Peter Pays Paul

When you take a piece of frozen meat out of the freezer generally the meat needs to thaw out before you throw it on the grill. Just because the meat has started to thaw doesn’t mean that it is ready to be consumed.

News around the nation indicates that capital markets for commercial real estate indicate that things are beginning to thaw.

First, the Wall Street Journal is reporting that Harvard Tests Market for Its Property Bets.

Harvard University’s $26 billion endowment is looking to unload a chunk of its $5 billion real-estate portfolio as it seeks better investment opportunities and to reduce its exposure to the troubled property market.

The folks at Harvard Management Company must think that now is a better time to market this opportunity than in the past two years. Stanford tried this approach last year and was offered between 80 and 85 cents on the dollar for their investments.

Second, Simon Property Offers $10 Billion for General Growth. Simon is the nation’s largest mall owner. The majority of their offer, $9 billion, was in cash. Simon would not put $10 billion on the line if they didn’t see commercial real estate markets improving.

Finally, GlobeSt.com is reporting Cautious Optimism for Finance at the 2010 MBA CREF Conference.

Unlike 2009 when the majority of lenders were out of the market, over 90% of the lenders surveyed by the MBA have indicated they have or plan to return to market to lend in 2010.

A good friend told me that while attending the conference, he was surprised by the optimism and the amount of funds available for investment. His concern was that there may be an abundance of optimism that would lead to a repeat of the folly at the height of the real estate cycle.

While none of these items make a case for a hot capital market, collectively they do indicate that markets are changing. By no means are the markets functioning at full speed, but they do seem to be thawing.

What do you think are markets thawing out?

Photo credit: Frozen Steak by stevendepolo.

The hotel industry is undergoing major stress. With incomes down and unemployment up, families are vacationing less. Fewer vacations means lower hotel revenues.

Many hotels were bought or sold during the height of the commercial real estate market. Take for instance the Casa Madrona Hotel in Sausalito, CA, which sold in 2005 for an estimated $20 million.

The San Francisco Business Times is reporting:

Sausalito’s Casa Madrona was sold at auction today for a reported $11.4 million — the estimated opening bid.

The article also mentions that this one hotel supplies almost half of Sausalito’s hotel tax revenue. It is no wonder why so many city and county municipalities are in trouble.

The San Francisco Business Times is reporting that More Lembi buildings sell.

Washington, D.C.-based Klingbeil Capital Management has paid about $10 million to acquire three San Francisco apartment buildings that were part of the Lembi Group’s rapidly disintegrating multi-family empire.

Page C1 of today’s Wall Street Journal is reporting that Blackstone Group, LP and CIM Group are attempting to acquire commercial real estate assets by buying the mortgages for a steep discount.

Private-equity firm CIM Group has teamed up with New York developer Harry Macklowe to help him regain control of what is regarded as one of the most valuable vacant lots in the world, according to people familiar with the matter.

This strategy is being used in a number of transactions. The success of this strategy depends upon the lenders willingness to take a loss on the property. Lenders that are in need of cash or understand that they are underwater on a property are more likely to take a discount.

In the case of the Drake Hotel site, a vacant piece of land doesn’t offer a lender much to work with. When Mr. Macklowe bought the lot it had a hotel on it which is more marketable. A lender is likely going to avoid a situation where they have to develop a piece of land.

The WSJ article also quotes Keith Barket from Angelo, Gordon & Co., a private-equity firm. Mr. Barket believes that the deleveraging of commercial real estate will take 3-5 years to complete.

It will be interesting to see if it does.

From the Square Feet Commercial Real Estate Blog

The Mercury News reported yesterday on a proposal by the Bay Area Air Quality Management District that could require some housing developers to go study air quality as part of their entitlement process. According to the article, developments within 1,000 feet of major transportation corridors seem to be those affected.

The Bay Area Air Quality Management District is the group in charge of regulating the pollution of the air in the San Francisco Bay Area. They are responsible for “Spare the Air” days that prevent private home owners from burning wood, wood pellets or manufactured fire logs on Spare the Air days.

“Although troubling times are ahead for many investors, lifetime investment opportunities are forming for the real estate cycle players with cash in hand,” according to the most recent PricewaterhouseCoopers Korpacz Real Estate Investor Survey, which polls major institutional equity investors who invest primarily in institutional-grade property. Investors who are patient, but also daring and selective will acquire high quality assets in markets such as Boston, Washington, D.C., San Francisco, New York and Austin.

2010 Promises More Deleveraging for REITs, Great Buying Opportunities.

San Francisco Magazine has an updated article on the fall of the Lembi real estate empire in San Francisco. The collapse may take down a local bank that lent the Lembi controlled CitiApartments in excess of $40 million.

The Lembi real-estate implosion (see “War of Values,” December 2009) is on the verge of claiming another casualty: little Tamalpais Bank of San Rafael,

…

Tamalpais Bank made most of the Lembi loans between December 2007 and April 2008. In spring 2008, the bank’s parent company announced record earnings and assets, propelled in part by expansion of its commercial real-estate portfolio.

(HT: Square Feet)

East Palo Alto, in the San Francisco Bay Area, is suffering due to the default of the city’s largest landlord. The WSJ details the plight in Firm Takes Heat Over East Palo Alto Crime.

A wave of robberies and burglaries is hitting East Palo Alto, threatening to reverse the city’s recent period of stabilization. One reason behind the crime surge is the financial troubles of real-estate firm Page Mill, say locals, law enforcement and other officials of the town.

Page Mill Properties LLC, which began snapping up local apartments in 2006, became the city’s biggest rental-unit landlord and attempted to transform the town by redeveloping properties into higher-end condominiums.

Earlier this week I wrote about San Francisco’s Apartment Woes caused by the default of the Lembi family.

In both of these scenarios, inexpensive CMBS debt allowed the investor to buy property at unrealistic prices. “A rising tide floats all boats.” The acquisitions made sense so long as the price of real estate was rising and cheap debt was available.

However, once real estate values began to fall, financing dried up, and vacancy began to rise these over-leveraged investments don’t make sense and don’t cash flow. Lax underwriting by the CMBS issuers and unrealistic assumptions by borrowers are damaging the cities where investments were made.

Hopefully, the commercial real estate industry will learn from our mistakes and excess before this cycle is repeated.

San Francisco Magazine has an article detailing the rise and now fall of the Lembi family’s real estate empire in San Francisco. It is a long but interesting read.

The abundance of low cost money from Wall Street allowed the Lembis to acquire properties at an unbelievable rate. Now much of the portfolio is in default.

Walter Lembi, on the other hand, was willing to go all in.

It’s not clear how and when the Lembis and Citi­Apartments started taking advantage of this wild new market, but by 2005, they were in the thick of their record expansion. Like Frank at the beginning of his career, Walter put very little of the Lembis’ own money into their real-estate purchases. Most of the financing was in the form of short-term, interest-only loans. Sometimes, the family financed more than 100 percent of the purchase price covering everything from closing costs to interest payments to the cost of future renovations—using buildings they already owned as collateral.

…

One effect of buying so much real estate in a neighborhood: “The Lembis were setting their own comps,” says David Gruber, whose family owns more than a dozen apartment buildings and who serves as president of San Francisco’s rent board. He is referring to the comparable prices for buildings sold recently in the surrounding area—the basis on which buyers, sellers, and agents set the price for other properties. Every time the Lembis paid top price for a building, they provided a precedent for the next sale, driving up the paper value of all their holdings. When it came time to refinance or take cash out of a building, they could use these higher values to get bigger loans.

The loans on the Lembis’ new purchases were then bundled into CDOs assembled by leading investment banks, such as J.P. Morgan. A July 2007 CDO, worth $5 billion, included some Holiday Inn Express hotels in Ohio and North Carolina, as well as the Health Net headquarters in Connecticut. The Lembi piece of this was loan number 11, the Lembi Portfolio, a $90 million loan for 662 apartments.

(HT: Square Feet)

Where is the Market?

One of the most difficult tasks for commercial real estate professionals is determining where the market is today. Too few transactions, too much distress, unrealistic sellers, and opportunistic buyers make the demand for property and the proper pricing of property an exercise in futility.

Determining a rate of return commensurate with risk is difficult in these uncertain times.

Three news stories illustrate this point.

Retail Center in Vallejo, CA

GlobeSt.com is reporting that the First Grocery-Anchored Sale Closes, More to Come. The article details the sale of a 66,000 square feet Safeway anchored center in Vallejo, CA.

According to the article the property sold based on a 7.71% cap rate on current NOI. As well, the seller had an assumable loan at below market rates providing an attractive cash-on-cash return for the buyer.

The cash yield seems to be the bigger selling point. Dan Wald of Terranomics said that investors are requiring a 10% cash yield on investments.

While this property gives us an idea of the value, it is not a firm indicator. This center is well located at the entrance to a housing development. A superior location would induce a buyer to pay a higher price for the lower risk.

AIG Headquarters in Manhattan

CPN is reporting that the AIG Headquarters Sale Makes Splash in Quiet Manhattan Investment Market. (HT: David Stejkowski)

Youngwoo & Associates (YWA), a New York-based investment and development firm, together with Kumho Investment Bank (Kumho), entered into an agreement to acquire the AIG building, 70 Pine Street (pictured), and an adjacent office building, 72 Wall Street. The two buildings will total 1.4 million rentable square feet in the heart of Manhattan’s Financial District.

The rumored salesprice is around $100 million. This would value the property at around $100 per square foot.

While this may be the biggest acquisition in New York, the entire property is going to be vacated once AIG is wound down. This again doesn’t establish a firm enough foundation for other investors.

Office Building in Orange County, CA

The WSJ has an article explaing why Maguire Sells Office Site at 40% Off.

Maguire Properties Inc., a struggling Los Angeles-based real-estate investment trust, sold a newly developed office building in Irvine, Calif., for about $160 million, a price representing an estimated 40% discount to its construction cost.

The price of 3161 Michelson Drive, during a lean year for commercial real-estate sales, is the latest sign of the severe drop in values in the commercial real-estate market, which is threatening to become a major anchor around the economy just as it is struggling to come back to life.

This property like the AIG bulding suffers from vacancy issues. As well the seller was under pressure to reduce their debt load and needed to sell the asset.

The Bottom Line

Each of these sales while indicative of the current market demand and supply are not conclusive enough to determine a market pricing strategy.

Until owners begin to sell non-distressed assets, market pricing will be a moving target.