The Focus In Commercial Real Estate Right Now is on Finding Value, Not Growth

All right, you may call me a ‘nattering nabob of negativism’ for labeling commercial real estate as in a bear market, but the way property investors are reading today’s commercial real estate fundamentals is compelling some to revert to a traditional way of doing business: the good-old buy-and-hold.

Mid-year market conditions are clearly pointing to flat rental growth, rising property vacancies and a drought in property sales. That alone may not be enough to constitute a bear market because properties are still experiencing positive net absorption and many markets are still posting price increases.

However, in the cyclical world of commercial real estate, many in the industry identify this as a downturn.

“There is a big difference in buying property in a bull market and hoping prices will continue to rise, and hoping you’re not stuck on the top of that pyramid,” said Daniel Cabrera, senior account executive with Empire Commercial Funding Group in Albuquerque, NM, “and buying property in a bear market knowing prices will eventually rise and that you’re not on the top of that pyramid. Estimating the time of the eventual rise will be done best by those that perform their due diligence.”

“An investor client (in his mid 40s) said to me the other day, “this is the best market for creating wealth I have ever seen,’” said Jerry Anderson, executive managing director of Sperry Van Ness Florida. “I couldn’t agree more. I’ve personally seen markets like this before and in my opinion, most agents that have been “playing matchmaker” with buyer and seller the last five years are clueless about the opportunity.

“Sellers have been spoiled with multiple buyers clamoring to buy at any price,” Anderson said. “Buyers have been spoiled with easy money covering up buying mistakes and lack of market dynamics. And brokers have really been spoiled - list it, throw it out there, get out of the way of the deal and show up and collect your commission.”

“Now ’solution selling’ is in play - solving problems for owners and finding opportunities by truly understanding the dynamics of the local economy for buyers,” Anderson said. “Wealth for your clients and you is created in a down market not an up market. This is the best opportunity we have seen to create wealth in quite some time.

CoStar Group Mid-Year Market Reports characterize market conditions as follows.

Office

• Increasing vacancies: 26 office markets have seen vacancies increase over the past year, while 15 have seen vacancy decrease.
• Rents are continuing to go up: 35 office markets have seen rents go up, while eight markets have seen rents go down.
• The square footage of buildings is off 54% from the same quarter one year ago, dollar volume is off 59% from a year ago, and the total number of transactions is off 40% from a year ago.

Industrial

• Vacancy has been relatively flat: 19 industrial markets have seen vacancies drop over the past year, while 23 have seen vacancy increase.
• Rents are continuing to go up: 31 industrial markets have seen rents go up, while 11 markets have seen rents go down.
• The square footage of buildings is off 38% from what it was one year ago and the total dollar volume is off 39% from a year ago.

Retail

• Vacancy rates are up 10 basis points this quarter, 20 basis points since last year this time: 27 retail markets have seen vacancies increase in the past year, while 15 have seen vacancy decrease.
• Rents continue to go up: 35 retail markets saw rents go up, while eight markets saw rents go down.
• The square footage of buildings is off 46% from same quarter one year ago and the total dollar volume is off 55% from a year ago.

“I agree that demand has stalled and rent growth has slowed,” said Corey Schwartz, president of Serinova Financial LLC in Phoenix. “It’s interesting that I have not seen much movement in cap rates, which I really expected to rise by now. I think investment purchases have slowed primarily because of the inability of buyers to find financing rather than slowing of demand or rents. I have had a number of gold plated buyers cancel transactions and postpone projects because they were not able to find financing or unable to find financing on acceptable terms.”

A Buyer’s Market

However, Schwartz added, “the savvy real estate investor has been waiting for this part of the cycle and is poised to acquire the properties that will sustain his growth in the next cycle. Our strategy is to opportunistically buy everything that we can find that is well located and significantly below its replacement cost.”

“Investments sales seem to be centered on properties that have CMBS loans maturing and people that made bad buying decisions in 2005 and 2006,” said David S. Miller, vice president/national accounts commercial sales manager with CTT in Phoenix. “Targeting those sellers seems to be the most logical way to attack the investment market.”

“In any market condition — bull or bear — it is always a great time to make money. Just ask any of the recent buyers of real estate. Deals are being done because of a realistic seller and an opportunistic buyer, both win because one gets to move on to another investment, while the other gets to acquire another opportunity,” said Harry Looknanan Jr., an advisor for Sperry Van Ness in Port Charlotte, FL.

Stuart Baldwin, principal of American Capital LLC in Fairfield, CT, noted the old saying that there are always opportunities to profit in real estate, they just change with market conditions.

“There will be a tidal wave of workouts and foreclosures from all the bad individual and large-scale mortgages banks are holding,” Baldwin said. “Certainly the massive amounts of capital being raised right now for bad debt/distressed real estate purchases suggests that many see an opportunity there.”

Not Just Any Property

Cash is king was common response we heard from those surveyed when it came to the investment market, as was the focus on primary markets over secondary markets.

“All real estate is certainly not equal,” said Krista P. Black, principal of Smart Hard Money LLC in St. George, UT. “We see a dramatic opportunity in properties with this type of core value as the market continues to talk about all real estate in averages; particularly national averages. Some properties, and some markets, are an excellent bargain if they are in use for, or can be converted to, recession-resistant purposes.”

“We have redefined core value not as what is sellable, because we obviously do not expect sales in this credit market, but rather what rents actually support over the long term,” Black added. “For example, space not only needs to be occupied but must be occupied by recession resistant businesses or be supported by entry-level rents in the case of multifamily. We are not interested in the luxury market, luxury retail or travel-related real estate in this market.”

“Flexibility for the use of the property is probably key as some owners may need to go to plan “B.” This is usually achieved by staying at much lower leverage than we have seen for a long time,” Black said.

Another common theme was to invest in value.

“The best real estate strategy in a bear market is to wait for the price bounce,” said Vince Norris, a partner in Delson|Norris|Fischer in Woodland Hills, CA, “don’t jump in too early, and look at value investing not growth investing.”

“The traditional approach to investments is total return equals growth and yield,” said Brian S. Brennan, director, real estate acquisitions of Allianz of America in Westport, CT. “Now, while growth is taking a holiday, focus on yield. For real estate, that’s traditional asset management leasing, tenant retention, property renovation and/or expansion.”

Work It

Whether buying new or holding on to existing properties, the key many respondents said will be what is done with the property during the holding period.

“If you own it already and you’ve had tenants move out because of the ‘bear market,’ you’d better be sure you’re working cooperatively with the brokerage community to get it re-leased. Consider offering incentives like some free rent, tenant allowance, but hold your rents,” said Nancy L. Yates, vice president of ICORR Properties International Ltd. in Sarasota, FL. “When things turn around, you won’t be stuck with low rental rates and you won’t have to struggle to increase the rates. Always try to have a ‘wait list’ of prospective tenants. Do pre-emptive work — renew tenants early to make sure they are committed to your location. Offer them incentives - no increase for the first year for being a loyal tenant.”

“Bear market means you are offering something else to differentiate yourself, such as amenities, price point, location, etc,” said Cris E. Zenobio of Titan Realty & Construction LLC Plainview, NY. “Good product leases and sells and the capital and credit markets dictate at what prices.”

“If you are in a secondary market get aggressive in your leasing strategy and fill your vacancies,” Zenobio added. “Once you are full with quality tenants, then you can market for sale. But keep in mind what you had to do to lease up the space when you are marketing it for sale.”

Joseph S. Galli, executive vice president and managing director of Consortium Capital, an affiliate of The Bernstein Cos. in Washington, DC, concurred.

“The only tried and true tested bear market strategy is to take this time and look inside at your properties,” Galli said. “Do the things that you did not have time to do when we were so busy. Especially work your tenants and keep them happy — an ounce of prevention is worth a pound of cure.”

Sandy Schonberger, president of Schonberger Associates LLC in Livingston, NJ, summarized it best.

“Buy low and sell high,” Schonberger said. “It is advice that works. Bear markets are cyclical; they don’t last forever. They are re-adjustments that bring inflated prices back to reality. Over a period of time, prices will again increase providing value for the smart buyer.” Source: http://www.costar.com/News/Article.aspx?id=A18CF657583797014CB3AA357FC6DA9A&ref=100