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Turning Pain into Gain - I.M.P.A.C.T. A.L.P.H.A.
September 23, 2022 at 4:00 PM
by Fred B. Cordova III
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In times of volatility and change, it can be very challenging to discern what action an owner or lender should take to Impact Alpha for a property or portfolio. By definition, “Impact Alpha” is capital focused. It’s directive is to maximize profits and minimize losses. While it is always challenging, if not impossible to time a market, it is possible to be insightful about the impact dramatic changes, which are beyond our control can have on property performance and value. Insight is the first word in our acronym of IMPACT ALPHA, and rightly so, as it is by far the greatest determinant of equity returns. Of all the components of purchasing, developing, leasing, improving, financing or selling commercial real estate, the greatest impact on alpha will be transaction timing. When is the right time to buy and when is the right time to sell? This is because timing is directly corelative to capital markets risks; and capital markets risk is the most impactful risk to value than any other risk.

So, what insight can we glean from current events and what actions do they suggest about how to Impact Alpha? A lot depends on several factors such as investment horizon, property capitalization (debt vs equity), debt maturity, income stability, income growth, property relevance (tenant demand), operating costs (inflation), property capital requirements (obsolescence), location, and competition to name the major ones. To be sure, humans will always want and need shelter to live, work and play. The difference with society today is that technology has, and is continuing to redefine, what that property relevance (and demand) means to all property types. The mission of capital is to facilitate the delivery of the supply of the “experiences” through purposeful properties that customers (tenants) want. Insight tells us that pumping liquidity into the marketplace through quantitative easing – for infinity, then shutting down the supply side must have the result of explosive inflation sooner or later. Anyone involved in the world of commercial real estate (“CRE”) knows that inflation and higher interest rates were long overdue. Change in CRE, like evolution, happens violently, usually when there is a major environmental shift in supply and demand, that causes dramatic changes in liquidity, interest rates, inflation, and purpose. The environmental shift, exacerbated by the “black swan” event we now know as the Covid Pandemic, accelerated the disruptive impact of these change catalysts.

Insight suggests that a great many properties are no longer purposeful, such as lower tier shopping centers, class B & C urban and suburban office, strip retail, power centers, and some full service business hotels. The collapse of demand coming from a loss of purpose for these properties suggest that they will need substantial amounts of capital to repurpose them for more relevant uses. If you are an owner of one of these properties, you need to determine whether or not your property has sufficient attributes to become purposeful again and assess whether or not you have the investment initiative, capital structure, liquidity, and team capacity to successfully execute a redevelopment plan. If you are a lender, you need to consider whether or not the property is worth more than the debt and if its current performance justifies the current level of debt it supports. Survival (Equity Preservation) is always the first order of business. If you are a custodian of capital, whether you are an investor or lender you must look to equity preservation as early as possible when navigating a stormy and volatile economic environment where rising inflation and interest rates will exacerbate and accelerate declines in purpose, performance and valuation. We are already seeing pension funds, REITs and other institutional investors taking action to preserve equity by selling assets that no longer fit their investment profile. We expect to see a lot more to come as loans come due on properties that have challenging business models and capital structures and are in need of significant repurposing.

Corion specializes in property and portfolio market driven valuation, developing business strategies designed to optimize asset performance and maximize the preservation of debt and equity investments. If you have CRE challenges, we can help turn your pain into gain. We look forward to hearing from you.

Fred Cordova

Founder & CEO