The Recalibration of CRE: The Who, What, When, Why, and How
The commercial real estate (CRE) market is in the midst of a recalibration as a result of rising interest rates, widening cap rates, and other effects of recent market shifts. These shifts are causing CRE owners, borrowers, and investors to rethink their cashflow management strategies to change with the market rather than against it. The recalibration of CRE may differ from the norms of the traditional commercial real estate cycle; however, this shift can create new opportunities for CRE firms to assess their portfolio and adjust their cashflow management strategies.
Read ahead to learn about the recalibration of CRE, when it is expected to occur, who it may impact, and how to prepare.
What: Defining the Recalibration of CRE
The Recalibration of CRE
From 2012-2022, the capital and commercial real estate markets experienced tremendous expansion. This expansion created opportunities for just about everyone in the commercial real estate space to make money. However, the dynamic is changing and shifting expectations about the opportunities and returns created by real estate investments.
The Impacts of the Recalibration of CRE
The new dynamic of rising cap rates, cooling valuations, tightening debt marks, and disrupting supply chain issues will have two primary impacts on the market:
- Compression and yield and lower asset valuations
- Tighter deal dynamics and deal structures for new acquisitions and dispositions
The compression and yield and lower asset valuations are expected to drive weaker returns. Tighter deal dynamics and structures could also jeopardize returns and ultimately the promote.
Cashflow Management and The Recalibration of CRE
In commercial real estate, cashflow is critical to meeting and exceeding financial obligations, expectations, and growth projections across the firm. Essentially, cashflow dictates your property’s overall performance. Positive cashflow creates opportunities to grow the portfolio and can produce faster returns to the sponsor and investor(s). On the other hand, negative cashflow can drain your resources and impact portfolio growth.
As a direct result of interest rate spikes and ongoing global economic volatility, institutions will be forced to “recalibrate” and redefine success regarding their portfolio and performance. To address and mitigate the impacts of this new dynamic, more and more CRE firms are turning their strategic focus to cashflow management to manage, predict, and act on performance driving investment returns and protect the promote.
When: Projecting When the Recalibration Will Occur
Over the next three years, we anticipate a reset to market-based interest rates and pricing, or the “recalibration of CRE”. In this new dynamic, cap rates will rise, valuations will cool, debt markets will tighten, and supply chain disruptions will continue to push inflationary pressure.
During this time, we project that portfolio performance will depend on:
- Timing between rising cap rates, rising rents, lease renewals and tradeouts, and loan maturities
- The ability to be nimble and quickly adjust cashflow management strategies
- Longer-term asset management and investment horizons
According to the Colliers’ 2023 Global Investor Outlook, “A recalibration of the global real estate market is underway, and we expect stabilization to take hold [by] mid-2023. The speed and timing of this stabilization, re-rating, and recovery will vary by market and sector.”
Who: Identifying Who Will Be Impacted by the Recalibration of CRE
The recalibration is likely to impact commercial real estate owners and investors across all asset classes. But more specifically, multifamily owners and investors may experience changes in transaction volumes and deals as increases in expenses like insurance and utilities rise. In fact, some multifamily expense categories have doubled and even tripled over the years.
To navigate today’s inflationary environment and maximize operation’s management, commercial real estate owners can:
- Consider each asset’s geographic region
- Examine each asset and its expenses
- Review each line item
- Identify where cost adjustments can be made
- Determine expense growth
How: Preparing for the Recalibration of CRE
Although we are already in the midst of the recalibration of CRE, firms can still take precautions to effectively navigate the ongoing effects of this shifting market. Two impactful methods firms can consider using in this new dynamic are to implement a cashflow management strategy and to leverage asset management software for better CRE portfolio management.
Implement a Cashflow Management Strategy
In commercial real estate, cashflow is critical to meeting and exceeding financial obligations, expectations, and growth projections across the firm. Essentially, cash flow dictates your property’s overall performance. Positive cashflow creates opportunities to grow the portfolio and can produce faster returns to the sponsor and investor(s). On the other hand, negative cashflow can drain your resources and impact portfolio growth.
An effective cashflow management strategy can help boost NOI and provide faster returns to sponsors and investors. Below are three cashflow management strategies that can help your firm prepare for the recalibration:
Cashflow Management Strategy #1: Monitor asset and portfolio performance daily
Many commercial real estate organizations have long used Excel or another similar spreadsheet tool to manage and analyze their data to gain portfolio insights. With this method, all of your data is essentially jammed into one spreadsheet, which creates rooms for inaccurately input numbers, deleted figures, and other errors. This approach can also create silos across the organization and pose the risk of some team members not understanding the formulas or how the model works.
To achieve effective cashflow management in 2023, firms will need access to monitor asset and portfolio performance daily. With a single source of truth and a standardized process, your firm will be able to quickly assess financial and operational performance.
Cashflow Management Strategy #2: Assess and report on performance across all levers
As mentioned before, organizational silos can create hurdles as you build and implement your cashflow management strategy for the year. No longer will the “unicorn” in the organization be enough in 2023. Now more than ever, CRE teams need better visibility across the organization and all hands on deck to drive cashflow.
Cashflow Management Strategy #3: Prevent and solve gaps in performance now, not later
For a solid cashflow management strategy, you need to be proactive about preventing and solving gaps in your portfolio. Having context not only about your own portfolio but also external benchmark data will be incredibly valuable in 2023. Benchmark data will allow you to understand how your property stacks up against other similar properties in the same area. You can use this information to make decisions now rather than later.
Leverage CRE Asset Management Software
CRE asset management software can be useful when implementing a new cashflow management strategy. Asset management technology is a powerful tool that can be used to track and manage your property’s income and expenses in real-time. Having on-demand access to income data means that the firm can easily track its profitability and quickly pivot to a new cashflow management strategy if needed. By using either custom-built or templated dashboards, you can keep a pulse on your portfolio’s financial performance and health.
Watch the webinar 2023 Outlook Across the Four Levers of Performance for a deeper discussion on the importance of cashflow management over the next three years and beyond.
