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‘Dancing in the rain’ in time of crisis

Presented by: Gary Williams, Rothchild Capital Solutions of Illinois LLC and Gary Shelton, Rothchild Capital Markets of Atlanta LLC

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While no U.S. industry was left untouched by the pandemic, the commercial real estate industry—particularly the special use and multi-family markets—has experienced some of the most dramatic losses. As a result, many CRE owners and investors have found themselves facing depleted cash reserves, empty business books and unsustainable cash flow projections.

In this environment, investors and owners need to get back to basics in evaluating risk.

“Early in my career I learned a very valuable lesson—that all investments and the risk that arises from them share the same key elements,” said Gary Williams of Rothchild Capital Solutions of Illinois. “The people who face the greatest risks don’t understand the importance of measuring debt vs. equity,” he said. “They also use unsupported financial theories and avoid thoughtful risk mitigation, using market speculation to create asset valuations.”

Williams said that when assessing loans, the capital stack is the most important thing investors need to understand and consider.

“Many new investors have trouble assessing risk and making investment decisions, particularly when it comes to their capital stack,” added Gary Shelton, of Rothchild Capital Markets of Atlanta. “Mezzanine, equity and preferred equity will have to take on a new approach with longer terms at play and much lower leverage.”

Shelton recommended packaging mezzanine, equity and/or preferred equity into five, seven, or eight-year terms under a joint venture partnership to mitigate the effects of unforeseen economic bumps in the road.

Avoid using unsupported financial theories

Monetary and financial stability are of central importance to the commercial real estate sector or any sector that depends on a functioning market economy. Stability provides the basis for rational decision making. Instability creates damaging uncertainties that can and often lead to failed projects and bank/lender losses.

Credit risk, or default risk, is the risk that someone will not be able to meet a financial obligation. Lenders face default risk that a borrower will not be able to make a monthly loan payment on time. Similarly, property owners face the risk that tenants will not be able to make timely lease payments as expected. In these cases, sponsor/borrower financial accountability is key. Sponsor/borrower skin-in-the game, default reserves and lower leverage ratios will help mitigate some of the risks.

Always include thoughtful financial risk-mitigation strategies

In the real estate securities market, you need to stay informed. Reliable news and intelligence are vital to understanding and analyzing global trends and the interpretation of financial, operational, and asset-level detail. Rothchild Capital Solutions has created a customized model for faster, more in-depth analysis and updates the model automatically with the latest information from Global Market Intelligence. Our system helps clients develop peer analysis models, create company tear sheets, and analyze financial performance.

Don’t make asset valuations based on market speculation with an unsupported opinion

Williams said that his 20 years of experience at Rothchild Capital Solutions of Illinois has taught him that highly leveraged transactions without a supporting balance sheet are often problematic.

Speculative investors tend to make decisions based on the technical analysis of market price action rather than on market fundamentals. Here’s a quick overview of the difference between the two:

  • The main difference between speculating and investing is the amount of risk involved.
  • Investors try to generate a satisfactory return on their capital by taking on an average or below-average amount of risk.
  • Speculators are seeking to make abnormally high returns from bets that can go one way or the other.
  • Speculative traders often utilize futures, options, and short-selling trading strategies.

“When it comes to the pandemic, many questions remain unanswered: Will the market return to normal soon? Will equity investment bottom out? Will banks and or new construction financing continue?” Williams said. “The truth is, there’s no quick fix, but if investors avoid common mistakes and focus on making smart moves, we may be one step closer to a better tomorrow.”

Gary Williams
Rothchild Capital Solutions of Illinois LLC

Gary Shelton
Rothchild Capital Markets of Atlanta LLC