Peter Pays Paul

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.

CoStar interviewed Hessam Nadji, managing director of research services for Marcus & Millichap Real Estate Investment Services, asking him his thoughts on the current recession.

Here are some of his thoughts on the length of the current recession:

We think job losses and the recession will end in 2009. We’re expecting that job losses will bottom by the third quarter, perhaps into the fourth quarter. For 2010, if you look historically, we’ve had plenty of instances where sharp declines and severe and sudden recessions have been followed by years of growth spike and better-than-average growth — especially the first year after a recession. But this time around, we still have a significant amount of consumer debt to unwind and we’re still dealing with a lot of headwinds in housing and corporate debt. I don’t think 2010 will bring an economic spike.

Nadji acknowledges that retail is going through some issues and may not recover until 2011 or 2012. He ascribes this to a problem of overbuilding in the retail sector.

On Distressed Property

We also need to know how much distressed inventory is going to appear and move through the market. I believe a lot of buyers with lots of cash are sitting on the sidelines looking for signs of an economic bottoming and waiting to see the scale of distressed property sales. Over the next six months, we’re going to get a better reading on the market because both financial institutions and owners of properties are still having stress and they’re going to have to decide what to do with those assets. I think there will be more motivation to sell at more realistic prices than there was a year ago.

…

One or two high-profile deals are not going to refine the market. Its going to take a little more volume, and a sampling of different asset sales in different places starting to trade, for it to become more of a widespread conviction that it’s time to get back in.

Using Cap Rates in Today’s Market

Nadji that cap rates are not as important as they once were in the realm of commercial real estate.

That’s not to say that no one thinks about cap rates anymore — they certainly use it as a metric — but you have to look at return on cash, number one, and using the new underwriting parameters to clear this market for financing, which requires more equity up front and much more realistic rent growth projections and occupancy projections. That would lead you to look at the return on investment for years year one through three in terms of cash flow, which is right now far more important than just a cap rate, which you can come up with in so many different ways.

RTC 2.0?

Nadji doesn’t believe that the current recession and distress in commercial real estate will lead to a second coming of the RTC.

Rather, the forces are working to minimize foreclosures, and therefore this notion of an RTC 2.0 that will bring quality assets to market at huge discounts may not materialize the same way.

He suggests that there are still quality deals available that have cash, can underwrite to today’s rent and occupancy rates, and are seeking to add value to their projects.

Here are a few tidbits from around the web.

• The WSJ covers the Treasuries new plan in: Treasury Releases Details on Program to Buy Troubled Assets
• Calculated risk writes CRE: Cap Rate Expansion
• Retail News Blog explains: The Role Of An Appraiser
• CoStar warns of: The Return of the Miserly Lender
• Square Feet informs us that Moody’s Commercial Property Price Index Posts Large Declines
• Bloomberg. com is reporting that Defaulting Commercial Properties Hit Banks on Vacancy-Rate Rise

Here are a couple of items from around the web on commercial real estate:

• Is this a sign of things to come? Mish comments on Commercial Real Estate Mutiny In Downtown LA where retail tenants held a two week “rent strike”, while they demanded their landlord lower rents and stop charging for advertising.
• Square Feet has noticed that January Unemployment Shoots to 10.1% in California.
  
• The Dirt Lawyer  cautions that Before you think there’s no money out there… Blackstone claims to have $12 Billion sitting on the sidelines.
• Ever wonder how to determine a market cap rate? Lucas Rotter Grant Norling has written Scarcity in Capitalization Rate Examples? An In Depth Approach To Find The Right Cap Rate to help answer your question.
• CoStar.com proclaims Market Turmoil Takes Aim at Life Insurers

I’m taking a few things home to read this weekend. Here they are if you want to print them out and read them too.

• Marcus & Millichap 2009 Real Estate Investment Outlook – Marcus & Millichap provides 12 pages of data for you to chew on.
  
• Everything You Wanted to Know about Credit Default Swaps–but Were Never Told – More than a 5 minute read from RGE Monitor – Home of “Dr. Doom” Nouriel Roubini.
• Putting Office Rent Declines into Historical Perspective – Torto Wheaton Research gives there thoughts on the direction of office rents are headed.

See you on Monday!

The CoStar Group is reporting that Centro Sells Power Center to Acadia for $78M; 40% Discount.

Acadia said the $78 million purchase price, which equates to $122 per square foot, represents a 40% discount to the center’s replacement cost. Acadia’s president and CEO, Kenneth Bernstein, said the REIT “may be acting ahead of the real estate market’s trough,” but added the company is confident in its purchase due to the center’s “great price,” remaining category-leading tenant mix and high barrier-to-entry location.

It seems like Acadia is getting a huge discount. Whether, it is a good deal remains to be seen. Currently the center is running at a 15% vacancy as two of the national tenants have gone dark.

Cap Rates Rising

Cap rates are rising.

Take for instance this shopping center in Fresno, California. Using the current income and deducting the pro forma expenses, I calculated that the cap rate is north of 9% based on current income for the listing price.

A reasonable cap rate and a discount, do not a deal make.

As the commercial loan market and commercial real estate market deleverage themselves expect prices to come down and better deals to be had.

UPDATE: Lucas Rotter has posted about Capitalization Rates – On The Move at his blog.

Chris Rodriguez of Retail Chatr has written on Determining Market CAP Rates. It details how CAP Rates have fallen during this recession and where they could go.

Now we are in a recession and retail property prices are moving as fast as the stock market. It is almost impossible to accurately pinpoint a property’s value as there is no common motivation from the buyers in the marketplace. One buyer is yanking money out of stocks to buy something more “secure” while another is in a 1031 exchange having sold at a great price and is now watching as his purchasing power increase daily. Not to generalize too much, but yesterdays 5.00% – 5.50% CAP Rate single tenant properties are (or should be) trading between 6.25% – 7.25% CAP Rates, depending on the lease terms, strength of the tenant and location.

Commercial mortage brokers get paid based on the value they bring to the client in a transaction. The truly successful brokers bring value to their clients consistently.

2009 forebodes to be a difficult year for certain commercial real estate sectors. Much in the residential real estate industry has changed since 2006, we can expect similar changes in the commercial real estate. They key is to be one of the survivors that come out on the other side.

Adding Value

Most borrowers would not pay a broker’s fee if they did not get something in return for it. A commercial mortgage broker must provide something  the client “needs”.

The client may “need” a smoother transaction, a greater selection of lenders, a higher LTV, a lower rate, or more flexible loan covenants. In exchange for this the broker receives their loan fee.

All of these were solutions to problems that a broker could provide that might not have come through direct contact with an institutional lender

In the current market brokers are having more difficulty providing these items of value. LTVs have decreased, rates have gone up, and many banks are only lending to existing customers.

How does a broker survive and add value in this market?

Bring Equity

A broker that was able to provide an equity injection to a property that needs refinancing will have no shortage of business. Borrowers that cannot qualify for a refinance with new, lower values may be open to a fresh equity injection to facilitate the refinance and ownership of their property.

Offering this as a solution to a borrower’s problems will make it more palatable. Many borrowers may balk at this idea at first.

However, if the only alternative is foreclosure, this idea is likely to become less offensive.

Finding Equity

This will require some work on your part as the broker. Finding reliable and reasonable sources of equity capital. The equity investor must have the funds available to respond quickly. They also must not be so greedy as to kill a deal and offend your borrower.

One way to do this is call your existing database to see if they know anyone that might be willing to invest in projects for an equity position. Some of your existing clients may have extra cash that they would be willing to invest in the right project.

The deal structure will need to be worked out between your equity investor and the borrower.

Commercial mortgage brokers need to continue to add value to their clients’ transactions in this difficult financing environment. How do you plan to do this for 2009?

Photo credit: somethingstartedcrazy

I just created a new page with a calendar of San Francisco Bay Area commercial real estate networking events.

If you are looking for a chance to network or meet other professionals here in the Bay Area please visit the calendar for more information.

San Francisco Bay Area Commercial Real Estate Networking Events

As an aid to my San Francisco Bay Area readers I wanted to compile a resource of local events for commercial real estate brokers and agents, commercial mortgage brokers and bankers, and those interested in commercial real estate.

This not a comprehensive calendar but is a compilation from a variety of sources.

Organization Key

• 680 CIX – 680 Commercial Idea eXchange
• BAMA – Bay Area Mortgage Association
• BOMA – Building Owners and Managers Association
• CCIM – Certified Commercial Investment Member
• CREW – Commercial Real Estate Women
• ICSC – International Council of Shopping Centers
• IMF – Investment Marketing Forum
• IREM – Institute of Real Estate Management
• NAIOP – National Association of Industrial and Office Properties
• ULI – Urban Land Institute

EB = East Bay
SF = San Francisco
SV = Silicon Valley

NAIOP publishes a monthly trade organization calendar here: http://www.naiopsfba.org/pdf/MonthlyCalendar.pdf.