For many years, we at SVN have issued our annual Top Markets to Watch report.  Segmented by product type, the report seeks not to dissuade investors from targeting markets omitted from the report, but rather to highlight those markets which we believe to be positively influenced by emerging trends.  Included in the third issue of our The Advisor magazine, it is our hope that you extract actionable insights from the report’s rich content, regardless of your position in the industry. A brief synopsis is as follows:

Defying expectations during the depths of the financial crisis, an extraordinary investment rebound in major coastal markets fueled a rapid recovery in sales volume in late 2010. In 2011, sharply lower cap rates in these major markets are motivating investors to explore a broader range of opportunities. Apart from the search for yield, the improving economic outlook and a revival of credit channels, including the CMBS market, are now enabling buyers to reengage with sellers across a widening geography.

The metros included in this year’s Top Markets to Watch lists reflect this evolution and are as varied as today’s investors. Some markets and property types will appeal to buyers eager to compete aggressively for highly liquid properties. Other markets will appeal to discerning investors with an eye for long-term value or the turnaround potential of a distressed asset. The common thread, every market in this year’s lists offers a unique opportunity for investors to capitalize on commercial real estate’s resurgence.

The Advisor Magazine – Top Markets to Watch.

For nearly 20 years, Sam Zell, the grave dancing, yet eternally optimistic public and private entrepreneurial investor, has issued hard hitting prognostications. In typical, creative, Zell fashion, he delivers his predictions for the year ahead in the form of year end gifts – bronze encased music boxes. Redesigned each year with a new look and feel, their one commonality is that all of the boxes share one feature – when you press a button, you are rewarded with the music of a popular tune, accompanied by lyrics, written (but not sung) by Zell, wherein he expresses his current view of the world.

On the heels of a difficult 1994, Zell’s music box theme was “Staying Alive,” which, perhaps, would have been equally apropos in any of the last 3 years.  The music in 2005 was set to Burt Bacharach’s “Raindrops” classic, which included such lyrics as “Capital is raining on my head…”  But my all time favorite was his 1999 edition, the theme of which was “The Emperor Has No Clothes,” where Zell played off of the similarly titled Hans Christian Anderson story, suggesting, with remarkable accuracy, that the valuations of the technology companies of the day were way out of whack – without balance sheets, earnings, and in some cases, revenue.  Interestingly, and consistent with his 1994 theme, the lyrics could be applied to later, more contemporary controversies, such as the over-valued commercial real estate market of a few years ago.

Like him or not, find him combative or just succinct and to the point, today’s post is not intended to exalt Sam Zell, but rather to steer you to a powerful collection of Zellesque music boxes:   The folks at www.CRE-Advice.com have assembled the first ever, free and online Commercial Real Estate Leadership Summit, which features industry insights, market overviews, and prognostications from close to one dozen of the commercial real estate industry’s thought leaders…it’s like having unfettered access to some of the most influential leaders in CRE on your time and in a setting of your choosing…or like pressing play on a dozen of Sam Zell’s music boxes.

I was a participant, and my video contribution appears in the video above.  You can gain access to the free summit by registering here: CRE-Advice Leadership Summit

A Strong Close to 2010

Following two years of unprecedented upheaval, commercial real estate market conditions have improved markedly over the course of 2010. In the final days of December, Real Capital Analytics reports that the rush to bring deals to closing has pushed national transaction volume for the year past the $100 billion milestone, roughly doubling the market’s tally for 2009. This improvement in property sales reflects investor confidence in the long-term prospects for our industry as well as improvements, though sometimes modest, in supporting measures of economic and job market activity.

Coinciding with rising sales volume, broad measures of property prices have also firmed in 2010. Over the last three quarters, cap rates have fallen for virtually all property types. The gulf in pricing expectations that separated buyers and sellers in 2009 has narrowed, closing the “bid-ask” spread and allowing more parties to come to agreement. More confident in market valuations than during the depths of the recession, lenders have shown increasing eagerness to make loans for high quality property sales in recent months. While many banks are drawing down their commercial real estate portfolios, the CMBS pipeline is now reestablishing itself with roughly $15 billion of securitization projected for the first quarter of the New Year…a positive combination of events, indeed.

Imbalances in the Recovery

The overarching trends show an industry on a sustainable path of recovery. But as with any recovery that is not backed by a robust economy, the last year’s gains in commercial real estate investment activity and pricing have been uneven. Similarly, mortgage-financing terms have improved in the strongest investment markets while credit too often remained constrained elsewhere. Our team is acutely aware that the headline statistics of national sales activity do not properly convey these differences across our broad array of markets.

For much of the last year, the weight of institutional investor and lender interest has favored larger deals in a small group of coastal markets. Capital inflows to these markets have been unusually concentrated, pushing prices higher. According to the Moody’s/REAL Commercial Property Price Index, based on data from Real Capital Analytics, property prices have come off their lows. In the top three markets – New York City, Washington, DC, and San Francisco – they have done much more than that, rising 38 percent since 2009. As competition for trophy assets in these markets has intensified in recent months, a handful of record-setting deals have been added to the rolls. While that is welcome evidence of the market’s improving vigor, gains in the $500 thousand to $5 million segment of the market have lagged trends for larger properties in 2010, as has investor appetite for assets in non-primary markets. This, however, is quickly changing, and secondary and tertiary markets are back on the radar screens of opportunistic investors.

At the year’s close, the transaction record shows clearly that greater momentum is building in a wider range of markets and for a more diverse pool of properties than even just a few months ago. It is with this in mind that I offer some thoughts on the outlook for 2010:

The Economy

At this time last year, I described a scenario of measured growth in 2010, characterized by slow but sustained expansion in economic activity and an eventual return to business hiring. Consistent with these projections, the economy has expanded at a modest pace over the last year. Regrettably, the expansion has been insufficient to dent our national unemployment challenge. Barring any unexpected shocks, such as that which might result from a serious deterioration of sovereign debt conditions in Europe, the outlook for 2011 is brighter. The consensus among economists and industry leaders points to a much-needed acceleration in growth in the coming quarters, supported by the extension of tax cuts and the temporary payroll tax holiday. Consumer and business confidence has improved as well, benefiting retail spending and business investment and inventory levels.

While job growth has been flat out disappointing, leaving too many American families out of work this holiday season, employment has stabilized tremendously over the last year. Key to the stabilization of commercial real estate fundamentals, employers created almost one million net new jobs in 2010. In 2009, in contrast, employers cut nearly five million jobs. While current employment trends fall far short of healthy levels, the return to even modest job growth has ended the freefall in property rents and occupancy levels that has undermined buyer confidence, sense of value, and should be viewed as a good sign. With a stronger growth potential in 2011, we can look forward to more sustained job creation and further stabilization in property cash flow. A long road lies ahead, I’m not underestimating the challenge before us, but employment is trending in a positive direction.

Investment Activity

Following December’s year-end rush of closings, activity may appear to lull in the early months of the New Year. Offering volumes and deals now coming into contract portend a sustained improvement in activity underlying these seasonal fluctuations. As for how the market landscape will evolve over the next year, several key issues now dominate the drivers of investment trends:

More Balance Across Markets

Already evident from recent transaction activity, the erosion of yields in the most visible markets is now leading investors to broaden their sights. Buyer interest in relatively smaller-scale assets and in secondary and tertiary markets is on the upswing. Of course, the outlook for property fundamentals remains a consideration for many potential investors in these markets. As a result, improvements in pricing and sales volume have clearly favored high quality assets with strong tenant rolls and limited short-term exposure to leasing risk. Assets with this level of stability, and which are located in non-primary markets are now receiving considerable attention, which is another indication of an improving market. Investor willingness to geographically diversify will increase markedly in the coming quarters.

Less Distress But More Distress to Buy

Opportunities to invest in distress have been growing in 2010 though distress sales have not been allowed to overwhelm the market. Expect this to continue. For many investors, this controlled approach to distress management by banks and other lenders has been frustrating. The availability of distressed properties in the for-sale market will continue to increase in 2011, supported by generally improving investment conditions, and lender willingness to cleanse their balance sheets. But the floodgates will not be released and prices for these assets will remain higher than during previous cycles. Note sales will continue to play an integral part in the distressed asset market, and we expect loan sales volume to increase significantly in 2011.

Rising Interest Rates

One of the emerging challenges facing the industry results from rising interest rates. Up to now, the recovery has been supported by extraordinary interventions by the Federal Reserve, an absence of inflation, and very low interest rates. This combination of circumstances has kept borrowing costs low for qualifying investors and has also eased the path to refinancing and, in distress situations, modification of loans. In recent weeks, long-term interest rates have been rising even though inflation remains subdued. Already, higher treasury rates have resulted in a rise in 30-year residential mortgage rates, dampening the outlook for housing markets. In the arena of commercial real estate, we will have to remain watchful for the impact of rising interest rates on cap rates and the impact on borrowing costs. While cap rates will not necessarily rise with interest rates, lenders may be forced to raise lending rates.

Conclusions

• Buying into the recently firmed US market now, taking advantage of low interest rates (which have nowhere to go but up) is a strategy that many astute investors will implement. This said, we will not see a “rush” of activity stemming from the newly established pricing floor.

• Given the market’s positive momentum, locking-in historically low lease rates (for 5 & 10 yr. terms) will become much more prevalent in 2011. H2 leasing volume levels suggest that this is already occurring.

• Geographic diversity and a willingness to pursue quality investments in secondary & tertiary markets (where spreads are greater, competition is weaker) is a key to re-entering the market in 2011. We will see much more of this in the year ahead – first with performing assets in secondary markets, followed by same in tertiary markets.

• As opportunities to invest in distressed assets remain less than plentiful, real property investors will look to note acquisitions with more interest. In many respects, a note purchase will continue to be the shortest path to real property ownership of troubled assets.

• 2011 will represent a calendar year of overall recovery – more balanced than we saw in 2010, but not without fits and starts.

Look around the commercial real estate industry and you’ll find that many practitioners have taken shelter and have even found comfort in the weakened market as far as their low transaction and production levels are concerned. Other slightly more optimistic practitioners are working, but were perhaps late to the restructure game, are in “batten down the hatches” mode and are hyper focused on the “now.” With so much pressure to survive current challenges, my fear is that many will take their eye off the real drivers of long-term success: vision, strategy, and innovation.

There is no denying that the commercial real estate industry has struggled over the past 2 years. It is human nature when things are tough to get very tactical – survival mode requires you to live in the moment. That said, winning the battle does you little good if you lose the war.

Dr. Sam Chandon, of Real Capital Analytics, recently spoke at the SVN national conference, and had the following to say about U.S. sales volume: “Just as we found it hard to believe that 2007′s record setting sales volume levels would appreciably decrease, so goes the common belief that 2009′s extraordinary low sales volume levels will appreciably increase any time soon.” In other words, regardless of how you may feel about current market dynamics, the one thing I can assure you of, is that what we’re experiencing today, won’t be what we have to contend with tomorrow.

My challenge to you is to not confuse surviving with thriving. Take the lessons learned over the past two years and apply your new found tough mindedness to forward thinking actions. Begin to reevaluate your operating strategy, consider increasing investment back into your business, start applying strategic focus to preparing for where the market is going, because it will be there faster than you realize. And while it might be less dangerous to fail to capitalize on a market upturn than to over invest in your business too soon, the former failure is just as tragic – capitalizing on emerging markets, timing upturns, developing strategies that deliver results, and earning are why you are in business.

The bottom line is this…It is not possible to prepare for the future without anticipating the future. In fact, the most important job that I have as CEO of SVN is to describe the future, to anticipate what lies ahead. Your job as CEO of your practice, or as CEO of “You,” is to do the same.

If your comfort zone as a leader has been built around the discomfort associated with current market conditions, it is incumbent upon you to break out of this unhealthy mindset. You cannot grow a business by maintaining the status quo, and in fact, any attempt to do so is an exercise in frivolity. For the good of your business, to the benefit of those you serve, and for the betterment of the industry it is time to elevate your vision and begin to look forward.

The Year Ahead | December 2009
The last year’s upheavals in the economy and credit markets have presented commercial real estate market participants with unprecedented challenges. The ablest and the most innovative have survived the year and, in some cases, have been able to seize upon change to flourish amidst the disarray. The industry’s ranks have been thinned somewhat, but those of us who now look forward to 2010 are better positioned to shape the market than any group that has preceded us.

The next year will not be an easy one – the recovery will come in fits and starts, at least at first – but the outlook is brighter than was originally forecast.  While certainly good news, I would remind you that good brokers find ways to succeed in any market.  Given our high level of specialization and encyclopedic market knowledge, our rare and collaborative culture, the industry’s only true “client’s interests first” philosophy, and a focus on the $500 thousand to $5 million segment of the market, I see few firms capitalizing on 2010 opportunities as well as SVN. In the text that follows, I will share my thoughts on the economy, the commercial real estate market, the profile of the 2010 buyer, and will issue some predictions for the future.

The Economy
At the year’s close, it is apparent that our worst fears for the economy and our industry have thankfully not been realized. Instead of a protracted period of economic malaise, the weight of evidence now shows that the economy returned to modest growth in the third quarter. Temporary employment numbers (a leading indicator of permanent employment conditions) have improved and job losses have eased substantially, narrowing to a small fraction of the cuts reported at the beginning of the year. As anxiety over record job losses has subsided, consumer and business confidence has improved.

Looking forward, the consensus amongst economists and industry leaders calls for measured growth over the next year. Lagging the stabilization in the health of businesses, and barring any unexpected shocks, sustainable job growth is anticipated towards the end of the 2010. This is, of course, welcome news for the commercial real estate industry, since improvements in demand for space depend critically on new jobs replacing the millions that have been lost.

Investment Activity
It was a mind-numbingly slow year in the investment sales market.  From a low-point in the first half of 2009, investment activity has been improving in the second half of the year.  Sales volume increased to $12.4 billion in third quarter, according to data from Real Capital Analytics, up 27 percent from the second quarter and 35 percent from the first quarter.  Annualized sales volume to date is at the astonishingly low level of $40 billion.

What will 2010 look like?  Some economists predict that volume will rise to just over $70 billion next year. Sales volume in Q4 will be in the $15 billion range, which suggests an annualized run rate of $60 billion, and a modest increase of 20% certainly support this 2010 estimate.

Who is buying?  Growing from a small base, equity funds reported an increase in acquisitions of nearly 50 percent between the second and third quarters. While equity investors remain a relatively small share of overall activity, they will capture a larger share of total activity in the next year. Public REITs also reported large increases in asset purchases, supported by capital-raising earlier this year, and will pay a larger role in 2010.  The trading “action,” however, will continue to be on the smaller end of the spectrum.  Properties in the $500 thousand to $2million range, purchased by private investors, will dominate the year.  Brokers, buyers, and sellers of properties in this category can expect to be the busiest in 2010, relative to all other price points.  This too, is welcome news for SVN Advisors whose focus has long been on properties in this price class.

On the supply side of the investment equation, distressed asset sales have clearly fallen short of equity and opportunistic investors’ hopes thus far, yet some of the impediments to this market are expected to ease over the next few quarters.  In particular, banks that have been unwilling or unable to offload problem loans because of large anticipated losses will be better able to do so as other aspects of their business normalize. The inevitable deterioration in cash flow that is resulting from current lease rollovers is also increasing pressure on less-able property owners who are increasingly inclined to see their assets in the hands of best-in-class operators.  Distressed asset sales activity will pick-up markedly in 2010, but we will not see a repeat of the early 90’s, nor will we see a return of the RTC.

While the market has been slow to develop momentum, the underlying signals point to further improvement. MIT’s Transaction-Based Index shows a 12 percent spike in its measure of demand in the third quarter, and the bid/ask spread, or “cap gap” is narrowing, in part, because of further concessions on the part of sellers.

2010 Transactions
The adage, “Seller’s sell based on pain or opportunity,” can be applied to any commercial real estate market, even that of 2009/10.  Certainly, a high percentage of sellers in the next 12 months will be in some sort of distress, others whose need to sell, while not immediate but must occur within the next few years, will capitalize on the lack of properly priced supply and will find opportunity by selling in a low competitive, Q1, 2010 environment vs. a market which will feature an increasing amount of listings and more competition as the year progresses.   It’s a simple function of supply and demand.

In examining the profile of the 2010 buyer, I could start and stop by commenting on the incredible buying opportunities that this emerging market will present, discuss the massive exchange of wealth, but those topics are old news by now, so I’ll offer the following as reasons that buyers will strike deals in 2010:

• Buying real estate as a hedge against inflation: And inflation is coming…While CRE as a hedge against inflation is an invalid strategy when significant supply and demand imbalances exist (as they do today), long-term holds of properties in “A” markets can compensate investors for an inflation premium.  Conversely, inflation will lead to higher interest rates, which can be disruptive to the market and negatively impact property values.  Views on the subject differ, yet buyers will re-enter the commercial real estate market in 2010, citing hedges against inflation as their reasons for buying.
• Low interest rates: Clearly, interest rates are not the issue today, and credit availability is hindering sales volume.  Fact remains that interest rates are at historically low levels, will remain low for most of 2010, and a bevy of investors will capitalize on this opportunity over the next 12 months.  Group buying and seller financing will bring private investors to the low LTV table, cash rich equity funds and REITs will also benefit from the low interest rate environment.
• Investors have to do something with their money: You can buy in to the investment grade bond market and earn a whopping 3.75%, or you can buy NNN leased, credit tenant real estate and more than double your return.  As Bill Gross of PIMCO points out as a cost of capital sitting on the sidelines: “an effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive.”  In 2010, buyers will exit the payless funds earning close to 0% in search of manageable risk.  Quality commercial real estate will receive considerable attention in this context.

Because problems with debt structure will motivate a large number of sales, pricing will remain in flux in the next year.  As a result, headline measures of cap rates will fail as indicators of the underlying variation in property trades.  Rather, buyers and sellers alike will be depending on their Advisor’s knowledge of the market and of the emerging mechanisms of exchange – such as auctions ­– to guide their investment strategy.  Investors with strong operational capabilities who are seeking to acquire assets over the next year are in an ideal position.  This group will be able to purchase assets during a period of dislocation, before asset prices normalize and while long-term yields are at the their peak.

Advisors that anticipate and master the new models of engagement will lead the pack in the months and years to come.  Advisors, and not brokers, are poised to have a productive 2010, as clients demand encyclopedic knowledge of the real estate markets, capital markets, and consultative service from practitioners who possess creative, problem solving skill sets.  “Matchmaking” brokers will be forced to leave the business as they are squeezed out by more talented Advisors.

Call to Action
My suggestion as you move forward in 2010 is to take what’s written above, couple it with the valuable knowledge you’ve gained during the last year and reach out to your clients and prospects. Offer to help them refine their investment strategy to reflect what will be happening in the year ahead, and help them not to be blinded by what happened in the year we’re leaving behind.

Okay, back to the original questions: why a blog and why now? I happen to possess a passion for two age old disciplines: communication via the written word, and applied critical thinking. With a penchant for these two disciplines, how could I possibly pass-up blogging? It is also important for you to understand that as I assumed the role of President and CEO back in December, I committed to myself and to my board that I’d take an aggressive and active role in expanding my role within the industry, as well as broadening the reach of our voice in the marketplace. While most of my peers have yet to embrace the blogosphere, I’ve never been accused of being bashful, but more importantly, I can’t think of a better way to communicate with my stakeholders. So, after having worked with an incredible team to restructure Sperry Van Ness (we were the first of the nationals to act in Dec, 2007), turning our model into a franchise only, scalable, sustainable and healthy business, I felt it was time to issue periodic commentary and to reach out for feedback.  In my role as President & CEO, I highly value the input of our clients, advisors, lenders, investors, and partners. I therefore felt there was no better forum to communicate this message than via this inaugural blog post…

The world has a few great thinkers, and many a pontificator who thinks they’re great. I don’t really fall into either camp, but in the weeks and months ahead via this medium, I hope to simply bring you a combination of personal thoughts, professional observations, corporate announcements, pithy musings, the occasional rant, and other topical content of interest in order to challenge your thinking and to hopefully make a positive impact in your world. 

So, why the changes you ask? It is important for you to understand that all the recent corporate changes you have witnessed in this first half of 2009 have been in direct response to your feedback and input. The simple truth of the matter is that you have spoken, and unlike many service providers in the market place, we have listened. In the text that follows, I’ll provide you with three representative examples of some of the more noticeable changes, but I’ll also provide a summary of what those changes mean to you, and things you can look forward to in the months ahead:

• Our Tag Line: The bottom line is that we’ve embarked upon the path of reengineering our brand to more closely reflect our attitude, culture and brand promise. The first step in this process was introducing a new corporate tagline. While the spirit of our old tagline “Maximum Competition Equals Maximum Value” remains entrenched in our credo and our methodology, our new tagline “Your Creative Edge” sets a new tone for how we’ll communicate, collaborate, and innovate with our customers and partners moving forward. The new tagline provides a simple, and clearly communicated, direct correlation to providing our clients with a much needed edge in an increasingly tough and competitive market.  There are new buyers, sellers, rules and regulations, and thus the need to be creative and innovative in resolving complex real estate issues will be keys to success for the foreseeable future. In a business known for its self-centered competiveness, we built our business model (and brand) on a very simple premise – a total commitment to a customer centric culture, while breaking the rules of the non-cooperative broker establishment with our philosophy and process designed for clients, not our own self-interests.  This has been our consistent strategy, not one we adopt when it suits our needs, but simply because we passionately believe this is the way it should be – We believe these are the primary value propositions that our clients look for when selecting their professional advisors, and they are clearly two of our main business drivers.

• The Sperry Van Ness Asset Recovery Team: Launched late last year, this group of 65 advisors specializes in distressed asset sales and provides immediate, nationwide  underwriting and disposition solutions to financial institutions and real estate clients with distressed portfolio assets. Sperry Van Ness is the only national commercial brokerage with an integrated auction division, which will play an active, important and valuable role in the distressed asset arena for years to come.  Collaborating with 950 Sperry Van Ness “boots on the ground” the “ART” has coverage in “A” markets throughout the US, but has the most comprehensive footprint in the industry in “B” and tertiary markets, which are homes to thousands of distressed assets.  Sperry Van Ness remains unique in this regard. 
   

• The Sperry Van Ness Magazine: You’ll notice that we have released The Advisor   which is just another example of the steps we’ve taken to add value to your interactions with our firm. Here, we’re making substantial, but smart investments in expanding our efforts at providing you with market data, industry information, and timely advice to better help you manage market complexities.

I realize that today’s post was a bit lengthy given the medium, but because it was my first, I wanted to take the time to lay a solid foundation. In the weeks and months that follow I’ll continue to announce new roll-outs designed to continue our focus on improving your customer experience with Sperry Van Ness. And have no fear…I won’t hesitate to offer my thoughts, commentary and updates on industry current events. As always, I welcome your comments, input and feedback.