The news continues to be filled with uncertainty about the current and future condition of the commercial real estate market. While there are a variety of opinions, the consensus is that no one really knows what the future holds, as this economic downturn has been unique in its depth and breadth. So how should investors proceed in these uncertain times?
“There is no question that the past year has caused a great degree of stress in the capital markets and subsequently for investors,” says Ginger Gelsheimer, a vice president with CB Richard Ellis’ Private Client Group. “Current investors saw challenges to their existing properties, while the risk adverse lending brought both dispositions and acquisitions to a standstill. Everything ground to a halt.”
Smart Business spoke with Gelsheimer to get an update on the commercial market as we move into the second half of the year and to see if there is some clarity ahead.
When do you expect to see some stability in the market?
Stability will begin to occur when value can be re-established. The heated market conditions over the past few years served to distort value in many cases. Very aggressive underwriting and an almost endless supply of capital drove prices to all-time highs. Risk was continually reassessed and repriced. Today, it is a very different environment. First, it is almost impossible to use those transactions as comparable sales, which typically are one of the best measures of what the market will bear. In addition, today’s underwriting standards are much more stringent and available capital is very risk adverse. As pricing has adjusted, however, we are beginning to see buyers looking to again acquire. This is a good sign as expectations between sellers and buyers are becoming more aligned, and value can be re-established, creating the ‘new normal.’
So why should investors come back to commercial real estate?
While certainly cyclical in nature, over the long term, real estate has been an important part of a diversified portfolio, especially for the private sector. There is much that can be said for owning a tangible asset that can provide an annual cash flow and potential long-term appreciation. While not as liquid as securities, the equity markets have also shown their vulnerability to adverse economic conditions. In either situation, however, buying at the right time is always the basis for garnering long-term wealth. With values being reset, those with the available financial resources will be able to acquire commercial real estate at some of the best pricing seen in years. In addition, the lack of new development will help keep the fundamentals of supply and demand in check.
If, in fact, value is stabilizing, is financing available?
It appears that the banks have made good progress this year with their balance sheets and so this lending source is slowly opening up. However, with the collapse of the CMBS (collateral mortgage backed securities) market, which funded the majority of the commercial transactions over the past few years, there are fewer alternatives available. Again, underwriting is very stringent and debt-to-equity requirements have changed dramatically. For good quality assets — now more reasonably priced — and with real equity in place, debt is available. Many private buyers, however, are ‘all cash’ purchasers, so that eliminates the financing piece in some cases.
Have the current market conditions created opportunities for private investors that they may not have had previously?
In the peak of the market, high-net-worth private investors were at times challenged when pursuing institutionally owned, high-quality assets, even if they were offering more. Many institutions were simply more comfortable dealing with another like entity, especially if they had transacted together previously. Now, however, there is an opportunity for these private investors to win trophy assets, especially in the secondary markets, where institutional capital is still sidelined for the most part. In addition, private investors have a less complex approval process, so their ability to move forward can typically expedite the transaction process.
Will the demand support future commercial investments?
There is no question that the effects of the current economy have dampened demand for almost every type of commercial real estate. However, it is important to remember that we are a community of nearly 3 million people and with that comes a built-in need for goods and services. While the rapid pace of growth was seen as opportunistic, it was also unsustainable and caused many challenges. I expect that as we begin this recovery period we will see a more balanced period of growth, which will be better fundamentally long term. We are on the cusp of the next growth curve and those that participate now will be well positioned for the opportunities ahead.
