Getting Back to Real Estate Basics

As economic uncertainty continues to spread throughout world markets and the lingering impact of a global credit crunch places more risk on commercial real estate companies, now is the time for owners, investors, and users of real estate to prepare for the next period of economic growth, advises the 2009 Ernst & Young real estate business risk report, produced in conjunction with strategy consulting firm Oxford Analytica.

The top ten risks that will confront the industry this year include:

• Continued uncertainty and impact of the economic crunch, which will affect commercial vacancy rates as well as property valuations.
• Global economic and market fluctuations.
  
  Impact of an aging or inadequate infrastructure, particularly in the U.S.
• 
  A global war for talent.
• 
  Changing demographics.
  
• The ability to find new deals that will meet return expectations.
  
• Valuations becoming a growing problem for existing owners, as well as buyers and sellers.
  
• The green revolution, sustainability, and climate change.
  
• Economic vulnerability and regulatory risk in markets where authorities seek to jump-start the economy.
• Increasing energy costs, especially the return of high oil prices after a temporary respite.

“There will be a fundamental shift back to traditional real estate underwriting principles, including comprehensive cash flow analysis and prudent levels of debt and equity in consummating real estate transactions,” predicts Howard Roth, Global and Americas Real Estate Leader at Ernst & Young. “This ‘back to basics’ movement will lead to the greater transparency necessary to restore confidence between buyers and sellers,” he notes.

The real estate sector has felt the tightening conditions in credit markets perhaps more than any other sector due to its heavy reliance on capital. Financial conditions for real estate projects are undoubtedly worsening, and the current financial markets landscape is expected to persist for the next couple of years.

However, all is not doom and gloom. “Real estate is typically the second highest cost item on an income statement after payroll and so provides excellent opportunities for companies to unlock hidden value, particularly through a back to basics approach,” says Mark Costello, who is with Ernst & Young’s construction and advisory services practice.

On the construction side of the industry, two out of three capital projects are currently over budget or behind schedule, according to Costello. “Yet, deploying risk mitigation or accelerated delivery methods after careful assessment of a project can also reduce risk and cost, and bring in projects on time and on budget.”