The many meanings of leverage

The many meanings of leverage April 28, 2020

I have been in commercial real estate for 25 years and have been through several economic cycles. No two cycles are never the same but there are two things I take comfort in knowing about how they all seem to work. First, our economy always comes back. Second, we always emerge into a different economy than the one we left behind.

As I ponder what is next in our post-COVID world, I have been thinking a lot about leverage. Leverage is a term used frequently in commercial real estate and business in general, but it can have a couple different meanings.

In real estate we use the word leverage to describe the ratio of debt to equity. Pretty basic. Real estate owners and developers borrow money and use leverage when they can increase their return on equity. With the low rates we’ve enjoyed recently, and expect to enjoy going forward, many owners have borrowed as much as they can. Why not? Money is so cheap, and terms are favorable which means you can get higher returns on your capital.

Leverage is also used in business to describe control over a situation. Companies with value propositions that are superior to their competitors are able to leverage their success. Individuals can leverage their own success by working harder, smarter, and by obtaining skills beyond what their peers possess.

Financial leverage is an accelerant. It accelerates returns in good times and accelerates losses when markets go bad. Over leveraged investors are suffering the most right now. Their tenants are not paying rent, so these owners are facing challenges meeting debt service obligations. Some lenders are allowing forbearance of debt for a short period in hopes that the current situation rectifies quickly. However, buying time might not do the trick for some. It may just delay the inevitable and leave larger debt obligations to deal with later. Tenants are looking for landlords to solve their problems and landlords are looking to their lenders. Lenders are looking to the Federal Reserve to continue to provide the liquidity they need to maintain balance in these financial markets. Additionally, for some types of debt, like CMBS financing, it’s simply not possible for the lender or servicer to offer borrowers the flexibility they’re looking for.

There are some landlords with little or no debt. Their low level of leverage is giving them the ability to offer flexibility to their tenants to help them survive. There are also tenants with little or no debt who can focus their time and resources on developing strategies to not only remain in business but also to develop creative solutions for their customers. They aren’t bogged down with negotiating with landlords and lenders for forgiveness, raising capital, or trying to figure out how to keep their companies alive. They are being strategic and thinking long term. Going forward, de-leveraging is a strategy many are considering.

What is interesting in the current environment is that the property owners, companies, and individuals with the least amount of financial leverage are the ones with the most business and personal leverage to succeed in the future. Without the burden of excessive debt, they can think clearly in the current moment about how to make the best long term, strategic decisions. They have the capital to seize the numerous opportunities I am certain our new economy will present.

Nick Banks is the global leader of Avison Young’s Retail group and a member of the company’s U.S. Executive Committee. He is based in Gainesville as managing director responsible for overseeing the firm’s activities in North Florida.