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CIRE Magazine Investment Analysis
Buyers Are Back: Investors step into the light in search of safe bets.
by Beth Mattson-Teig

Commercial real estate investors are lumbering out of the woods and back into the game. The menagerie of buyers shopping for properties in today’s market runs the gamut from private individuals to billion-dollar institutions. But one thing they all have in common is that competitive spirit and a belief that commercial real estate markets have hit bottom.

“The volume in investor interest and activity is way up,” says Gary Hunter, CCIM, a managing broker and commercial investment specialist at Colliers International in Seattle. Over the past year, Hunter has closed several transactions totaling about $3.3 million. “At this point, demand for all asset classes is beginning to pick up with multifamily, small retail, and industrial buildings seeing the most activity in our market,” Hunter says.

Clearly, the desire — and the money — to get deals done exist. Investors who have been sitting on cash waiting for market fundamentals to stabilize are now getting ready to pull the trigger on acquisitions. Debt markets also are beginning to loosen with more capital available, especially for properties in strong locations that are well-leased to credit tenants.

Following a record-low year for sales transactions in 2009, commercial real estate sales volume rose in 2010 and many industry experts expect that momentum to continue in 2011. The volume of commercial real estate sales reached more than $120 billion in 2010. Although that is a marked improvement over the $54.5 billion in property that changed hands in 2009, it is still well off the record $514 billion in sales that occurred at the market peak in 2007, according to data from New York-based Real Capital Analytics. The research firm tracks office, industrial, retail, apartment, and hotel sales valued above $5 million.

Market Drivers

So what are some of the dynamics driving today’s investors? Overall, institutional buyers such as real estate investment trusts and life insurance companies are aggressively shopping major metros such as Washington, D.C., New York, and San Francisco for core properties in all segments of the market — apartments, retail, office, industrial, and hotels. Competition and pent-up demand for quality properties is pushing those buyers further out into secondary markets such as Minneapolis, Denver, and San Jose, Calif. Smaller private buyers, especially those with access to capital and local expertise, are finding solid investment opportunities outside of major metros in secondary and tertiary markets. Those private entities are pursuing a variety of strategies ranging from conservative triple net lease properties in Florida to opportunistic land acquisitions in busted residential subdivisions in Alabama.

Investors today are generally chasing properties in one of two categories: the relative “safety” of quality — well-leased properties in top markets — or the higher yields of opportunistic or distressed real estate assets. Core properties remain the favorite investment type.

“Throughout the entire year of 2010 there has been a tremendous flight to quality, whether it is retail, office, apartments or what have you,” says Craig Thomas, CCIM, a senior associate and associate director of the National Retail Group at Marcus & Millichap in Jacksonville, Fla. That demand reflects the caution that is still rampant in the marketplace today, and the recognition that both the economy and commercial real estate markets are still facing a long, slow recovery.

Top Investment Picks

Multifamily is the property of choice among buyers due to improving fundamentals and a positive outlook for strong renter demand. Apartment vacancies dropped from 8.0 percent in 2009 to 6.6 percent in fourth quarter 2010, while effective rents rose 2.3 percent in 2010, according to New York-based Reis. “The primary reasons for the strong interest in multifamily properties are the availability of financing and a growing supply of renters due to the echo boomers, aged 20 to 34, moving out of their parent’s house and into apartments,” says Andy Burnett, CCIM, a senior adviser at Sperry Van Ness/William T. Strange & Associates in Oklahoma City.

Government service entities such as Fannie Mae and Freddie Mac have continued to finance multifamily transactions over the past three years, which has helped to fuel sales transactions within that sector. For example, Sperry Van Ness/William T. Strange & Associates brokered the two largest multifamily transactions in the state of Oklahoma during 2010 with the $17.2 million sale of Regency Tower and the $19.7 million sale of Stoneleigh at May apartments. Both Oklahoma City transactions were funded through Freddie Mac.

In fact, demand for apartments is so strong that it is spurring buying activity across the spectrum of class A, B, and C properties in primary, secondary, and tertiary markets. That competition has put pressure on pricing. Capitalization rates for top quality mid- and high-rise apartments dropped 75 basis points in 2010 to average 5.5 percent in 3Q10 and remained unchanged in 4Q10, according to Real Capital Analytics.

“Apartments are always on the radar but are overpriced today,” says Ronald D. Jury, CCIM, president of Jury & Associates in Shawnee Mission, Kan. As a result, some investors — particularly those with access to capital and the ability to hold an asset long-term as the market recovers — are finding good value-added opportunities in other sectors. For example, it is a buyer’s market as it relates to office buildings that are either in foreclosure situations or are struggling with high vacancies. “With today’s unemployment, you have to have a strong investor who is willing to buy those because it is going to take five to seven years to get any type of occupancy back in those buildings,” Jury says.

Last fall, Jury assisted an owner-user in acquiring a 225,000-square-foot, class A office building in downtown Kansas City that included a covered parking garage for 565 cars. The property sold for just under $12 million, which is less than it cost to build the entire parking garage. “It is not often that you have an opportunity to buy a parking garage at cost and get a class A building thrown in for free as a part of the transaction,” Jury says. “It will be a long time before we see pricing like this again.”

Investors and lenders alike also are demonstrating a stronger appetite for single-tenant net-lease properties. Marcus & Millichap closed 950 retail transactions nationwide during the first 11 months of 2010. Those transactions were valued at $2.23 billion, which represents a 10 percent increase compared to 2009. The majority of those retail sales, about 65 percent, involved single-tenant net-leased properties priced between $1 million and $20 million.

“There is a lot of risk aversion that still exists in the market,” Thomas notes. Triple-net acquisitions are very attractive for the asset preservation and steady cash flow of long-term leases with corporate credit tenants such as Walgreen’s or McDonald’s, he adds. The surge in demand for net-leased properties is driving prices higher, especially among top credit tenants. For example, Thomas recently brokered a ground lease on a McDonald’s in north Florida that went for a 5.5 percent cap rate.

Searching for Bargains

Although there has been an expectation that there will be a significant number of distressed properties hitting the for-sale market, those bargains have been slow to materialize. Lenders have been reluctant to foreclose and instead are willing to do loan workouts and extensions wherever possible in order to keep the distressed assets off their books. However, some of those deals will continue to hit the market in 2011.

“Banks are ready to start moving these commercial properties that they may have taken back in foreclosure almost a year ago in some cases,” Hunter says. For example, Hunter is listing a vacant restaurant property in Seattle for Wells Fargo. The property reverted to the bank after the restaurant operator filed for bankruptcy. Most of the offers on that property have been well below market. The current offer for the 5,280-sf property is about two-thirds of the $1.2 million appraised value. The bidder is a religious organization that would like to convert the restaurant to a church.

Investors also are chasing bargains in discounted land plays. Spanish Fort, Ala.-based Bellator Real Estate and Development represents several investment groups that are making discounted purchases of developed lots, partially developed subdivisions, and raw land. “Once we acquire these subdivisions, the focus is on facilitating activity within them, whether that is raising money to loan back to home builders or promoting the subdivision to generate pre-sale houses,” says Nathan Cox, CCIM, Bellator owner and president.

Bellator currently manages about 20 separate investment groups that vary in size from several hundred thousand dollars to a few million dollars. So far, the investment groups have committed about $10 million to land acquisitions throughout Baldwin County, Ala. “There is a lot of interest from investors who don’t want to miss the boat,” Cox says. Bellator has been able to acquire lots at between 20 cents and 40 cents on the dollar compared with what they sold for at the peak of the market. For example, the firm has bought some lots at $12,000 that were selling for $130,000 in 2007, while others have been priced at $20,000 compared to sale prices of $80,000 a few years ago.

“We have seen a big shift in the last few months by banks trying to get this stuff off their books, so we have been real active trying to acquire property,” Cox says. Bellator anticipates a very busy year in 2011 with some of the bulk residential land deals starting to slow down in 2012. The firm is targeting opportunities within Baldwin County — specifically the eastern shore in communities such as Spanish Fort, Daphne, and Fairhope — which experienced a big boom and bust in its housing market.

Although distressed sales are still scarce, many industry observers are hoping that the resurgence of investor demand and thaw in debt markets will help to bring more for-sale properties to the market in the coming year. “As a whole, whether it’s investors, developers, retailers, tenants, or brokers, folks know they are going to have to work longer and harder on each individual deal to get them across the goal line,” Thomas says. “But that is happening, and overall, I think the outlook is very positive for 2011 and 2012.”

See the digital edition of the full magazine here.

This article recently published on culturemap examines the idea of a high-speed rail connecting the “Texas Triangle.” How do you think such innovation would change our state’s culture, economy, real estate, and landscape?

Fast Trains, Slow Politics
By Peter Barnes for culturemap

After missing out on the last round of funding, Texas is finally in a position to spend some of the $53 billion the Obama administration recently proposed for a high-speed rail. Boasting five of the country’s 20 largest cities, separated only by an abundance of wide-open space, Texas practically goads engineers to conquer it.

Yet, unless someone invents a bullet train that can tear through the fabric of space-time, Houston travelers shouldn’t plan on taking 40-minute trips to Dallas any time soon.

Third Time’s a Charm

All the conjecture about American high-speed rail systems, their practicality and their cost would look a lot different if a group of private investors had succeeded in building one 20 years ago. Back then. a consortium of train manufacturers and banks won a franchise from lawmakers to build the “Texas T-Bone” route linking Houston, Dallas and San Antonio. But trouble raising $5.6 billion in financing and a fight with airlines like Southwest deep-sixed the project by 1994.

While European Union countries Japan and China spent the ensuing years breaking speed records with ever-faster trains, stalled projects like the one in Texas left the American public without any frame of reference as to what an American bullet train network would look like, let alone how much it would cost to build. By the time President Obama opened a new trove of federal funding and public attention for high-speed rail last year, Texas hadn’t even adopted a passenger rail plan detailed enough to qualify for the money.

This time around, the state is ready. With an updated rail plan that was approved by the Texas Transportation Commission in November, TxDOT rail director Bill Glavin says his office is eager to “apply for everything and anything we can get our hands on”.

Decision Points

Dramatic as it is to imagine lithe, space-aged locomotives whistling across the Texas prairie at the speed of a Bugatti Veyron, it’s important to note what winning those federal dollars would actually look like. States that have already ironed out much of the complex planning for new lines could use federal money for construction. Texas’ share, though, initially would go toward more studies on ridership, potential routes, cost and how much relief it could bring to highways and airports.

Even if the proposed rail funding survives the current cost-cutting Congress, it would take at least a couple of years before the state would be ready to approve actual construction projects.

In the meantime, Glavin’s office is more than happy to wrangle all the research and present it to the Legislature. At that point, lawmakers will have a few options to consider. One scenario could involve dedicated tracks and electric trains like those in Japan, capable of speeds in excess of 200 miles per hour. A slower, but simpler, option would add capacity to existing freight railroads to accommodate more passenger trains at higher speeds.

Glavin points to improvements in the tracks between St. Louis and Chicago that have enabled speeds up to 79 miles per hour. Amtrak trains could potentially reach 110 miles per hour on dedicated tracks.

“It all can fit within existing right-of-way that Union Pacific has,” Glavin said. But he also noted that adding tracks and upgrading crossings would involve significant costs. Likewise, curves in existing rights of way would limit top speeds.

Then there’s the question of where the train should run. The federal government’s “high speed rail corridors” around the county would link Houston to a hub New Orleans, but not to Dallas.

The feds’ priorities continue to evolve, though, and the regulations for the most recently proposed round of rail spending haven’t been developed yet. Glavin said that if the emphasis shifts to connecting cities of two million people or more, situated less than 500 miles from each other, the state’s earlier plans linking Texas’ three largest metropolises may gain more traction.

What’s Next

Even if plans for high-speed rail gel in Texas, the average traveler is unlikely to notice for a very long time. Over the next five years, Glavin indicated that his office’s most visible work would continue to be commuter rail projects and efforts to improve the safety and efficiency of freight lines.

Recently, the chairman of Japan’s largest railway dazzled the Greater Houston Partnership with the prospect of a privately financed high-speed rail line from Houston to Dallas. Yet even with private money freeing the project from the political roadblocks associated with tax-payer funding, it would take at least a decade to build.

Like any transportation project of that magnitude — think new airports, freeways or light rail — going faster takes a long time.

Tuesday’s edition of Bisnow Houston featured Clay & Co’s Timothy K. Clay, Amy Silvey, and Kevin Dalrymple discussing our Investment division. See the article below:

Clay & Co recently created a $25M investment partnership, with plans to buy $64M worth of assets in the Texas Triangle. It’s the first fund created by the Houston-based firm best known for holding large, multi-property auctions. We snapped president Tim Clay between Kevin Dalrymple and Amy Silvey, who tell us they’re forming the “Texas Triple Net Real Estate Partnership” to acquire income-producing properties that are triple-net leased to strong credit tenants. Other requirements: Location is important (as is location and location); all assets must be single-tenant with at least a five-year remaining lease term; and returns must be double-digit. Tim would like an even spread between office, retail, and industrial properties, but is seeing more opportunities in the industrial sector.

Tim tells us Clay’s launching the fund now to capitalize on ideal interest and cap rates. Plus, it can get leverage returns of 13% or higher (its last purchase brought in 16%). Tim says he plans to hold the properties for five to seven years. Clay’s most recent buy was the Water and Power Technologies’ 20k SF warehouse (pictured). Tim says the facility has 10k SF of expansion capabilities, and he liked the lease (10 years), location (near the port), and tenant’s industry (water purification). Clay has contracts out for its first fund purchases.

See the complete edition here.

Last Friday, the CCIM Gulf Coast Chapter held the 18th Annual CRE Forecast Competition. Here Barton Kelly has summarized the days lectures for you.

Dr. Mark Dotzour, Chief Economist at the Real Estate Center at Texas A&M University, opened the competition with a report on the state of the national economy giving a positive outlook for the commercial real estate industry. Below are some of his key points.

• Every metro area in Texas is experiencing positive job growth this month and the private sector is ready to get back to work. Government layoffs are inevitable in the coming years, but the private sector’s willingness to hire should offset this.

• Banks need to clear their shadow inventory to bring normal values back to CRE. Thorough auditing and foreclosures of bank’s underperforming assets will help the nation in the long run. “Extend and pretend” practices need to stop. While it is unfortunate that many banks will go out of business, Dotzour sees new banks quickly taking their place.

• Look for Class A properties in large gateway cities to perform well; however, all other assets seem to be frozen. This is causing a “double bubble” effect in certain cities and inflated prices in Washington, New York, and San Francisco.

• In closing Dotzour stressed how important it is that the government show confidence this year and that banks stop solely buying treasuries.

Other area real estate experts were asked their opinions on the industrial, land, retail, office, and apartment sectors. Below we’ve broken down their predictions:

Industrial:

• Times are good for tenants with economical rental rates available; but with low vacancies and very little new construction, potential tenants are having a hard time finding the right property, especially on the north and west sides of town where very few crane-served buildings are on the market.

• Industrial cap rates are coming down: expect to see quality assets in the 7.5-8.5 cap range.

Land:

• Insiders predict midtown Houston land prices to remain high at $45-55/SF. Multi-family developers are purchasing land; currently there are 10 very large land deals in the Houston area set for apartment development, 6 of those inside the 610 loop.

• As housing is concerned, there’s only a 4-5 month land supply of quality lots in Houston.

• Interesting facts: Walmart paid $50/SF for the land between Washington Avenue and I-10, part of the new Washington Heights development by Ainbinder. Kroger recently paid $49/SF for the land to build their new store on Studemont.

Office:

• Insiders predict Class A, downtown office space will command rental rates between $34- $37/SF and sales will average $200-230/SF.

• Job growth was repeatedly stressed as the saving grace for the industry, and experts expect corporate management to finally make hiring decisions this year.

• Large nationwide firms perceive Houston to have office rents at below market rates, a favorable outlook for the city.

• To the investors out there: Don’t be looking for steals, because you won’t find any. Expect to pay market prices.

Retail:

• Service-oriented retail will weather this recession stronger than solely merchandize-driven stores because internet sales are hurting brick-and-mortar companies harder than you’d expect. Given this fact, companies looking to open additional stores need to tap into the opportunites that internet sales provide.

• Zip codes and shipping addresses of current customers are an invaluable asset for expanding chains.

• Similar to the industrial markets, rental rates will increase in 2011 with quality space hard to find.

• “Lifestyle” retail centers with the “right” tenant mix and well-conceived parking garages will see a comeback after the recessionary years; however, population densities are key to their success.

• Investors best bets: size matters, small grocery-anchored centers with stable tenants.

Apartments:

• Big life insurance companies will be prolific lenders in the 2011 multi-family markets but expect to pony up at least 60% equity for such deals.

• We should expect big buys from large institutional investors in core, inner-city markets and for smaller, private companies to acquire apartments in the suburbs.

• Panelists forecast a $1.25/SF rental rate in Class A properties with average market occupancy rates to hover near 88%.