are supply constrained. Crowdfunding platforms like Yieldstreet allow investors to participate in a wide array of alternative investments, including real estate.
The benefits of investing in real estate are that it historically has outperformed U.S. equities, it’s a natural hedge against inflation and it offers income and growth opportunities.
“If it’s your first time, get your feet wet with someone who has done it, and invest into a pool,” Whitmore said.
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