This article is a segment of a four-part series titled, “Why I’m Excited For a Correction.”
– Part 1: Why I’m Excited For a Correction
– Part 2: Who Are the Predators and the Prey?
– Part 3: Who Are the Most Vulnerable?
– Part 4: Missteps That Cause Implosions
It feels like most of my colleagues that are playing at a high level in business surmise that some variety of a CRE market correction is pending or already here. Many lament with angst, concern or an apocalyptic tone, as if there is an apportioned collective pool of money. We do share from a common water source when the market is hot, but I believe it will start to look like this 20-second video of an African Waterhole in Kruger National Park shortly.
When the correction hits, which it will, transactions and deal volumes decrease across many segments, restaurants/businesses/retail stores will shutter and lending will tighten. That isn’t necessarily a bad thing, and I will explain with a lesson from an old friend and professor.
I am not a macroeconomist but I have observed that, for whatever reason, we have had bullish growth recently in the American economy. Commercial real estate in Florida seems to be moving, rents are increasing significantly compared to inflation and there were a lot of recent deals that consummated because of emotion and group influence.
In graduate school (Rollins/Crummer ’06), one of my favorite professors, Dr. Sam Certo, taught us how to dissect a situation, looking deeper than the symptom to diagnose the underlying problem. These are from notes that Dr. Certo emailed me following a great breakfast conversation:
“Why is it important to clearly pinpoint underlying problems? In his book, Chasing Wisdom, Dr. Certo tells us that without precise definitions of problems, it’s mostly hopeless to meet the business challenges that you face. Use symptoms you see as guideposts for building worthwhile definitions of problems. Without such definitions, effective and efficient solving of problems is mostly hopeless”.
I will illustrate further with the analogy of keeping our bodies hydrated. Think about if you have strenuously exercised, but are dehydrated. What happens? Dry mouth, fatigue, dizziness and fainting. It’s straightforward; it’s your body telling you to slow down. If you continue to operate in the same manner, your body will shut down, which is tantamount to a market correction. When this correction is in full swing, the entire theatre of commercial real estate will metamorphose into something that we cannot predict, but only somewhat anticipate. In attempting to gaze through this veil and forecast a confluence of events, I will share a few of my predictions broken into two categories:
Symptoms that will Remit When a Correction Strikes
Thinning of the Herd
The video above shows a pack of hyenas, which are considered scavengers in the African ecosystem. In a hot market, there are significantly more opportunities to live off another producer’s abandoned carcasses. These are accounts they decided not to hunt or were already ravaged by the lion picked over by his pride, and is an abandoned, yet still nourishing, corpse on the Serengeti.
It feels like new names appear on my email every week and the market is bloated with Millennial up-and-comers. Most brokerage firms are heavy with 2-3 brokers per department, and there have been many transitions lately, similar to 2007/2008. We strive to run a lean company based on agility and strike teams dynamics.
I wish everyone out there the best, but in my opinion, CRE in Florida is a glaring example of the 80%/20% rule. For simplicity sake, let’s say there are 100 commercial real estate advisors at a handful of dominant companies, there are only twenty spots available for the top-tier accounts. Are you in the top twenty in your market? If you don’t know, then you aren’t. That’s where everyone in commercial real estate should strive to be, and it’s all about relationships, PERIOD.
Consolidation & Dissolution
Holy guacamole—are the big boys gobbling up executors lately! This rampant consolidation is very similar to the mergers that stick out from the 2007 era: CBRE & Trammel Crow, JLL & Staubach, etc. Overleveraging, a flatline in lending and tenant expansion, and a plethora of commission revenue drying up led to the downfall of multiple organizations in CRE such as Grubb & Ellis. Grubb finally succumbed to the blows they suffered during the 2008 financial crisis in bankruptcy court in 2012.
Construction Pricing Adjustment
It’s just insane, our pro formas are so sideways on deals, I feel guilty quoting the rent sometimes. Labor and material pricing will unquestionably compress, making deals easier to pencil.
This is directly tied to construction pricing. Concepts are stretching to make deals, developers have to charge high rents to make their pro forma work, and eventually, the sales don’t justify the occupancy costs, the business hemorrhages money until they close or a default event occurs.
Benefits of a Correction for the Tactically Prepared
Employee Pool Shakeup
There is a big problem with entitlement in the younger generations, but there are also a lot of great young people I’ve worked with and met. I am talking more about a cultural phenomenon that has occurred due to failed parenting strategies a couple of decades ago.
Those who have a real sense of entitlement will either fizzle out of the industry or need to cloak their true intentions and work hard for a few years. Bloated firms won’t be able to feed everyone in their army and the talent pool for young, experienced (5+ years) executors will fill more.
As market leaders, look for the potential hires that are the most solid and buoyant during the turmoil, wait for the right opportunity and strategize a way for them to approach you—you then have the high ground and leverage in your negotiation. Your organization will prepare to absorb an economic body blow, then hit back. This is the time to find multi-year talent and they will come to you, unlike current times.
Off Market Deals
For those in the industry with solid relationships, off-market deals are typically lucrative and rewarding. The strong concepts will prevail, and new opportunities will arise as the chessboard perpetually resets itself. There will be new means of innovation, interconnectedness and relationship building. With this new interconnectedness, the “Gold Old Boy” clubs of the past will drift into local obscurity and irrelevancy, relationships will be constructed based on digital presence. Those that are truly networked in the digital world will be exposed to opportunistic, unilaterally clandestine deal opportunities that the financially and myopic-driven minds of the past will never get a glimpse at.
Think of each person’s relational network like a glass spider web. When a market corrects, it becomes transitional, established ties are shattered, and that means opportunity for external parties (especially if your clients are following your competitors on social media, reading their thought pieces and blogs, and listening to their podcasts ).