Distressed Property Outlook: Valbridge Forecasts 2021 Opportunities
When the pandemic took hold and rents of commercial properties began to waver, many experts in the industry expected a flood of distressed properties to hit the market in mid- to late 2020. To date, however, that hasn’t happened to a large extent. Valuation firms assumed they would get busier as properties fell upon hard times.
Karl Finkelstein is vice president of Business Development and senior managing director for Valbridge Property Advisors, an independent, commercial valuation and advisory services firm based in Naples, Fla. with 80 offices nationwide. Finkelstein spoke recently to REBusinessOnline and explains that while not many high-profile sales have happened, other factors have kept those in his area of the industry busy in recent times. Finkelstein covers likely outcomes for distressed properties in 2021 and which sectors are performing well. A flight to quality, low rates and a reevaluation of shifting pandemic timelines have meant that the valuation business has its work cut out for it.
Asset Type Winners and Losers
There isn’t much surprising in the list of property types experiencing difficulties at the moment. Lodging properties (especially those tied to conventions), fly-to resorts, urban retail and standalone restaurants (particularly those without drive-thrus) all experienced a severe decline in performance this past year, concedes Finkelstein.
What has managed to maintain value or even thrive? Limited-service hotels have held on to their value, although their ability to flourish depends on local dynamics within their market. Drive-to Airbnb properties have seen astronomical numbers, according to Finkelstein, as people attempt to travel and take vacations without flying.
A focus on quality and reallocating risk has meant that investors are overwhelmingly interested in single-tenant, net lease credit properties that have essential uses, like Walgreens or O’Reilly Auto Parts. “Investors are seeking properties with a worthy income stream and some durability to them.”
Finally, there has been some surprising strength in the world of big box retail. Tenants like Hobby Lobby and The Home Depot have seen positive year-over-year increases, benefitting from customers who would typically spend their money on experiences and travel.
2021 Distressed Property-Type Projections
“First quarter, we’ll probably see weaker landlords in some public distress. We fully expect that some properties will come to market and we will begin to hear more about them,” says Finkelstein. Those with small balance sheets — the weak performing and smaller property owners — will likely be the first distressed properties available. Older-style mall properties will continue in the same direction of transition, changing hands as they did prior to COVID-19’s arrival.
Without further legislation, banks may be running out of ways to assist borrowers. Previously lenient banks may feel that now that some federal assistance and protections have expired, the banks must also bring to a close the leeway they were once able to provide.
Geography will also be a determinant of distressed properties: “Where the lockdowns have been severe, we’ll begin to see some higher profile distressed properties come to the surface. Southern California, for example, is in a pretty big lockdown right now, and that could have a fairly dramatic impact on unemployment,” says Finkelstein.
Valuation in a Time for Distancing
Valbridge has had to change certain aspects of their business in the face of COVID-19. Inspection processes have evolved with safety in mind, with some exterior only or video inspections. But the fundamentals have not changed, explains Finkelstein. “As far as the valuation process, our job is still to investigate and report on what the market’s telling us.” The business is location specific: some markets are better than others and some tenant mixes are preferred.
“The difference is now that we’re in an era where there’s been an absence of sales for a whole host of reasons,” he adds. “A lot of it has to do with the fact that even though the seller may be distressed, he or she really wants to hang on. Perhaps they are not interested in selling at the price that the circling sharks are willing to pay, unlike in 2008.”
The unchanged need for in-depth research for valuation means that valuation firms have to really understand a market’s characteristics and local market nuances. “Our folks have to go back and really dig into learning from market participants,” says Finkelstein. “This means a lot of broker interviews, a lot of landlord interviews and a lot of tenant interviews. They are talking with people at the Fed to really learn what’s going on in the market, plus how to take that data and apply it to valuation.”
The most challenging aspect is determining the discount on a property based shifting timelines: vaccine rollouts and economic recovery, rent forbearance and concessions for both retail and multifamily, plus the type of runway that can be expected for potential upturns all play into the difficult calculus of assessing value.
“I think everyone agrees there needs to be some accounting for either heightened risk, loss of income, increased expenses, etc. The really difficult part is ‘How far out in time do we go with the discount?’”
2021 Outlook and Trends
In spite of uncertain timelines, Finkelstein explains that there does appear to be a level of pent-up demand from investors and consumers. “From an investor standpoint, given that rates are so low, there’s certainly an appetite to take on some risk,” he says. “On the consumer side, as soon as people feel safe, there’ll be a lot of folks traveling, doing things that they haven’t done in more than a year.”
Local retailers who are benefiting from stay-at-home measures and restaurant businesses that can survive the pandemic through winter and into the spring will see some opportunities, explains Finkelstein. Any place with a strong, diverse, tenant mix also has a good chance.
Finally, for office assets, location is extremely important. Finkelstein predicts a return to the physical office (albeit at potentially lower capacities). What may change is where these offices are located. “There is some truth to the fact that there’s a lot of people leaving the big cities, whether it’s fear of overcrowded areas or taxes or something else. But the population migration is a fact. We’ve certainly seen it in the Southeast and out in the West. It’s logical to think that the folks in the C suite are going to relocate their offices to where they’ve just moved.”