LOS ANGELES -- The residential real estate industry could drag the commercial property sector into a downturn in 2008, and real estate investors, developers and service companies need to start preparing now for what could be a tougher business environment.
"No one knows what will happen to the economy, the credit markets, or oil prices next year," said Stan Ross, chair of the USC Lusk Center for Real Estate. "But real estate companies shouldn't wait to see if a storm will hit, or how intense it will be," he added. "They need to start their contingency planning today."
Ross said companies can begin by assessing the current health of their organizations. Then they can consider how to maintain the stability of their companies in 2009 under different risk scenarios such as the economy's sliding into a recession or property markets weakening further.
A health checkup includes a diagnostic of the organization itself and analysis of the external forces including the economy, business environment and especially local market conditions. Ross suggested that companies conduct ongoing market assessments and evaluate the impact of market changes on an organization's health.
Key areas to consider are:
INTERNAL
Development pipeline
- Land inventory: land owned or under option
- Proposed developments
- Development deals under negotiation
- Deals closed but not yet under development
- Development projects in the pipeline
Assets
- Existing inventory: location, type, acreage, number of lots, square footage, etc.
- Market demand by location
- Status of home sales contracts and cancellations or commercial lease renewals
Income
- Property sales
- Rental income
- Other income streams
Costs
- Land acquisition and development costs
- Operating expenses
Liquidity
- Cash on hand
- Access to capital (from lenders, governmental bodies, outside investors)
Financing
- Debt outstanding
- Debt covenants
- Debt service
- Financing costs
EXTERNAL INDICATORS
- Economic
- Business
- Property market
- Regulatory
- Consumer confidence
"By having a clear understanding of their organizations -- projects, cash flows, costs, liquidity and financing -- and the external economic, business, and property market environment, developers and investors will be better prepared for whatever happens in 2008," Ross said.
Companies may decide not to exercise options to acquire land, or decide to sell selected assets in their portfolios, put in new cost controls or restructure their debt or take other steps to hedge against such risks as a recession or property market downturn. In any event, Ross recommended early communication with lenders as these strategic decisions are being considered. "The point is, companies need to take the initiative and not let themselves be overtaken by events," Ross noted.
For more on how developers and investors on the commercial side can ready their companies for the challenges that 2008 will bring, go to: