The ideal time to invest in commercial real estate is 2010 – that’s when commercial property prices will hit bottom, according to a recently published survey of industry experts, including investors, developers, lenders, brokers, and consultants.

The Emerging Trends in Real Estate 2010 study, released last week by PricewaterhouseCoopers LLP (PwC) and the Urban Land Institute (ULI), says commercial real estate (CRE) players predict vacancies to continue to increase and rents to decrease across all property sectors before the market hits bottom next year.

The consensus is that property values will ultimately drop 40 to 50 percent on average from 2007 market peaks, making 2010 and 2011 the opportune time for investors to buy at or near cyclical lows.

The survey data also indicates that investors believe capital will slowly begin to flow back into commercial real estate markets by the end of 2010, led by all-cash investors.

The research firm Real Capital Analytics, Inc. estimates that commercial real estate loans in default, foreclosure, or bankruptcy now total roughly $130 billion. By being selective on offers from both distressed sellers and banks that are clearing out bad loans and real estate owned portfolios, investors will score bargains on premium properties, according to the study.

The CRE property market recovery will most likely begin to gain traction before 2012, and survey participants believe that the markets performing well before the crash should be the top-performers coming out of it, with investors continuing to favor global gateway markets on the East and West Coasts.

According to the survey, Washington, D.C. ranks number one as the “recession-proof” city. Value declines there have been less than other markets as employment is buffered by the federal government.

Long-term confidence holds for New York and Boston despite financial industry downsizing. West Coast gateways – San Francisco, Seattle and Los Angeles – have all suffered ratings declines, but remain among the survey’s top major markets. Texas markets also continue to show strength, according to survey participants.

As prices hit their floor, the PwC and ULI study predicts that lending will be conservative, expensive, and extended only to the most-favored banking relationships. Real estate investment trusts (REITs), private equity funds, and even refashioned mortgage REITs will start to provide loans to battered borrowers but at a steep price, the companies said in their report.

About Investment Analytics Group
Established in December 2006, Investment Analytics Group (IAG) provides integrated commercial real estate advisory services to investors. Our core services include asset level due diligence, asset management, financial modeling, feasibility studies and other related advisory services.
For more information visit us at www.iagroupllc.com or contact us at 208.846.8476 or info@iagroupllc.com.

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An interesting article in CIRE (Commercial Investment Real Estate) magazine discusses the landscape for brokers trying to close deals that we wanted to share.

The credit crunch has reduced office transaction volume to a trickle and factors weighing on the sector are likely to limit deal making through year-end. Asset values have declined nearly 30 percent from their peak, financing is scarce, and downward pressure on office fundamentals is exacerbating the wide gap between bids and asking prices.

It’s a difficult landscape for investment brokers and their clients to navigate, whether they are office buyers, sellers, or developers. In the first four months of this year, property owners put nearly $13 billion of office properties up for sale but only closed $4.4 billion in transactions, according to Real Capital Analytics. Nationwide, sales volume is down 70 percent from year-ago totals.

Perhaps more critical is a dearth of acquisition financing that hampers deals even where buyers and sellers reach a middle ground on price. Conduit providers have ceased to issue new loans due to a logjam of commercial mortgage-backed securities, and life insurers largely have reached the limits of their real estate lending allocations.

Yet today’s market provides opportunities for CCIMs to apply experience, training, and creative thinking to make deals work, says Stan Watson, CCIM, owner of Watson Real Estate in Ann Arbor, Mich. “You can pick lemons off a tree but you have to dig for diamonds, and right now that’s what we have to do,” Watson says. “We have to work a little harder. We have to be extremely creative.”

Just last year, Watson helped a client obtain $5 million in financing to develop a single-tenant office project on St. Joseph Mercy Hospital campus in Ann Arbor. Local lenders expressed interest in the deal but balked at the requested loan amount, so Watson pooled resources from five local credit unions to assemble the necessary sum. The tenant moved into the completed building earlier this year.

“You need to develop relationships and seek out those lenders that are really lending money, such as state-chartered banks, credit unions, or others you maybe haven’t considered before,” Watson says. “I never thought I’d be pooling credit unions, but in a market like this you start thinking what else can I do?”

Done Deals
What enables some deals to close while others founder? Details vary, but brokers say success comes from persistence and having the courage to take unconventional approaches to problems that otherwise would derail transactions.

Brian Andrus, CCIM, owner of Stonebridge Real Estate Co. in Clearwater, Fla., recently sold two office properties, and both required extra effort. In the first case, an office user was attempting to purchase a former automotive service station that had been converted for office use. The buyer lined up acquisition financing from a regional bank offering 85 percent loan to value to owner-occupants.

But before the new investor could close, the bank halted the deal, demanding documentation that the property had been cleared of underground fuel storage. After an exhaustive search, an environmental assessment firm working with the seller tracked down proof that the tank in fact had been removed years before, and the deal closed.

In another recent example, Andrus marketed an office project that required him to spend 40 hours reworking an existing lease to suit a prospective buyer. “Every deal is taking more care and more time,” he says.

Getting Up to Speed
When the credit crunch began, the highly leveraged buyers that fueled bidding wars in 2006 and 2007 effectively were excluded from the market. The few remaining active buyers demand lower pricing to reflect their higher cost of capital, which includes substantial equity and comes with an aversion to risk that must be placated with greater returns.

Throughout most of 2008, buyers and sellers simply disagreed on prices and trading slowed to a crawl while the market worked out corrected pricing based on existing income streams. Commercial real estate values have wilted in that time, particularly those predicated on income growth projections that did not come to fruition. The Moody’s/REAL Commercial Property Price Index showed office asset values in April 2009 were down 29 percent from one year earlier. Real estate investment trust share prices, which are considered a forward indicator, suggest commercial real estate values will decline 40 percent from peak to trough before the market hits bottom.

After more than a year of job losses and economic contraction, declining office fundamentals threaten to eat away asset values. Whether due to companies negotiating lower rates on lease renewals or tenants going out of business and defaulting on lease obligations, many property cash flows have faltered and further reduced the value of investors’ holdings.

“The office vacancy rate is now a little over 16 percent, and over the next six months it will creep into the high teens and maybe crest at 20 percent by the middle of 2010,” says Ben Breslau, Jones Lang LaSalle’s Americas research director. “Then it becomes a matter of when the economy picks up. If the economic recovery takes hold this year, we might see vacancy rates stabilize by the end of 2010.”

As a result of rising vacancy and softening demand, rental rates are flagging and will drop 8.1 percent on average over the course of 2009, the largest one-year decline on record, according to New York-based researcher Reis. Negative absorption this year will range near 70 million square feet, shy of the 100 million sf of negative absorption Reis tracked in 2001, but enough to make 2009 a painful year for the office market.

Buyers Want Bargains
For owners trying to unload distressed assets, speed is critical, says Brian E. Estes, CCIM, president of Prudential Commercial Real Estate in Jackson, Miss. That’s because the property usually is costing the owner money. Setting a price to meet the market also can be a challenge, because a distressed asset often lacks part or all of its income stream. Without income to use in extrapolating value, capitalization rates become irrelevant, so a buyer is more likely to consider a distressed property’s price relative to construction or replacement cost, Estes says.

Earlier this year, Estes helped a bank sell an 115,000-sf office complex after a foreclosure. He found an all-cash buyer who bought the complex, made improvements, and brought in new tenants. In a separate deal, Estes helped a client sell a struggling retail property that had lingered on the market for more than two years, finally moving the asset at a price equivalent to 40 cents on the dollar. “We knew no one would get financing to buy this shopping center, so the first all-cash offer we got, we took.”

Investors waiting to buy at rock bottom prices aren’t waiting for sellers to come down in price, brokers say. They are waiting for sellers to go into default and foreclosure. Owners are unlikely to sell even distressed assets for pennies on the dollar because they still hope to recover their investment. Banks, on the other hand, may be willing to sell at a substantial discount in order to unload foreclosed properties from their portfolios. “A bank is motivated to stop the bleeding,” Estes says.

So far in this cycle, such real-estate-owned sales are few. RCA tracked only 13 REO sales by banks to third parties in the past year. But distress is mounting. The inability to obtain replacement financing for a maturing mortgage or construction loan is a common source of distress for investors. By this definition, more than 525 U.S. office properties, representing almost $18 billion, have fallen into distress since February 2008, according to RCA.

Estes believes a wave of distressed sales soon will break on the investment market and provide investors with tremendous opportunities to snap up discounted assets. He passes along these words of advice, given to him by a banker earlier this year: “If you are an investor and you buy real estate from anybody other than a bank in the next two years, you probably will have overpaid.”

Creating Success
Against this bleak backdrop, how can CCIMs overcome both the national stagnation in office sales as well as the unique challenges of their individual markets? It’s a good idea to start building relationships with lenders who soon will take possession of foreclosed properties, says W. Darrow Fiedler, CCIM, director of KW Commercial in Santa Monica, Calif.

Even after a foreclosure, lenders may be reluctant to sell an asset at a discount right now because that would force them to realize portfolio value loss. This creates an opportunity for CCIMs to help those banks manage their REO properties, keeping them in operation to postpone the need for a sale until the market improves, Fiedler says. Ultimately, CCIMs will be in a good position to pick up the sales listings, too.

Investment advisers can help a property stand out and succeed by taking a comprehensive approach to its marketing, says Peter Kozel, chief economist for commercial real estate service provider FirstService Williams in New York City. That begins with establishing a business plan for the asset in both the short and long term.

“You have to come up with a consistent argument for the property,” Kozel explains. “What is the property’s reason for being? What niche does it have in the marketplace? What kind of tenant does it attract? What’s the outlook for that tenant base?” Today, not just prospective investors but even tenants are asking for details about a property’s capital structure, he says.

Jeremy Kronman, CCIM, executive vice president at CB Richard Ellis in Pittsburgh, agrees that a comprehensive plan of attack increases a building’s chances for retaining or even increasing its value. “We talk about what’s the plan for each individual tenant,” he says. “Today we’re sitting there with the owner and the lenders and talking about what loan to value they want to achieve. We’re not just leasing agents; we are whole-building consultants.”

Financial Footwork
Financing remains a serious challenge, and dependable financing can differentiate a buyer from other bidders on an asset, says David Brightwell, CCIM, vice president of business development at Validus Group in Tampa, Fla. He is lining up funding sources in advance to prepare for future acquisition opportunities. “In this market, the No. 1 offer doesn’t necessarily get taken because the seller will accept a lower offer from a buyer that he knows has the ability to close,” he says.

Government-backed lending through the Small Business Administration’s 504 program provides a good source of leverage for buyers who plan to occupy all or most of a new space themselves, says Steven W. Moreira, CCIM, president of Magic Cos. in Longwood, Fla. “That’s one government stimulus that is working,” he says. “A bank can write a construction loan under 504SBA and have a 90 percent takeout guarantee from the government.”

Yet even this oasis of capital may be evaporating, says Soozi Jones Walker, CCIM, owner of Commercial Executives in Las Vegas. In the past 12 months, banks have increased their scrutiny of 504 loan applicants and will decline those who don’t have a track record of strong financial performance, she says. “If a potential buyer has had either flat growth or a little bit of declining income, they won’t approve them,” she says. “It’s a great program; [504 loans] are just hard to get now.”

In this market of stress and distress, CCIMs must continue to bring all of their skills to bear in order to preserve the value of their clients’ properties and help investors identify assets offering the greatest possible return. Despite the persistent challenges of the market and economy, this is not the time to slack off: The best buys are made at the end of a recession and investors make the most money in a cycle during the first five years after recession, Walker says.

“There is no coasting, but there are success stories out there,” Kronman says. “When you do your homework and when the ownership, financing, and leasing are all talking, you absolutely can pull off success stories.”

About Investment Analytics Group
Established in December 2006, Investment Analytics Group (IAG) provides integrated commercial real estate advisory services to investors. Our core services include asset level due diligence, asset management, financial modeling, feasibility studies and other related advisory services.
For more information visit us at www.iagroupllc.com or contact us at 208.846.8476 or info@iagroupllc.com.

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There’s Value in Real Estate – An Article from The New York Times

The last thing most people are thinking of investing in right now is real estate. The collapse of residential values stung almost all homeowners. And the commercial market, from offices to shopping malls, is full of uncertainty as unemployment rises and consumer spending continues to be weak.

Greg Rand, managing partner at Better Homes and Gardens Rand Realty, a brokerage in the suburbs north of New York, even has a theory to guide investors. He calls it “house rich.”

Simply put, the days of buying almost anything and watching it appreciate are over. Those who want to make money in real estate now will have to do extensive research and expect to hold the property for at least a decade.

The crux of the idea is not buying a distressed property but “finding your Florida.” By that he means investing in a piece of real estate, be it residential or commercial, in a hard-hit place that has to rebound.

“Florida is in a storm right now,” Mr. Rand said. “It’s overdeveloped, overspeculated and overleveraged.”

Yet, with 78 million baby boomers expected to retire in the next two decades, the state’s long-term prospects are solid: a good proportion of them will want to be someplace warm and sunny when they stop working.

Mr. Rand is not alone in this. Some of the biggest players in real estate see opportunity around the country.

“We are now looking at one of those rare opportunities to invest in commercial real estate,” said Hessam Nadji, managing director at Marcus & Millichap, a commercial real estate investment adviser based in Encino. Calif. “There are plenty of properties in the $5 million to $20 million range, whether they’re apartments or shopping centers, that are located in places where supply is constrained.”
He added that these otherwise solid properties were for sale now because losses elsewhere were forcing their owners to raise money.

While many investors may not believe that real estate is returning as a steady, performing asset, the following criteria can guide those ready to re-enter the market.

Investing in real estate has always carried risk. But where many people went wrong was in taking a house vanity approach — they bought their dream home without knowing how its price compared to either historical levels or the prices in nearby neighborhoods.

Mr. Rand tells the story of the Trump Tower, in White Plains, which he represents. When the sales office opened during construction, buyers focused on the penthouse condominiums with views of Long Island and New York City. At that time in 2004, the going price for 2,200 square feet on a high floor was around $1.8 million, he said. That would seem to be a deal for a buyer in Manhattan, 30 miles south, but in White Plains, few single-family homes had ever sold for that much.

He said investors who bought units on lower floors — priced closer to $700,000 — did much better. The reason was that their fixed costs — mortgage, fees and taxes — were lower, which meant they could attract a larger pool of renters to cover their investment.

The lesson here was that anyone who really knew the White Plains market would have been more hesitant in buying a $2 million apartment as an investment. “The key is due diligence over sex appeal,” he said.

What makes or breaks any real estate investment is fixed costs. Investors need to know how they are going to cover the amount they have to pay, whether the property is rented or not.

In Trump Tower, the monthly fixed costs for the penthouse apartment were $11,100 with an expected rent in 2005 of $8,000, Mr. Rand said. On the lower floors, the costs and expected rent were the same, both about $5,000.

Any experienced real estate investor will tell you there are times when even the best properties, whether apartments or shopping centers, have vacancies and that means some of those costs fall on the investor.

This sounds obvious, but from 2005 until early last year, there were plenty of amateur investors who only realized this after their tenants left.

What signals a return to understanding that basic principle is a return of savvier investors.
“A lot of people who are coming back into the market that I’ve known for decades are saying the market is normalizing again,” said Harvey E. Green, president and chief executive at the commercial real estate brokerage Marcus & Millichap, and a 40-year veteran of the real estate market. The years “2005, 2006, and 2007 were the frothiest part of the marketplace, and these people stepped out on the sidelines.”

In other words, the smart money is back after years of watching. Consider the South Florida market again. Many people who got caught had visions of renters covering all the costs on properties they bought. When renters became scarce and values plummeted, these investors did not have a backup plan. A better way is to set a goal for the investment. Do you want to add to your cash flow immediately or can you afford to take a longer view of 10 to 15 years?

If your goal is to make money now, you will probably have to buy an older property and fix it up. This requires a more active role, and still, the return will not be what it was at the peak.

Mr. Nadji said investors in Class B commercial real estate — solid but not marquee properties — can expect returns in the high single digits. But most of those properties are not likely to appreciate in value for two or three years.

With a longer view, the options change. Ruth Trettis, a broker at Premier Properties in Naples, Fla., said one investor bought nine homes, worth more than $32 million, in the last year in Port Royal, the town’s most affluent neighborhood. Another investor bought three homes in Port Royal worth $14 million over a single weekend in May and a fourth one last month for $13.5 million (it was listed at $19.9 million).

So far, she said, neither buyer has done anything with the properties. Even though both bought these houses at steep discounts, the costs of just holding them are immense. But they clearly have a long-term goal and a belief in the area.

Real estate is like every investment today. Experts and amateurs alike have strong opinions on what will work and what won’t.

The message within the real estate market itself is mixed. Last week’s report on flat home sales from April to May seemed to be heartening, but it was misleading. Homes sell better as the weather warms up. The better indicator of a bottom will come when year-on-year numbers are flat, and those have yet to appear.

The one upside is inflation, or at least the fear of inflation. Hard assets like real estate historically do well when there is inflation.

What this means is the longer your time horizon for investing in property, the better your chance of achieving real returns.

“Real estate was never a short-term investment,” Mr. Green said. “It was just in that frothy market.”

In this sense, the one certainty is that the age of the flipper is behind us.

About Investment Analytics Group (IAG)
Investment Analytics Group (IAG) was established in December 2006 ago to provide integrated commercial real estate advisory services to investors. Our core services include asset level due diligence, asset management, financial modeling, feasibility studies and other related advisory services. Our business model and services are not reactionary to what many other firms consider “opportunity” in this current distressed environment. For more information visit us at www.iagroupllc.com or contact us at 208.846.8476 or info@iagroupllc.com.

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A heads up for real estate professionals: H.R. 2454, the cap and trade legislation approved by the U.S. House of Representatives on June 26, if passed into law, would have a profound effect on the real estate sector.

Key real estate-specific provisions of the House cap and trade bill are the following:

• National building energy efficiency targets would be established by the Department of Energy (DOE), linked to baseline standards set for commercial buildings under the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE) Standard 90.1 – 2004 and for homes under the 2006 International Energy Conservation Code. [Note: The legislation also permits the national standard to be based on a recognized national consensus standard. Presumably, this would be Standard 189.1, the model building energy efficiency code being developed through an ANSI standard-setting process headed by ASHRAE, the Illuminating Engineering Society of North America and the U.S. Green Building Council.]

• Upon enactment of the bill, new commercial and residential buildings would be required to achieve 30 percent improvements in energy efficiency relative to baseline. By January 1, 2014, new residential buildings would have to improve energy efficiency by 50 percent; commercial buildings would be required to achieve 50 percent improvements relative to baseline by January 1, 2015. Additional reductions in energy use would continue in subsequent years at 5 percent additional savings every three years. DOE could accelerate or lessen these standards on the basis of lifecycle cost analysis. The baseline under consideration is 2005.

• Within a year of enactment of the federal legislation, state and local governments would be required to adopt the national code or revise their building codes to meet or exceed the federal standards. For states in which building codes are adopted by local governments, the state would be required to document that appropriate local building codes were adopted by jurisdictions representing 80 percent or more of the state’s population. Compliance would be verified by the Department of Energy. Competitive awards for local government, disbursed through the federal Department of Housing and Urban Development (HUD) would be used to assist localities with building code enforcement.

• The federal sale of carbon allowances would be used to fund building retrofit initiatives to promote energy efficiency, to be known collectively as the Retrofit for Energy and Environmental Performance (REEP) program. REEP would be administered by the U.S. Environmental Protection Agency (EPA), in consultation with DOE and the U.S. Department of Housing and Urban Development. REEP funds would be distributed through states and local governments and could be used for the establishment or operation of the establishment of revolving loan funds, loan guarantees, or other forms of financial assistance. [The REEP program is part of a larger effort to pass through to states funds raised by the auction of carbon allowances; this initiative allows state governments to establish State Energy and Environmental Development (SEED) accounts with proceeds raised by carbon allowance auctions.]

• Building energy performance under REEP would be documented through Energy Star Portfolio Manager, the Home Energy Rating System (HERS) rating system, or other energy modeling software approved by EPA.

• A model building energy labeling program would be created by EPA in consultation with the Department of Energy within a year of enactment of H.R. 2454. Labels would be proposed for new commercial and residential buildings and demonstration programs conducted to help develop the model label and to test the usefulness of labeling in additional building types.

• The development of net zero energy buildings would also be funded through demonstration grants.

What are the real estate industry implications of the House cap and trade legislation? If the bill should pass the Senate in substantially similar form later this year (by no means a sure thing) the U.S. real estate industry will be reshaped in the following ways:

• Increasing reliance on building codes (instead of voluntary standards such as LEED) to establish energy efficiency and green building practices.

• A stronger role for the federal government in prescribing building energy efficiency requirements.

• Increasing standardization in building energy performance metrics in the commercial and residential sectors.

• Greater reliance on the public sector and on public-private partnerships in creating and financing building energy efficiency programs.

• Growing employment in green collar jobs related to building energy efficiency.

An unanswered question is whether the increasing importance of building energy efficiency will accelerate real estate industry consolidation.

It is possible that the combined effect of new building energy standards and energy efficiency labeling will leave under-capitalized building owners — who cannot afford energy efficiency retrofits — at a more significant competitive disadvantage.

At the same time, the playing field could be leveled by public programs that provide financial assistance directed to smaller commercial property owners and households.

The legislation, if enacted, is transformative. Residential and commercial buildings, multifamily and low income housing, new and existing buildings, development and real estate finance will all be impacted. The surprise is how quickly the time frames are proposed. The reasons appear centered on the substantial opportunity buildings offer, with almost 48 percent of all greenhouse gas emissions and 70 percent of projected electricity use over the next decade.

About Investment Analytics Group (IAG)
Investment Analytics Group (IAG) was established in December 2006 ago to provide integrated commercial real estate advisory services to investors. Our core services include asset level due diligence, asset management, financial modeling, feasibility studies and other related advisory services. Our business model and services are not reactionary to what many other firms consider “opportunity” in this current distressed environment. For more information visit us at www.iagroupllc.com or contact us at 208.846.8476 or info@iagroupllc.com.

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The Commercial Property New’s Dee Stribling wrote an interesting article about how the commercial real estate industry is changing its green movement. During the recent commercial real estate boom, developers and owners had the luxury of deciding how and if they would incorporate green elements into their new buildings. The CPN article argues that the one-time voluntary decision is becoming an industry mandate, driven by LEED and the US Green Building Council.

You can read the full article here.

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