A few weeks ago, our firm was faced with an incredibly difficult situation. We were under contract to purchase a tremendous, dominant shopping center anchored by national tenants in a strong secondary market. We were full steam ahead and proceeding to the closing table. Our third party reports were completed and our financial due diligence was finished. Our equity was raised, and debt lined up. The deal had the makings of one of the most lucrative transactions our firm had worked on since its inception. And unfortunately, we had to walk away.
It was a very difficult decision to make as the property was sure to be one of the strongest in our portfolio and our equity partners would have done incredibly well. It was a difficult pill to swallow as we have developed a reputation for not pulling out of deals and being creative when a transaction hits a roadblock. Unfortunately this time, no amount of creativity could circumvent this road block. It wasn’t seller dishonesty, a dirty environmental report, a tenant who could not honor their lease, or numbers that did not add up which killed this deal. It was the economic shutdown brought on by the coronavirus.
In the current environment, trying to buy a multi-tenanted piece of real estate is like shooting a moving target. You don’t know what you are actually buying. Until that target stops moving, it’s not really possible to buy real estate with what the government deems are “non-essential tenants” right now. While it would have been great to bolt on another property, we would never gamble with our equity partners investment capital. For us, our goal is to acquire square footage and build wealth for ourselves, but our equity partners’ interest comes first. Taking a short term hit is always fine when you have a long term vision.
Stories like the one just shared with you have been commonplace over the last few weeks as short term uncertainty continues to mount. Buyers do not know if they go through with a transaction what they will ultimately buy and lenders are having a hard time sizing up deals. If you were closing on a property over the last few weeks and the rate on your debt was not fixed at application you were in for a wild ride. Many buyers walked away from deposits.
Luckily, life will eventually return to normal and we look forward to eventually buying the property we had to unfortunately walk away from. But in the short term, as a real estate investor, what should you be doing? Sitting and waiting? While many investors have taken just that stance, we have always prided ourselves on being entrepreneurial and being able to pivot to take advantage of an opportunity at a moment’s notice. And that is exactly what we are doing now.
Due to the current uncertainty in the market right now, we have shifted all of our focus on the acquisitions front to strong credit, single tenant, triple net lease properties, whose tenants’ business operations are deemed essential and are not only surviving this crisis, but thriving. Grocery stores, big box wholesale clubs, pharmacies, and distribution centers are currently our primary focus. Due to fear in the broad commercial real estate market, even these lower-risk assets valuations have been subject to undue cap rate expansion. We plan on taking advantage of this by isolating situations where we can purchase assets that, as an example, may have traded at a 6% Cap Rate prior to the crisis and are now available to be purchased above a 7% Cap Rate. Through the ongoing efforts of our acquisition team, we are identifying these assets on a one-off basis and we are being selective as we identify buying opportunities in the Single Credit Tenant NNN Space. We plan on continuing to isolate these one-off opportunities and will move quickly to make offers when the opportunity arises.
We believe that once we have emerged from this crisis, especially the longer it continues, there will be tremendous opportunities for FNRP to buy traditional multi-tenant assets at deep discounts. It is the opinion of our Investment Committee that it is too early to begin to aggressively pursue these assets.
Our plan is simple; in the short term, we will focus on buying risk averse high performing assets, like single tenant grocery stores, at deep discounts to pre-crisis valuations. This will allow us to acquire assets with stable cash-on-cash returns that will produce long term upside from cap rate compression as spreads normalize once the crisis ends. As we begin to see the light at the end of the tunnel, we are prepared to take advantage of what we believe will be a great buying opportunity at the end of this crisis. The size of that opportunity will be determined by how long the government needs to keep the economy shut down to resolve the pandemic.
Politicians are currently in a very difficult situation. Do they let business go back to normal and risk further spread of the highly contagious and dangerous COVID-19 sickness, or do they completely shut down a tremendous portion of the economy, causing death and despair in an entirely different way? It is certainly a lose-lose proposition and we need strong competent leadership among our policy makers now more than ever.
In closing, the Chinese word for “crisis” has two meanings: one is danger and one is opportunity. While it is certainly a dangerous time and we are managing our current assets with the utmost care and attention, there is also going to be a huge opportunity coming out of this crisis. The longer the economy is shut down, the bigger that opportunity will be.
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Anthony Grosso is Co-Chairman, Managing Principal and Founder of First National Realty Partners, one of the nations leading commercial Real Estate private equity firms. Mr. Grosso has been involved in all phases of FNRP’s development since its founding.
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