Commercial Investment Real Estate - If, When, and Why?

Posted By: Dewey Struble, CCIM
Senior Investment Advisor
dewey.stuble@svn.com
775.825.3330





What national investment market? With the overall economy weakness, deteriorating fundamentals, and the dearth of credit available in the commercial investment real estate market, times are TOUGH! Investment sales were down over 90% nationally in the first half of 2009. This followed, but dropped even more from the weakness experienced in 2008. The expected sales from the disposition of distressed assets by troubled lenders has not materialized in any meaningful way as there continues to be lots of “pretending and extending”. Such factors have lead to pervasive sales declines in all the property sectors. Vacancies increased first, and have then been followed by significant rent declines and increased concessions.

Cap rates have increased with the increased risks and the cost of what credit is available, thus further depressing values. The chasm between Asked and Bid remains wide as only severely distressed Sellers are making deals. There has not been too much Seller financing yet, but that should increase in the near term and “manufacture” some closings.

Many experts expect an uptick in sales, albeit at lesser prices, as we wind down to the end of 2009. As the large land buys are more of a speculation than an investment, those few transactions, plus considerably more smallish Owner-User sales are not counted as investment sales in this analysis. Word from offshore is positive for the outlook for investment in the U.S., and that is a decent forward indicator. As the market adjusts to the new real values, and more credit comes available, both from Sellers and new credit facilities not even in the market yet, expect a slow, but steady increase in investment sales going into 2010.

Tempering that bit of good news is the huge cloud hanging over the market with the multitude of maturing CMBS Loans coming due in the next few years, and no known solid solution yet.

Locally, we have also experienced very weak fundamentals, and in what has been a rare occurrence, actually worse than the national averages. This is especially noteworthy in the employment numbers, and the sky high unemployment. Northern Nevada certainly was not immune from the housing crash and that overbuilding and credit disaster started the bad swing here, and faster than in almost all other areas of the United States. Office buildings felt his right away, and subsequently retail properties. The primary issue for industrial nearby was driven by an oversupply of product, which, when coupled with the weak fundamentals, also hurt the big boxes dramatically. Retail also has suffered from an oversupply along with the many vacant homes and lack of new rooftops.

With Northern Nevada’s reliance on the tourism industry, and the recent poor numbers of visitors to Reno and Sparks, obviously the hotel market has been impacted negatively, and throughout all property types the slowdown has been felt.

A bit unique for Northern Nevada is the slowdown of investment equity coming into the market from 1031 Tax Deferred Exchange Buyers moving equity to Nevada. Their inability to sell their investment properties in California and other states due to the national recession is the primary cause.

As a Secondary-Tertiary market, Northern Nevada is even more impacted than larger markets by the “credit crunch”, and when combined with the horribly weak economic fundamentals, sales have been virtually non-existent in 2009, and even worse than in late 2008. The large industrial sale by Prologis to Stockbridge is noteworthy, but in reality was just part of a larger portfolio sale where some of the assets were located in Northern Nevada. As occurred nationally, cap rates have been increasing and prices decreasing. This negative trend actually almost doubled in early 2009 from late 2008! On a brighter note, this downturn should slow down as we go further into 2009, and turnaround in 2010. Reno-Sparks fell quickly when the downturn hit, but we should expect a relatively faster upswing once things turnaround in Northern Nevada.


MULTIFAMILY MARKET

The national multifamily market is a significant part of the properties that were sold or refinanced in the past five years in amounts totaling some $2.2Trillion. Many of these properties were leveraged in this five year period at a 70-80% level, and now are “troubled” since values have dropped so far that there is now little or negative equity. Prices for sold properties have dropped some 35-40% nationally, and while not good, apartments have only dropped some 15-20%. Unique in the market today, there has also been a pick up in sales of apartment complexes in the second quarter of 2009, especially in smaller and mid-sized complexes.

The plus for apartments nationally and locally has been the constraint on adding additional supply in the markets. The primary challenge to the fundamentals nationally and locally has been demand with the weak economy, high and growing unemployment, and the resultant job growth losses. While not unique nationally, the job growth multifamily key indicator has also dropped in Northern Nevada which has been unique in recent years and has proven disastrous to occupancy and rates in Reno-Sparks.

As with all real estate of late, the lack of and challenges involved in obtaining credit has also impacted the multifamily markets, just not to the same levels as office, retail, industrial and hotels. With the federal governments behind HUD, Fannie Mae and Freddie Mac, which has accounted for more than 60% of recent multifamily financings, the credit crunch has not been as bad for apartments except in the $50 Million plus transactions which have all but dried up. This is contrary to the current and looming disaster in the CMBS Markets which is the fastest growing sector for distressed loans, and stands at almost $40 Billion!

For the first time in recent history, multifamily sales increased nationally in the second quarter of 2009. The same could not be said locally, but an uptick in transactions is expected in Reno-Sparks by the end of 2009. Offering prices have finally started to decrease, and the former problem of unrealistic expectations of both sellers and buyers creating a large bid-ask spread is beginning to be mitigated as cap rates increase somewhat. Locally and throughout the Western U.S., the cap rates are the lowest here compared to the national and regional numbers.

Very poor job growth locally has created the anomaly, at least in my 30+ years of experience in Northern Nevada, of very weak demand for multifamily rentals. During all the former periods of notable stress in the local multifamily markets, it was caused by excess supply. In this major recession, the supply has been kept in check, and overall in 2009, the supply will be less than normal with the unfortunate fire at The Alexander in South Reno. With the relative land and resource costs still relatively high for new multifamily development, coupled with the dearth of construction financing, it is not expected that excess supply will occur any time soon. It is expected that the weak fundamentals of the past couple years has reached its nadir, and should begin improving in late 2009. Constrained supply addition and increased demand bodes well for the next few years in Northern Nevada. While not great when compared to our historical results, single digit vacancy rates can be expected within a year’s time.

Sales should also pick up, but at lower values. Cap rates will push toward 7% on actual numbers in nicer complexes, and toward 8% in lesser quality and/or poorer located apartments. Price premiums will be negotiated where Sellers carry financing on their deals. As other Western states, and especially California, improve economically and in the sales of investment real estate, the monies from 1031 Tax Deferred Exchanges should flow again to Nevada and increase the number of sales, and the values of apartments.

Finding the Bottom vs. Finding Value

Posted by: Thomas Y. Johnson, CCIM
Managing Director
Email: johnsont@svn.com
775.825.3330




Arriving at a decision on the best strategy for how to successfully navigate the commercial real estate market during these challenging economic times is vexing to many an investor. Do I, or don’t I??? That is the conundrum facing most commercial real estate investors in today’s market. Do I, or don’t I liquidate my portfolio (or at least my non-performing assets)? Do I, or don’t I stand on the sidelines and wait-out these turbulent times? Do I, or don’t’ I get aggressive and take advantage of the decline in property values and the spike in acquisition cap rates? In the text that follows I’ll put forth counsel based not upon the emotions of the times, but rather the forthcoming advice is based upon my years of experience in successfully advising clients in both advancing and declining commercial real estate markets.

It is often said that you can only count on two things in life: death and taxes. There is a third thing that is often overlooked…market volatility. Whether markets are moving up or down isn’t really the issue. The issue is whether or not value can be added or created in the investment being considered. What tends to happen to the non-sophisticated commercial real estate investor is that they rely on upward moving markets to create value for them. If the market happens to move in your favor that is a plus, but it should not be the sole basis upon which your investment decision is made. You need to be able to add value to an asset through operational improvements, repositioning, restructuring, recapitalizing, re-tenanting, or other proactive strategic or tactical value enhancements. This is the mark of a savvy investor.

It doesn’t really matter whether you’re looking at the equity market, commodities market, bond market, the commercial real estate market, or any other investment market, as all investment markets have certain similarities…It is my hope that the following five points will be useful in refining your investment philosophy moving forward:

1. Market Timing: Let me be very blunt right from the outset…not only is it an exercise in frivolity to try and time a market bottom, but many significant investment opportunities will simply pass you by as you stand on the sidelines waiting for that almighty market bottom to occur. I know…smart investors buy low and sell high right? Sure, but there is a difference between recognizing value and opportunity that lead to superior investment returns, and trying to wait for that ethereal moment in time that represents the exact bottom of a market. Put simply, one in a million will correctly time a market bottom, while many investors will generate significant returns by exploiting the opportunities that a declining market provides.
Finding The Bottom vs. Finding Value – Copyright © 2009 –Thomas Y. Johnson – Page 2 of 4

2. Professional vs. Amateur Investors: Tough times tend to separate the wheat from the chaff. The challenge facing most commercial real estate investors today is to become honest with themselves in determining whether they are in fact astute commercial real estate professionals, or whether they were among the masses just riding a wave while it lasted. You see professional investors are always in the market…during good times and bad. They understand that more "lasting wealth" is created in declining markets than in overheated advancing markets. You see it’s the non-professional investor (stupid money) that is both late to the market, and then overstays their welcome by holding on too long. In point number 1 above I mentioned top of the market…Whenever you reach a point in the market where everyone (even your cab driver) is a "real estate investor" you know you’ve found the top of the market.

3. Invest in Opportunities not Asset Classes: The most successful investors are fluid in their approach…they see changes in the market as being synonymous with the creation of new opportunities. While I certainly understand the synergies that come from developing a niche focus, I don’t believe they can make-up for the increase in diversification and scale that comes by exploiting opportunities across asset classes. Are you a retail investor, or a commercial real estate investor? Are you a multifamily investor or a commercial real estate investor? You see it is my belief that the core of sound commercial real estate investing is present across asset classes. The same characteristics that make an investment attractive in one asset class are ostensibly the same in others. Location, current market dynamics, tenant mix and quality, entitlement and construction risk, absorption and vacancy (supply and demand), age and construction quality, micro and macro economics, NOI and valuation drivers, etc. are relevant regardless of whether you’re investing in industrial or office assets. Furthermore, it’s important to be flexible in the structuring of your investment opportunities. As an example as long as the risk/reward ration falls within your investment guidelines it shouldn’t matter whether you are a principal in entirety, have a limited ownership interest, where you investment falls in the capital structure or any number of other considerations. You either like the opportunity or you don’t…the rest of the issues are just details to be worked out at the negotiating table.

4. Understanding Opportunity: Rarely will you come across a static opportunity in the sense that it will stand idle and wait for you to act…Significant opportunities are not only scarce, but they typically operate on the principal of diminishing returns. The longer you wait to seize the opportunity the smaller the return typically is. In fact, more likely is the case that the opportunity will completely evaporate if you wait too long to seize it. Keep this thought in mind; when opportunity knocks…answer the door. I can’t even begin to count the number of times I watched people miss great opportunities due to a poor sense of timing. Not too surprisingly, people who possess a poor sense of timing usually don’t even understand timing is an issue. How many times have you witnessed someone holding-out for a higher price, better valuation, evolving markets, technology advances, or any number of other circumstances that either never transpires, or by the time they do, the opportunistic advantage had disappeared? I’ve observed the risk adverse take due diligence one step too far, the greedy negotiate too long, the impulsive jump the gun, and the plodders move to slow. As the saying goes "timing is everything." The proverbial window closes on every opportunity at some point in time. As you approach each day I would challenge you to consistently evaluate the landscape and seize the opportunities that come your way. Better to be the one who catches the fish than the one who tells the story of the big one who got away…

5. Seeking Sound Counsel: The smartest commercial real estate investors surround themselves with professional advisors who extend their strengths, shore up their weakness, improve their access to market knowledge, and provide more visibility and broader access to investment opportunities. What really separates the successful investor from the average investor is that the successful investor has a broader sphere of influence and a larger network helping them to be successful than the novice investor. If you ever wonder why certain investors seem to get access to the best deals, it is usually because the professional investor simply enlists more resources working on their behalf.

My advice is this…don’t let the current market conditions intimidate you. Rather create an opportunistic approach to commercial real estate investment that will simply adapt your investment guidelines to the current market dynamics. There is every reason to get into the market and take advantage of once in a generation opportunities that exist now.

Thomas Y. Johnson, CCIM, serves as a Senior Advisor for Sperry Van Ness. With over 30 years of commercial real estate experience, Johnson specializes in office, industrial, retail and multi-family transactions in Northern Nevada.
Prior to joining Sperry Van Ness, Johnson founded Gold Dust Commercial Associates, a full service Commercial Real Estate firm located in Nevada's Capitol, Carson City. During his career, Johnson has been responsible for the sale of several key transactions, including the Ormsby House Hotel and Casino, Capital Plaza Business Center, Nye Lane Office Complex, Parkway Professional Complex and the Sierra Medical Center. He also successfully purchased and rehabilitated an entire city block of buildings in the Historic Downtown area of Carson City.
Johnson holds his Certified Commercial Investment Member (CCIM) designation, and has stayed an integrated part of the commercial real estate community. He has served as chairman of the Regional Planning Commission, as member and chairman of the Regional Redevelopment Authority, and as a chairman and member of the Board of Realtors since 1974. Johnson is also a member of the Western Bankers Association and the Northern Nevada Development Association.
Johnson received his bachelor's degree in Business from the University of Nevada, Las Vegas.