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.