It’s true that the real estate market is experiencing some turbulence right now. You have probably seen some alarming headlines on the news and in the media. These headlines are meant to scare and disrupt the general public.
But I’m here to uncover what’s actually happening in the real estate market in 2023. I want you to be equipped with information that will help you navigate these turbulent times with more certainty. It’s never a good idea to make rash decisions out of fear, especially in real estate.
The real estate market, specifically the commercial real estate market, is heading towards a crisis. But the more I have looked into this, the less I think the average American needs to worry.
In this podcast episode, we cover:
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The current state of the commercial real estate market around the country.
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The different types of commercial real estate.
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How working from home has impacted the office real estate market.
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What the future of office commercial real estate might look like.
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How major cities are impacted vs. smaller cities.
I hope today’s podcast helps answer any questions you have about the looming real estate collapse we are seeing right now.
Make sure to share this episode with a friend if you found the information helpful!
TRANSCRIPT:
Hey, this is Darryl Lyon, CEO and co-founder of PAX Financial Group. Thanks for tuning in today. You’re listening to Retire in Texas. As always, the disclosure is this information is general in nature. It’s not intended to provide specific tax, investment, or legal advice. Visit PAXFinancialGroup.com for more information. You can also visit that same website and get a copy of an e-book that we did called, Biblical Responsible Investing, really popular e-book.
So, check that out. And if you need to speak to an advisor for 15 minutes that has a heart of a teacher, just want to see if it’s a good fit, then text the word Texas to the number 74868. Okay, so there’s a looming storm cloud on the horizon. And I want to share with you what this storm cloud is made of.
And see if it’s really imminent threat, because you know how the newspapers work or the media works. If it bleeds, it leads. So, it’s going to be that they’re probably going to be talking about this a lot. And I want to make sure that you are a little bit more educated than the average person on this topic. So, you’re going to hear a lot of people talk about the upcoming real estate collapse, an upcoming real estate collapse.
I want you to be knowledgeable of what this really means. So, let’s unpack that. So first of all, there’s two major categories of real estate. There’s the residential real estate market and the commercial real estate market. We are talking about the commercial real estate market, the residential real estate markets doing fine. There’s certainly challenges there, but if you think about supply demand, there’s not imminent issues.
It’s the commercial real estate market that have many economists scratching their head and some of them, frankly, worried. So, we’re going to dive into the commercial real estate market, but I’m going to unpack it a little bit more so you can understand how the commercial real estate market works. And so I think back at my time when I was helping on the nonprofit board at Brooke’s city base, which used to be this is in the south part of San Antonio, used to be an active military base that had joint missions mostly focused on biotechnology, and the base.
And making a long story short was transition to the city and the missions at that base, Brooke City Base were sent to Wright-Patterson and Kelley Air Force Base and probably other places. And so it was a shell of land and buildings that needed to have new tenants. And the city was responsible for bringing new tenants to this large acre tract of land.
And they appointed a board and an executive director. I was on that board, I was the chairman of the board, and so not the only one, but one of them. And so I got a great exposure to commercial real estate. All kinds. So commercial real estate is a lot of different stuff. So for example, one of our funnest projects was apartments.
You know, it’s more housing that was needed in that area and not only housing, but really nice housing that had amenities and nice landscape. And so we partnered with some apartment developers and that was a very successful transaction. Brooks City Base. We also partnered with a hospital, another type of commercial real estate, the Mission City. Is it Mission City?
Mission Trail? Yeah, Mission Trail Baptist Hospital. So that’s another type. So, you got apartments, you got hospitals and another type. We actually before I got there, there was DPT Laboratories. So that’s industrial. That’s another type We think Yeah, It was after I left they put up some hotels and real nice hotels, another type of commercial real estate.
We actually sold off part of the property and somebody developed retail, which is another form of commercial real estate. That’s where if you go down to Brooks City Base, you’ll see Walmart and H-E-B and all that real estate there turned into retail. So, I’m giving you just kind of an idea, Brooks City Base, where we identified all the different types of commercial real estate.
And when the Air Force left brought in various types of commercial real estate to create a live-work-play type of community. So, when you talk about commercial real estate and somebody says, hey, commercial real estate is going to crash, we’ve got to say what kind of commercial real estate are you talking about? You are talking about apartments, which is also called multifamily.
I don’t think that’s an issue right now. It’s not. What about industrial buildings like these big warehouses? You know, the ugly ones? Well, that’s not really an issue because Amazon keeps building these things. In fact, my daughter’s like she ordered something online. She asked for permission thinking it was a bathing suit. She’s like, it’s not going to be here till tomorrow.
Gosh, I’m like, you’re like, you’re getting used to same day delivery. Is that where we’re at now? But how did they do this? Well, they’ve got these warehouses, industrial warehouses now you need a lot of land and they’re not really pretty. But man, these things are popping because of the distribution of, you know, our economy today. So multi-family apartments aren’t hurting.
Industrial’s not hurting retail, which is, you know, big, you know, like you think about like H-E-B grocery stores or Kroger’s, those are generally not hurting because they they’re typically services that you can’t do on Amazon or e-commerce. You know, if you want to get your haircut or your nails done, those you know, if you get a good grocery anchor tenant, those are typically going to be okay.
Not 100% hotels are coming back because people have pent up demand for vacations. So what is the problem in commercial real estate? I’ve just rattled off some of the major categories of commercial real estate. Which one did? I didn’t. Which one didn’t I mention? There’s one I didn’t mention. Did you guess it yet? If you haven’t guessed it, I’ll tell you it’s office.
Yeah. Office is the one category in commercial real estate. That’s a problem, but it goes deeper. So now we’re going to go another level deeper. We ask ourselves the question, is office a problem? So this is the one a lot of the economists there’s been a ton of being open. The Wall Street Journal, almost every day they talk about commercial real estate, but office has been the one that has everyone’s attention.
What is up with office? And the reason that they’re concerned about office is there’s a couple of them which I’ll get into, but one of which is the return-to-work environment. A lot of people love working from home and they’re not going back to the office and then offices are saying, we don’t need this much space. I was talking to a CEO just the other day and he’s like, we’ve got a lot of empty space now, a lot of people working from home, and you can’t have that blank space in that rent read check forever.
And so these offices, if you own an office building, you’re kind of nervous. But again, going one level, one layer below that, we ask ourselves, well, is it all office space across the country or is it just regional? Are there certain areas of the country that are worse than others? Well, first of all, office in general, I mean, generally speaking, this work from home is creating some tension in the office commercial real estate category.
But it’s really, really bad if you live in the major metropolitan areas on the west and East Coast. As you can imagine, Seattle, San Francisco, New York, you don’t want to be in the office building business. It’s really, really tough to cash flow that office space. And so when we look at office, we say, okay, some people say, well, real estate’s really bad.
It’s going to crash. Well, what kind of real estate? No, it’s commercial real estate that’s going to crash. Well, what kind of commercial estate? Well, it’s office that’s going to crash. Well, Where? In San Francisco. Okay, well, then this isn’t really systemic, is it? But then there’s another category. You go one step deeper, and this is looking at the quality which office space has different quality components, like class A office space has, you know, some amenities, sometimes gyms and then beautiful lighting.
And then sometimes they have, you know, just I mean, plants or whatever else. But really nice class A. Class B’s in the middle Class C is, you know, just not as nice. I think a Class C, not office, but Class C, a building in general. I think of like Rolling Oaks Mall, which is in the northeast side of San Antonio.
And you just have just kind of something you just can tell. It’s just starting to, you know, carpets are starting to wear in paints chipping in. It’s just starting to fall apart. That’s Class C. Well, if you have a business and you are in San Francisco and you’re in Class C Yeah, people don’t want to go to the go to office and work.
They’d rather work from home than go to a dungeon of an office. So, if you really want to talk about the real, real problems in real estate, we’re talking about commercial real estate office in San Francisco, Class C now that’s the worst of the worst. There are elements throughout the country that are problematic in the office space. You may see some in Franklin, Tennessee, or burning of offices that are struggling because some businesses decided to completely abandon the go to work kind of thing.
But generally speaking, it is not in the small states or the cities like Miami, Dallas, Houston, Austin, San Antonio. Those cities are generally doing okay. It’s but it is some big dollar bills in the big cities they’re having to deal with this. One of the issues they’re having to deal with that’s a real challenge is when the Federal Reserve started raising the interest rates, a lot of these offices, as the owners of the offices, finance these buildings over, let’s say five years.
And when those terms renew, which they renew over the next several years, they’re going to renew at an interest rate that’s about twice as much. So, their payments going up significantly. So the problem is when their payments go up and in the payments. So, if you own a office building and your payment is more than the rental income you’re bringing in, you’re upside down and you’re bleeding money and then you have to deal with, okay, all my maintenance crew, I have to pay them more money because the prices of this stuff’s going up.
Taxes are going up, insurance is going up. If you look at all these expenses to run an office building, they have gone up twice as much as rent has gone up. So, these loans coming due with these adjustable rates coupled with these higher expenses and the work from home environment has kind of created this like perfect storm for organizations like LLC’s and individuals who own office space.
It’s like a perfect storm for them. And its banks that are a little nervous. So, all the banks have started to crunch numbers and look at their loans that they’ve given out to these office buildings and said, what type of risk do we have on the books? Let’s talk to a couple of bankers about this. Here’s the really cool thing that I think is important for you to know.
A crisis occurs when an unpredictable event materializes. So, say that again. A crisis occurs when an unpredictable event materializes. Airplanes crash into buildings, the mortgage crisis, the mortgage bubble burst, pandemic. That’s the stuff that really gets us. This thing is relatively predictable. All bankers in the entire world that have loaned money out to people who have offices have penciled out what their risk is and are managing it accordingly.
So this is very well telegraphed. It may not come without some pain along the way. There might be some businesses that file bankruptcy, but to say that it’s going to cause a material systemic system wide market crash, I’d suggest to you that those probabilities are low. I think there will be pockets of pain. But as I’ve said, it’s not real estate.
It’s not even commercial real estate as a whole. It’s specific office space and it’s more painful in those urban areas. I think what will happen is some of these offices will end up, you know, if the owner doesn’t light him on fire to collect insurance, you know, they may get converted into some hotels or some apartments, That’s pretty reasonable.
What will ultimately happen is some people with a lot of money will buy these office buildings at pennies on the dollar. And then kick out the tenants that are there, the businesses that are there, and then just refurbish the whole thing, make it into condos, apartments or hotels and then cash flow it and the rich will get richer that way.
So, there’s great upward buying opportunity for office buildings for those that are angel investors or angel vultures. But it takes a lot of money and a lot of cash and a lot of guts to do that, but it’ll happen. So that’s kind of the landscape of real estate. It’s not terribly bad. It’s very interesting – keep your eye on it, but don’t worry about those big headlines that might try to freak you out.
I think this is very well telegraphed and we’ll navigate through it. And for those that think long term is just part of it. And remember, you think differently when you think long term. Have a great day.
Resources For This Episode:
https://www.wsj.com/articles/commercial-real-estate-woes-run-deeper-than-in-past-downturns-e0c1f2b3
https://www.wsj.com/articles/distress-in-office-market-spreads-to-high-end-buildings-c1adad48
https://www.reonomy.com/blog/post/types-of-commercial-real-estate
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