The streets of America are paved with gold for property investors and nothing can ever go wrong. True or false? Obviously, it’s false. However, in the right location and with a little education, it’s almost a true statement. In the most general sense real estate values will virtually always go up, even if they go do down for a while. Much of America goes through economic cycles.
We boom and we bust. Nowhere is this more common than my home state of California. It’s the “American Way” to heavily leverage our real property investments. And this is in contrast to what I perceive is the “Asian Way” of paying cash. The California coast is starting to resemble the French Riviera because of foreign cash buyers. Many are parking their money in seaside mansions, yet only occasionally opening their doors, while they maintain residency in their home country.
American real estate cycles are largely based on access to financing and interest rates. If you pay cash, keep the property insured, pay your taxes and keep it rented, an investor should do okay over the long term. This doesn’t mean financing or leveraging is a bad thing. Leveraging your assets clearly allows you to buy more property.
The fragility in the marketplace for commercial property investors using financing, is due to commercial financing being available for relatively short periods of time. Based on my personal experience, most commercial loan periods are due in seven years and amortized over 25 or 30 years. Many loan terms are for five years or even shorter.
Leveraged assets get caught in market rate adjustments when it’s time to refinance. The fear for an investor is if interest rates rise will my investment still “pencil” for refinance? Will I be able to get a new loan? This was the refinance scene during the 2008 U.S. foreclosure crisis. Although some investors walked away from their investments for a variety of reasons, the commercial note holders offered creative ways to keep the investors as owners of their assets. In many cases they offered “loan workouts” and lowered the interest rates or offered other solutions.
The commercial property space is vastly different than the world of single family and two to four unit residential dwellings. In America there are a plethora of long-term loan products for these asset classes and the majority of these properties are financed with 30-year loans amortized over 30 years. The majority of those who lost their homes during the last economic downturn signed for adjustable rate, short-term mortgages with little or no down payment.
The moral of the story? Financing isn’t bad if it’s the right financing but “cash will always be king”.