REBusinessOnline

THE LONG VIEW

Mark Zurlini, Palisades Financial

The current credit crunch and recession most of the world is experiencing will continue to erode real estate values for the foreseeable future. At some point the theory of supply and demand will prevail resulting in a positive effect on real estate values in the long run.

We need to take a step back, to the fundamentals of real estate where properties are purchased with low to moderate leverage and held as long-term investments and not traded as if it were a short-term commodity.

Higher equity requirements by lenders will impact the quality of investor. Recessions are known to “weed out” the amateurs who were able to enter the real estate game through access to cheap capital and were able to profit through artificially inflated values driven by a buying frenzy. As property values continue to drop there are numerous buying opportunities for those disciplined investors who have maintained manageable leverage on their real estate holdings and have accumulated cash and/or have access to patient capital. Those able to buy at the “right price” and hold onto the investment until values increase will make a fortune. The right price is different for each investor gauged by the level of risk each is willing to take.

Lenders will require lower loan to value ratios and higher Debt Service Coverage Ratio in the coming years. Lenders will require owners to contribute more capital into their properties not only at acquisition, but by maintaining adequate reserves for repairs, maintenance, tenant improvements and leasing commissions, throughout the term of any loan.

The forced build up of cash reserves and lower leverage is in effect self insuring your property for any adverse economic conditions, such as rising interest rates or vacancy rates. These will eventually affect an income producing property sometime during its economic life.

Lower real estate prices and cheaper debt in the foreseeable future will also be an opportunity for the small investor to perhaps purchase a small-income producing property that generates personal wealth. Again a disciplined consumer, who has saved over the last decade or so and maintained a high credit score, will be able to possibly pick up a 2-family home or small mixed-use property on the cheap from a bankruptcy or foreclosure sale. Such an investment properly capitalized and levered can realistically throw off a 10 percent (plus or minus) return. One man’s loss is another man’s gain.

For those seeking homeownership there will be added opportunities as prices continue to decline. But this will be possible by going back to the fundamentals of home ownership. Buyers will need to contribute 20 to 30 percent cash equity on a purchase and provide evidence that they can afford the future debt service payments. Over the long term, institutions requiring more equity will help stabilize the 1 in 4 family market.

A recession stimulates thinking and innovation. Individuals, companies, and government need to reinvent themselves and find ways to generate growth and value. As bad as the current recession may well become, this may be the downturn's positive upside: We are starting to bring the longer term back into view.

That would include the way people are now taking a hard look at their spending patterns, how much they save, and their longer-term financial plans. According to Andrew Pyle, a wealth adviser at ScotiaMcLeod “We need to boost our savings rate, so that's a positive thing and it comes directly out of what's happening this year.”

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Mark Zurlini is principal of Palisades Financial and of the Fund Manager. He oversees originations, underwriting, due diligence and asset management.

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