Last Updated on June 30, 2023 by Morgan Beard
Since the start of the COVID-19 pandemic, economists and analysts have warned of an impending recession. While the global economy has proved resilient, it’s best to be prepared, especially if your company owns or leases commercial real estate. We will dive into commercial real estate recession strategies for tenants.
In times of recession, real estate poses many challenges that can have severe impacts. Economic downturns often lead to decreased demand for real estate, leading to financial instability for your company. Another major challenge for real estate in recession times, especially today, is higher interest rates. Inflation can increase commercial tenants’ cash burn.
Fortunately, some commercial real estate investment strategies can help you navigate a rough patch and even come out ahead.
Key Factors Affecting Commercial Real Estate in a Recession
A recession, or even an economic downturn before a recession, can hurt in several ways.
Decreased demand for commercial spaces is one of the first problems. As economic uncertainties cause other businesses to scale back or close, the demand for office, retail, and industrial spaces diminishes.
This demand reduction can lead to longer leasing cycles, increased competition among property owners, and downward pressure on rental rates, which can negatively impact the bottom line.
Declining property real estate values is a common consequence of recession times. Economic downturns often lead to decreased property prices due to commercial tenants getting cold feet, and property owners experience difficulty accurately valuing their assets. And if they need to sell, they might find it tough to get the hoped-for returns.
Tenant defaults also tend to increase in economic slowdowns and rising interest rates. As businesses struggle, they may be unable to pay their rent or default on contractual obligations. Attracting new tenants or negotiating lease renewals may be challenging when the economic forecast looks bleak.
Vacancies can also lead to additional expenditures for property owners, such as increased marketing and potential property maintenance costs.
Moreover, lenders and financial institutions tend to become more cautious during economic downturns, tightening their lending criteria and reducing credit availability. That puts a crimp in financing for property acquisitions or refinancing existing loans. It may also affect lines of credit for property improvements.
Understanding Asset Classes and their Resiliance
The commercial real estate industry is sensitive to economic conditions. A recession’s impact on commercial real estate demand can vary depending on the industry. Consumer confidence in the current economy greatly impacts the real estate sector, and some asset classes represent more resilient sector than others. Here’s how some property types may be affected and takeaways on commercial real estate recession strategies:
During a recession, businesses may reduce their operations or downsize, leading to a decrease in demand for office space. This reduced commercial real estate demand can lead to an increase in vacancy rates and a decrease in rental rates. Additionally, businesses may increasingly opt for remote work, which can further decrease demand for office space.
Many landlords are seeing a significant decline in office sector leasing activity. As such, they are investing in real estate space renovations and offering rent concessions to retain tenants.
Retail properties are often sensitive to economic trends and changes in consumer behavior. During a recession, consumers may prioritize essential goods and services over discretionary spending, leading to decreased demand for retail properties. This can lead to an increase in vacancy rates, decreased rental rates, and a slowdown in new development and construction projects.
In our current economic climate, consumer spending is being allocated to community-oriented experiences like shopping and eating. E-commerce is projected to rise 10 to 12% in online retail sales increasing between $1.41 trillion and $1.43 trillion.
During a recession, consumers may cut back on discretionary spending, which can impact the restaurant industry. Additionally, restaurants may experience higher operating costs due to supply chain disruptions or increased food costs. This can lead to an increase in restaurant closures and a decrease in demand for restaurant space in commercial real estate.
A bright spot in the restaurant sector are coffee shops. Coffee represents an affordable luxury for many consumers that costs less money than lunch out.
The demand for healthcare facilities typically remains consistent. Office buildings, outpatient clinics, and senior living facilities can provide stable cash flow and even potential long-term growth prospects. Despite economic stagnation, the consumer demand for healthcare remains constant. In fact, more convenient and human-centric healthcare is on the rise in response to the covid pandemic.
Industrial properties like warehouses and distribution centers are in demand regardless of economic conditions. During a recession, there may be an increased demand for storage and logistics spaces as businesses focus on inventory management and cost efficiency.
Commercial Tenants Due Diligence Under Economic Uncertainty
As a tenant, it’s important to review your lease agreement regularly to ensure you’re getting the best possible deal. During a recession, this becomes even more critical. Local market conditions may push landlords to drop monthly rent prices and enable you to negotiate more favorable lease terms. It’s also important to understand the terms of your lease and your rights and obligations as a tenant. Consider consulting with a real estate attorney to review your lease agreement and advise you on any potential modifications or concessions you could seek. Some strategies to consider during a lease agreement review include:
- Rent concessions: During a recession, landlords may be more willing to offer rent concessions, such as rent abatement or reduced rent for a specified period, to retain tenants.
- Lease restructuring: Consider renegotiating the terms of your lease to better suit your needs. This could include changes to rent, lease term, or other lease provisions.
- Lease termination: If your lease is no longer meeting your needs, you may want to consider terminating the lease early. However, it’s important to understand the potential costs and consequences of doing so.
One of the best real estate strategies you can employ in tough financial times is strengthening your relationship with your Landlord. Replacing them may be difficult and expensive if they leave, but a little care can go a long way. If revenue from your retail or restaurant space is negatively impacted by economic turmoil then working to find a compromise with your landlord will go a long way.
In Lean Times, Utilize Conservative Financing
While a recession may impact financing activities—including your ability to get loans or loans for larger amounts—make the most of the opportunities you do get. It makes sense to utilize a conservative financing strategy.
First and foremost, focus on maintaining low levels of debt. This is often the best way to see a company’s finances through an economic downturn. As revenues decline, you want to spend less on debt and interest.
If you do take out new loans, prioritize long-term, fixed-rate financing options. This reduces the monthly interest you pay, and you’ll be able to accurately forecast your cost for fixed-rate loans.
Commercial Real Estate Recession Strategies
Landlords may be faced with an owned commercial real estate portfolio with high vacancies, outdated amenities, or poor management. During a recession,prospective buyers may work to purchase commercial space below it’s market value and aim to enhance its value by making necessary upgrades and renovations. This could include improving the property’s physical condition, upgrading amenities and facilities, or enhancing energy efficiency.
For commercial tenants, leasing this space, capitalizing on the opportunistic nature of undervalued assets may prove to be a long-terms strategy to set your business up when the market recovers.
Real Estate Transactions
As commercial tenants hedge their bets and vacate commercial space, those bullish tenants may have an opportunity to secure a favorable lease term. With less competition for prime real estate space and more space on the market, the negotiating power swings to the tenant. Pending your organization’s financial situation, strategically expanding your real estate lease portfolio may pay dividends in the long run.
Lease Restructuring and Modifications
In some cases, it may be necessary to restructure or modify your lease to better suit your needs during a recession. This could include changing the lease term, rent amount, or other provisions. It’s important to work collaboratively with your landlord to find solutions that benefit both parties. We recommend employing financial advice and consulting with a real estate attorney to ensure any lease modifications are financially and legally sound moves.
Lease Renewal Strategies
When it comes time to renew your lease during a recession, it’s important to be strategic in your negotiations. Landlords may be more open to negotiating favorable lease terms to retain tenants, but you’ll need to be prepared to demonstrate the value you bring to the property. Some strategies to consider during lease renewal negotiations include:
- Seeking rent concessions or reduced rent
- Negotiating a shorter lease term to provide flexibility in uncertain economic times
- Considering other properties in the market to demonstrate your willingness to explore other options
- Demonstrating your value as a tenant, such as by highlighting your payment history, length of tenancy, and contribution to the property’s community
Occupier is Real Estate Management For Every Economy
No one likes an economic downturn, and recessions are even worse. But businesses need strategies to survive in any type of economic conditions. When you follow some of these commercial real estate recession strategies, your company may overcome a looming recession and be stronger than before.
A comprehensive lease management platform helps you strategize your second largest expense, your real estate portfolio. The best leasing solutions will empower all stakeholders in the lease lifecycle to evaluate areas for growth and opportunity as well as areas at risk. That’s what we offer with Occupier. Lease accountants can analyze the financial cash flows of your portfolio and your lease administration team can evaluate lease terms with a few clicks.
To see for yourself, request a demo of Occupier today.