The "Fiscal Cliff" is looming, with the entire country poised to tip over the edge on January 1, 2013. While the cliff primarily has to do with taxes and government spending, it is likely to have a broad impact on the economy. These broader effects will have CRE portfolio management consequences. Formulating a strategy for the remainder of 2012 can help to mitigate these risks. These three best practices should prove helpful in protecting commercial real estate tenants from its impacts.
1. Carefully Review Your CRE Portfolio
If President Obama and Republican congressional leaders fail to come to an agreement soon, major tax hikes and spending cuts will take effect January 1. The combination of punishing tax increases and reductions in funding for state-level programs will most likely lead us back into a recession. While most companies have already trimmed their portfolios through the Great Recession, this looming downturn could also present an opportunity for further savings.
2. Delay Executing Renewal Options on Existing Spaces
Companies that have lease rollovers coming due in their CRE portfolio can benefit from waiting as long as possible to renew the spaces that are rolling. Most options give an extended time period during which they can be executed, and during that period companies can turn the uncertainty in the economy to their advantage. This flexibility gives tenants two options.
If the country goes over the cliff, they can probably take advantage of the weak economy to extract further concessions from their landlords, lowering their cost of occupancy below that predetermined in the option. On the other hand, if the cliff is averted and the government is able to work out a solution that puts the country on firmer financial ground while also stimulating growth, they can execute their option at the last second and lock in their occupancy costs. For this strategy to work, CRE portfolio managers must have a very clear understanding of the dates and requirements to claim their renewal options. Missing them by even one day could be a very expensive mistake.
3. Immediately Lock Down New Construction Spaces
While the Fiscal Cliff is likely to increase tenants' negotiating power, one category of commercial real estate is likely to become scarcer: spaces in newly constructed buildings. Businesses that need to add new spaces to their CRE portfolio because they need the prestige of being in the newest building or because they need the latest amenities should lock down those spaces as quickly as possible. The odds are that whatever happens with the fiscal cliff, new space will be harder to find in the short- and middle-term:
If the country goes over the cliff and ends up in recession, spec construction will largely stop due to a lack of tenants and a lack of available financing. This will not only decrease available inventory but also increase rents on what remains available.
If the cliff gets delayed through temporary options, developers are likely to delay construction starts, awaiting a more permanent solution. This will also reduce the ability for tenants to add new spaces to their CRE portfolio.
If the cliff gets averted, it will likely be through changes in tax policy that include eliminating "loopholes." One loophole that is particularly at risk -- the treatment of carried interest as capital gains rather than regular income -- is valuable to developers. Its elimination could potentially reduce development activity for a while.
Whatever happens with the fiscal cliff, one thing is sure for executives tasked with managing their company's CRE portfolio. Complicated and uncertain times are ahead. Good strategy backed up with good information is the key to managing them.
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