New Year’s Message
As 2009 draws to a close I thought this an appropriate time to not only sum up my thoughts on what has been a tough year, but also to share my feelings on what I believe will be a better 2010. I would also be remiss if I didn’t use this opportunity to thank our stakeholders for their continued support, without which, we would not have fared as well as we did. The contributions of our clients, employees, investors and partners have been truly remarkable, and I can’t imagine having to navigate 2009 without their steadfast commitment to the Sperry Van Ness brand. Please accept my wishes for a very happy and safe Holiday Season as well as a prosperous New Year.
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.
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.
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.
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.