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Below is a synopsis of this article by Mark Heschmeyer of CoStar

Five Years After the Onset of the Great Recession, Banks Are Ready To Venture Back in to Commercial Real Estate

• For the first time in five years, a majority of banks are finally talking about their ability to grow their loan portfolios.

• Up until the fourth quarter of 2011, non-performing commercial mortgage and construction loans were still increasing notably. And indeed, for many banks, they are still going up, but at moderating rates. So there is still a note of caution from bankers.

• “Because the financial condition of many of our borrowers has suffered over the last several years, we expect to continue to see downgrades within the portfolio into an extended recovery as a play,” said Daryl D. Moore, executive vice president and chief credit officer of Old National Bancorp. “This will be especially true in the commercial real estate portfolio where capital and liquidity continued to be an issue for many of our clients.”

• Some banks are still being aggressive in charging off some loans, particularly construction loans, and are trying to sell off their foreclosed real estate inventory and nonperforming loans as best as they can.

• However, in the Federal Reserve Board’s latest Senior Loan Officer Opinion Survey issued this week, U.S. bank loan officers reported that demand for CRE loans had strengthened, on net, over the past three months. In addition, during the past 12 months, on net, domestic banks reportedly eased maximum CRE loan sizes and many domestic banks trimmed loan rate spreads.

• “Through 2011 obviously we’ve all been very cautious in that sector due to some of the challenges that have been experienced,” said Claude Davis, president and CEO of First Financial Bancorp. “Where we’ve seen our new opportunities are really with those investors who have weathered the storm well, had the liquidity and the cash and the capacity to kind of grow and expand if you will, kind of win assets at a cheaper level. And so we’ve actually seen the quality be very good from our perspective in that book.”

• Banks are still staying away from the high risk areas like residential development.

• Philip Flynn, president and CEO of Associated Banc-Corp., said, “We continue to see opportunities for growth and expansion in CRE lending because of the retrenchment of other competitors and other sources of capital.

• While it is apparent that the growth in commercial real estate lending will be limited and cautious, the timing for an improved lending environment couldn’t be better for some investors who financed at the peak of the market five years ago. As mortgage production ramps up, investors will see banks being more competitive on pricing.

• The bad news is that, initially, it will be the well heeled who stand to benefit first and financing terms are likely to be fairly tight. Banks will also use the opportunity to restructure the makeup of their portfolios – weeding out the less creditworthy.

• At CVB Financial Corp., Christopher D. Myers, its president and CEO, said most of the deals his bank is doing are pricing in the 4.5% to 5.25% range — unless the bank does an interest rate swap. Then typically the bank is pricing CRE loans somewhere around 3% on a variable rate.

• In general, bank executives said they would be targeting the strongest growth in particular assets and markets. Multifamily was most frequently mentioned as a targeted asset category as were some select middle-market industry segments such as, restaurants, health care and energy.

• By market area, Bank of the Ozarks Inc.’s George Gleason, chairman and CEO, said, “I think the largest part of [our] growth is going to come from our Texas offices. The second largest part of that growth I would expect to come from our metro Little Rock, [AR], area offices and the third largest part of growth I would expect to come from our metro Charlotte [NC] office.”

• In the last quarter Bank of the Ozark’s Texas office had accounted for 41.8% of its total loan portfolio.

Investing in commercial real estate is a great way to generate wealth producing relatively consistent returns through monthly income or capital growth

Real estate returns are generated in two ways: income return and capital returns. The income returns comes from tenants’ rent payments and the cash that remains after all property expenses have been paid. Capital returns are the increase or decrease in the value of the property due to changes in market demand and/or inflation.

The first steps to investing in commercial real estate is to ask yourself why you want to invest in real estate and to define what type of investor you want to be. What kinds of returns are important to you?

An investor that is interested in income return, or stable cash flow, purchases a property that can provide a monthly income. The income return from real estate is directly linked to the rent payments received from tenants, minus the costs of operating the property and outgoing mortgage/financing payments. Analyzing this type of property has been likened to the analysis you may do if you were to buy a business. This means thoroughly examining the financial records of the property to prove it could stand on is own each month. Also important is the property’s ability to stay leased so that these financials remain.

When investing in a single-tenant office or industrial building this may mean you evaluate the current tenant more completely to be sure they intend to and can afford to continue leasing the building. For a multi-unit property, the strength of the leasing market and competitive rates of the property are more important.

One of our clients that favors triple-net investments recently reviewed the real estate deals he had participated in over the past couple of years. He found he was getting 9.4% return on cash and pointed out that the internal rate of return was even greater in that you are also reducing debt.

Unlike cash-flow investors, long-term or “hold” investors rely on capital returns through real estate appreciation to build their wealth. Capital appreciation of a property is determined by whether or not your property would sell for more than you bought it for. If so, then you’ve achieved a positive capital return. These investors rely on the simple strategy of patience. They look for real estate that will appreciate over time because of location, market changes, or inflation, or deals that provide an upside by offering the ability to increase cash flow or update the property.

The capital return is more difficult to calculate, and requires the property to be valued or appraised. The majority of the volatility in real estate returns comes from the capital appreciation component of returns. Income returns tend to be fairly stable. Capital returns fluctuate more and although this tactic can be riskier, many times the return is greater.

While you are out in your city, start looking at the real estate you see – from the retail center at the corner to the industrial building by your office to the vacant land by your house. Is the shopping center fully leased? What kinds of tenants occupy the buildings? An investor owns every one of these commercial properties.

An interesting article published in The New York Times about specialty investments like cell towers and data centers.
By Alison Gregor

Real estate investment trusts, or REITs, have largely outperformed other investment vehicles in the sluggish economy of the last few years. But one subset — “specialty” trusts that invest in real estate other than the four major groups of office, retail, residential and industrial — has been exceptionally solid.

Such trusts that fall into the specialty category can have trouble attracting investors, who often perceive them as being risky, real estate experts said. Typical investment assets are cellphone towers, cold storage warehouses, or transportation and energy infrastructure, among other things.

“What we’ve seen is these specialty or noncore property types have actually done pretty well this year,” said Steve Shigekawa, a co-manager of the Neuberger Berman Real Estate fund, which has about $378 million under management and has invested in several unusual REITs, for timber, self-storage properties and data centers. “You’ve seen pretty consistent demand, and growth in net operating income has actually been better than in the more traditional sectors.”

While the Dow Jones U.S. Real Estate Investment Trusts index shows a year-to-date total return of 3.32 percent, the Dow Jones U.S. Specialty REITs index shows a return of 7.94 percent.

Markets that drive the demand for assets of the specialty REITs tend to be different from the four core trust classes, which can make some of them particularly good investment opportunities in tough economic times, real estate experts said. Self-storage businesses, for example, are obvious beneficiaries of the increase in housing foreclosures and the downsizing of American homes, said Stacy Chitty, a managing partner at Blue Vault Partners, a Georgia company that tracks the performance of public nontraded REITs.

Another sector is data storage centers, which are growing because of increased Internet usage, which seems to be recession-proof. Mr. Chitty mentioned mortgage and real estate-related debt instruments and health care assets as other areas that could flourish in the coming year despite a poor economy.

Entertainment Properties Trust, a REIT that invests primarily in megaplex theaters, has benefited from a shift toward inexpensive entertainment in hard economic times. “Theaters have tended to be a touch countercyclical — not wildly, but a touch,” said David Brain, the chief executive of Entertainment Properties Trust, “and that proved itself in this most recent recession” in which 2009 was a record year for the trust. The REITs lumped together into the specialty basket are actually a diverse group of companies with unusual lines of business that can provide singular opportunities for investors, real estate experts said.

While the National Association of Real Estate Investment Trusts no longer has a “specialty” category, it places some of the more unusual trusts into a sector called “diversified,” said Ronald C. Kuykendall, the group’s vice president of communications.

Some REITs considered specialty in the past, like those investing in self-storage properties, health care assets and timber, have become individual sectors in themselves, Mr. Kuykendall said.

“If a sector gets large enough that it has a significant enough market capitalization, like timber REITs or self-storage, that becomes a sector,” Mr. Kuykendall said, rather than falling into the “diversified” class.

Breaking out of the specialty category has been a boon for the self-storage trusts, said Clint Halverson, a senior director of investor relations for Extra Space Storage Inc., a real estate investment trust based in Salt Lake City, said. The four self-storage REITs now have an equity market capitalization of $27 billion.

“Whereas before when we were lumped into specialty,” he said, “you had to market your brand more to investors. It was a little bit more work to get your name out there, and you had to clarify the story and help investors to understand the value proposition in your stock.”

Because REITs that invest in real estate outside the mainstream are often structured differently from traditional ones, financial planners and institutional investors have more research to do in formulating their real estate portfolio strategies. For example, specialty trusts often have an operating business linked with their real estate assets, said Thomas M. Ray, the president and chief executive of the CoreSite Realty Corporation, a REIT that invests in data centers based in Denver.

“Many of the specialty REITs have more of an operational component to them than the traditional four food groups in real estate,” Mr. Ray said. “Because that operating component is so much more important and larger in many of the specialty sectors, then expertise and specialization matter.”

For instance, CoreSite acquires, builds and operates data centers, which house the huge servers necessary to store data for businesses with growing Internet needs. Those unfamiliar with operating these types of businesses might have difficulties predicting the cash-flows of a business doing so.

A lack of consistent and long-term performance measures and the small size of some of the niche markets also can make specialty REITs harder to grasp for investors, he said.

“More of the specialty REITs came on the scene in the last 10 years or so,” Mr. Ray said, “so you have newer products in these specialty REITS that people need to get to know better, and I think that process is still under way.”

But for the data center REITs, a growing track record is helping overcome investors’ lack of experience and misgivings regarding the riskiness of the nontraditional real estate sector. Of the three data center REITs, with a total equity market capitalization of about $8 billion, two are well north of $1 billion, and “that is somewhat of a bright line for some large institutional investors,” Mr. Ray said. “Some investors say, ‘If you’re less than a billion, it’s harder for me to get the size of position I want and harder for me to move in and out of the stock.’ ”

Below is a valuable article on self-rental properties and the tax consequences. The article was written for CCIM by tax manager, Daniel Rowe, CPA, at the accounting firm Deemer Dana & Froehle LLP in Savannah, Ga.

Don’t get caught in a trap of unintended consequences.

The only thing worse than incurring a loss on investment property is incurring a loss that cannot be deducted for tax purposes. Self-rental property may cause this tax result for some property owners if rental arrangements are not strategically prepared. The following overview of the self-rental rule, including an explanation of passive activities in the context of rental real estate, may shed light for property owners who want to avoid such tax consequences.

Passive Activities Concept

The Internal Revenue Service considers most business activities to be nonpassive if a taxpayer materially participates in the business. One exception to this rule is rental real estate.

Partly because of their past use in tax shelters, rental real estate activities are generally considered passive regardless of participation level. (There are exceptions that go beyond the scope of this article.) The distinction between passive and nonpassive activities is important because under the passive activity loss rules, a passive loss usually can only be used to offset passive income. Generally, any passive loss that exceeds passive income is suspended and carried forward to be deducted in a future year. However, there is an exception of up to $25,000 for taxpayers who actively participate in a rental real estate activity. Nonpassive loss, on the other hand, can offset both passive and nonpassive income.

Self-Rental Nuances

Taxpayers can generally offset rental income from one property by rental loss from another property, as passive loss is deductible to the extent of passive income. However, an exception to this simple rule occurs when property is rented to one’s self or a business in which one materially participates. In such a case, the rental real estate activity’s treatment as passive or nonpassive varies depending on whether it produces income or loss.

For example, assume Juan has three activities for tax purposes: He is the sole owner of a bookstore, in which he materially participates, and he owns two rental properties—a warehouse and an apartment building—that are passive by nature. The activities generate $150,000 income and $100,000 loss, with a net gain of $50,000. (See Example 1.) The rental loss can offset rental income, with the excess loss then suspended. The result for Juan is $100,000 of taxable income and $50,000 of suspended loss.

But suppose Juan rents the warehouse to his bookstore instead of an unrelated third party. This is when the self-rental rules come into play to recharacterize the rental activity.

In the case of a self-rental, income is treated as nonpassive and loss is treated as passive. Thus, the warehouse income is nonpassive and the apartment loss cannot be deducted against it. Because of the self-rental trap, Juan’s tax result is $150,000 of income and $100,000 of suspended loss, as shown in Example 2.

Because he is renting to himself, Juan controls the rent that the bookstore pays. By adjusting this amount he can theoretically create a loss for the bookstore. If he increases the bookstore’s rent for the warehouse by $125,000, he will get the results in Example 3, which is $150,000 in taxable income and $100,000 in suspended losses. Again, because it is a self-rental, the warehouse income is treated as nonpassive.

The result would be the same even if Juan’s spouse was running the bookstore business. In determining material participation, participation by Juan’s spouse is considered participation by him as well. The self-rental rule’s primary purpose is to prevent taxpayers from manipulating rent for companies they (or their spouses) own and operate to create passive income to use against other passive losses.

Avoiding the Trap

Taxpayers can avoid or reduce the detrimental tax effect of the self-rental rule. One way is to reduce their participation level in the operating activity so it fails the material participation tests. Then both the operating activity and the rental activity will be considered passive and the self-rental rule will not apply. However, it is usually not feasible for owners to reduce their participation, especially when the operating activity is their primary business. The interplay of the operating activity and its income or loss with any other activities of the taxpayer should be analyzed in aggregate prior to considering a reduction in participation.

A more reasonable method of combating the self-rental rule is to minimize net income for the rental activity. A net loss will still be subject to the normal PAL rules, so minimizing loss may be important as well. However, fair-market rent must be charged, as an artificially high or low rent used to manipulate income will not withstand IRS scrutiny.

Another option is to rent from a third party. To avoid the poor tax results in Example 2, Juan’s bookstore could rent a warehouse from an unrelated party and he could rent his warehouse to another unrelated company for an offsetting amount. This method relies heavily on market conditions that allow Juan to find both a tenant for his property and his own lease space.

It’s not always easy or practical to avoid the reclassification of income under the self-rental rule. Property owners or investors who rent to themselves or their entities should be aware of the potential tax consequences that can make a bad situation even worse.

Is there anything you would like more information on? Do you have real estate questions? Let us know and we will get them answered for you.

12 PREDICTIONS FOR 2012 via Real Estate Bisnow Houston

1. HOTELS IMPROVE

Performance in the hospitality industry is on the up, according to Smith Travel Research and PKF Hospitality Research. Smith reports that Houston is doing particularly well; our hotels rank second in the US (behind Nashville) for year-over-year gain in room demand.

2. WESTCHASE RISES

With at least two spec office buildings slated to break ground in 2012, Westchase may just be the hottest submarket this year. Westchase District’s Sherry Fox tells us leasing volume in the submarket had topped 1M SF by Q3 ’11, well ahead of 2010 numbers. That put occupancy at 86.7% by the end of Q3, and Sherry says very big blocks are available.

3. FUNDS ARE UNPOPULAR

Ernst & Young American RE sector leader Mike Straneva (we snapped him at an E&Y/Baker Botts event in December to the right of Archstone’s Neil Bown and HFF’s Jody Thornton) says the recession taught people that they need to know who all investors are in a deal. That said, funds that do exist are attracted to RE because of returns.

4. CMBS IMPROVES, BUT IS THAT ENOUGH?

Commercial Mortgage Backed Security values will be on the rise this year: Wells Fargo Securities expects $25B, and Credit Suisse Group AG and UBS AG predict as much as $45B issued in 2012. But Andrews Myers CRE attorney Patrick Hayes has less confidence. Although Patrick has seen a resurgence of CMBS loans, he cautions borrowers that underwriting is tough to the point of being unreasonable. He suggests borrowers avoid that route unless they’re confident their properties can withstand the underwriting process.

5. INVESTORS COME TO CRE

Texas A&M Real Estate Center chief economist Mark Dotzour thinks US stocks and CRE broken deals are the most undervalued assets in the country right now. People are bound to catch on soon, making them the next investment trend.

6. AND TEXAS IN PARTICULAR

Houston and Dallas are among the top CRE hot spots (NY and DC are the others) generating investor interest, says Younan Properties chairman/CEO Zaya Younan. Foreign investors (including the Chinese and Europeans) only want to talk Texas because of its fast-growing, strong fundamentals.

7. DRIVING AUSTIN

A problem everywhere: traffic congestion. For Austin and San Antonio, the problem compounds with 70% of the NAFTA truck traffic making its way up I-35. But, that also means opportunities, too, according to the experts at the Bisnow Future of the I-35 Corridor in Austin yesterday. Only 80 miles apart, the two major metro areas may one day mesh into one greater MSA with a population of about four million. Major universities, international airports, and the NAFTA superhighway are a recipe for growth between the two cities.

7. OFFICE ABSORPTION INCREASES

Houston’s office leasing market fundamentals improved remarkably last year, according to PMRG VP of research Ariel Guerrero. Office product absorbed 3.2M SF, the most since ’08. Look for a continued shift to a landlord-favorable market as rents rise and quality space options diminish.

8. CLASS-A WILL DO EVEN BETTER

Of the 3.2M SF Houston absorbed last year, 2.4M SF was Class-A.

9. HEALTHCARE’S ABOUT CLASS-B

Marcus & Millichap’s Tanner McGraw tells us investors in the healthcare space are paying more attention to Class-B product. According to Marcus & Millichap’s October report, statewide MOB transaction velocity increased 28% from the same period in 2010. Activity accelerated dramatically for buildings below 5,000 SF, and lower-quality properties were the lion’s share of deals. Tanner is also seeing more health systems building and acquiring off-campus assets through physician practice acquisitions.

10. SPECIALTY GROCERS COME TO MARKET

The retail market in 2011 was dominated by HEB and Walmart, but look for specialty stores to creep into Houston in 2012. Transwestern’s Nick Hernandez says we’ll see Aldi, Trader Joe’s, Sprouts, and others open their first Houston stores this year. And here’s two for the price of one: Nick also says we can expect retail landlords to squeeze more value out of existing centers by adding pad sites in parking lots or tacking on small buildings for additional SF.

11. SELECTED CONSTRUCTION GAINS

Expect modest gains in construction this year, according to Andrews Myers construction attorney Ben Westcott. He expects construction to increase in infrastructure, municipal, education-driven, and multifamily projects. The latter three project types will see a bump from the population spread across our fair city. This is leading to more construction jobs: The Labor Department reports that 9,000 were added in November and 17,000 in December. Plus, construction spending increased over three of the last four months of 2011.

12. INDUSTRIAL STAYS HOT

Many of the spec developments under way will deliver this year, most have significant preleasing. And that means that concessions are burning off. The team predicts they’ll become the exception rather than the rule, a nice change for landlords from the previous three years. The north submarket will be the hottest, possibly running the risk of being overbuilt.

Each number has been summarized. See more on each category HERE.

Whether you’re looking buy a first home, start buying rental properties, or invest in land, it’s important to know your financing options. As investors and for our clients our relationships with the banks and our bankers are some of the most important. This article from the Commercial Property executive highlights the option of doing business with a community bank. However, we’ve taken the article a step further to try and explain exactly what a community bank is.

By Tom Ivory, Senior Vice President, Regents Bank – Community banks throughout the nation are struggling due to a low-interest-rate environment that compresses margins, weakens loan demand, lowers returns on excess deposits (that are then

invested in marketable securities), keeps a low ratio of loans to deposits and increases regulatory costs. While largebanks are turning to automatic credit-scoring technology to control costs, most community banks consider it a distinct advantage that they spend more time getting to know clients and their businesses through one-on-one meetings and rarely resort to automated credit-scoring-models to make loan decisions.

Most community banks are not major players in home mortgage lending or in extending small consumer loans. The mega banks and credit unions have some advantages in these niches. Community banks, do, however, continue to play a significant role in extending business lines of credit and in making commercial real estate loans, such as investment real estate, construction lending, owner-user and multi-family.

Large banks have turned to interest-rate wars to win commercial real estate loan opportunities away from rivals and away from smaller community banks. It remains to be seen in the years ahead if banks will suffer the consequences of negative spreads when deposit rates return back to normalized historical levels and these low yielding loan assets remain on their books.

Where the community banks often hold a competitive advantage is in situations where flexibility is called for in the credit structure, and knowing a client’s reputation and business history can make the difference.

The mega banks are investing millions of dollars into technology to better refine their automated underwriting approval process in order to reduce expenses. These technology investments take the form of remote loan application submittal, semi-automated application turnaround and one- to three-day loan approval response times with automated documentation production and little or no human intervention to impede the process.

This process will generate significant amounts of low-rate, no-touch, no-time loans for these mega banks, but while it may sound attractive, many borrowers may get turned down for such loans because technology has limitations.

This is where community banks enter the picture as niche bankers with the experience and creativity to fill the void left by these limitations. Borrowers may pay a modestly higher rate with community banks, but with human contact and flexibility, you will gain much more than you get when your sole focus is on just trying to secure the lowest interest rate on a real estate loan.

Below is more info on community banks from here:

Regulators, legislators and bankers commonly take “community bank” to mean a bank with “less than $1 billion in assets under management.” Roughly speaking, “assets under management” means the number of loans and other similar investments a bank controls (banks account for deposits as liabilities). This $1 billion rule of thumb is an easy metric to identify, but it doesn’t tell us much else. As of the first quarter of this year, 7,256 of 7,932 (or 92%) of FDIC-insured financial institutions held $1 billion or fewer in assets. But there’s more to these banks than asset size.

Community banks aren’t just small. They’re local. Your dollar in a small bank will likely underwrite a local home or business or be invested in U.S. government-backed securities. That same dollar in a megabank will fund loans across the country and may well buy foreign currencies or bonds, corporate stock or bonds and various other securities. Community banks tend to obtain deposits from local individuals and businesses and lend them out to local borrowers. Larger banks frequently derive their funding from sources around the country and the world, which are often far more complex than your typical checking account or certificate of deposit.

Community banks keep it simple, legally speaking. The vast majority are either stand-alone corporations or owned by what is called a bank holding company (BHC). A BHC is just what it sounds like — a corporation designed for the sole purpose of owning a bank. But big banks — the five biggest, in fact — are owned by financial holding companies. These corporations, authorized by the Gramm-Leach Bliley Act of 1999, can own subsidiary companies engaged in different types of financial activities, including investment banking, insurance sales, credit cards and stock brokering. Bank of America Corporation for example, owns companies that do all of the above.

Community banks specialize in “relationship banking,” as opposed to “transactional banking,” which large banks master through economies of scale. The former approach drives profit through long-term, multiple-account relationships and customized service for core customers. The latter makes money on volume — from large numbers of standardized accounts, numerous locations, and automated service.

Community banks make money their money from loans. They are far more likely than big banks to rely on traditional sources (e.g., interest from loans) as their main source of income. They earn the difference between the average interest rate they pay on deposits and the rate they charge to lend that money. Community banks can still profit from this simple model largely because their loyal customers’ money doesn’t leave with each competing bank’s promotion. These dependable deposits are called “core deposits”; they are essential to a community bank’s success, and are the goal of any relationship banking strategy. Big banks’ “non-interest income” amounts to fees associated with accounts, overdrafts, loans, brokerage and securitization of loans.

92% of U.S. banks — those under $1 billion in asset size — compete over just a fraction of the nation’s assets. The six largest banks in the United States control 72% or $9.4 trillion of the nation’s $13.3 trillion in assets. If small banks are going to stand a chance, then we ought to at least know what they are.

Source: This post relied upon Bank Management, 7th Edition, by Timothy Koch and Scott MacDonald.

Investing in Triple-Net Properties: Now Is the Time
By Randolph T. Mason
Senior Vice President & Partner, Lee & Associates Commercial Real Estate Services
Original article here. Reprinted by REDNews here.

If you could have an investment that paid you regularly with limited management, would that excite you?

If so, the long-term triple-net-leased property to a sound company with good financials (and maybe even personal guaranties or letters of credit) may be an investment for you.

One of the exciting components of a triple-net investment is that the tenant is the one who maintains the property and typically pays all of the building’s expenses. You, as the owner, receive your rent. Should you have any debt service on the building, this rental income goes to pay that expense. The balance is for you.

Let’s look at what’s currently happening in the market. Cap rates seem to be stable, or possibly shifting downward slightly, on most types of properties. Some of the lowest cap rates are apartments, followed by central-business-district office projects, R&D industrial, neighborhood retail and industrial properties. Some of the favorite triple-net properties are, not surprisingly, those that seem to offer the least risk – such as Wal-Mart, McDonald’s, Lowe’s, Walgreens and other high-profile tenants. Should an investor be looking for a higher return on their investment, they should probably look at lesser known, yet well capitalized companies.

While long-term triple-net investments provide stability and income, there is a downside. Your assets are locked into a long-term lease, and you’ll miss out on chances to capture any gains in rental income when fundamentals improve.

But there still seems to be a strong supply of debt available due to long-term leases to credit tenants, a trend strengthened by the ease of underwriting for single-tenant properties. We are still seeing institutional investors, REITs and foreign buyers, as well as private investors, investing in all-cash transactions; currently, they have nowhere else to put their money and achieve a decent return.

So, investors looking for limited management responsibilities, longer-term leases with a stable cash flow and the unique tax benefits from real estate, a triple-net investment may be the right play.

Clay & Co Note: See a recent example of this type of investment here or read more triple-net leased investments articles.

Investors vie for the safety, convenience, and ROI of top net-leased deals.
By Sara Drummond for Commercial Real Estate Investment, The Magazine of the CCIM Institute

Looking for a rock-solid investment in a shifting economy?

Look no further than single-tenant net-leased properties. In markets where shopping centers sit empty and office buildings are dark, the lights are on (usually 24 hours) at the corner drugstore — provided it’s a Walgreens or a CVS. With their invest- ment-grade credit ratings and penchant for long-term leases, these drugstore triple net- leased deals attract top dollar in almost every market.

But drugstores are only one of a stable of creditworthy tenants for net-leased deals, according to a recent anecdotal survey of CCIMs. Other tenants are also attracting buyers. CCIMs report that everyone from all-cash individual buyers in small towns to big-city real estate investment trusts are looking to add one, two, or 20 of these stable investments to their portfolios.

Supply/Demand
From every U.S. region, CCIMs report that the NNN supply is tight and the demand is high. “The entire state of California has more money than product,” says George L. Renz, CCIM, of Renz & Renz in Gilroy, Calif. He has the investors: His big- gest challenge is finding deals with good intrinsic value that “truly reflect safety and truly reflect investor’s goals — most of which involve risk avoidance.” In Atlanta, “I am seeing more out-of-town buyers from everywhere in the country and even international,” says Virginia I. Wright, CCIM, vice president of net-leased invest- ments for Bull Realty. “With a strong lease, tenant, and location, they are satisfied without having to visit the property and just enjoy the rent checks. Many buyers would love portfolios of properties; however, these are more difficult to come by.”

Many of those portfolios are going to institutional investors that have turned their attention to net-leased product in the past few years. REITs, insurance companies, and pension funds have contacted CCIM brokers in smaller markets this year, looking for portfolio deals.

Money Is Available
One reason for the interest in net-leased deals is that financing is available at alllevels. With most net-leased properties priced under $5 million, many single-asset purchasers buy with cash, according to the CCIM market round-up. “We have been doing transactions almost always with knowledgeable all-cash buyers who want to close swifly,” says Rob Murdocca, CCIM, of Prescient Property Group in Wayne, Pa. Len S. Jarrott, CCIM, of Jarrott & Co. in Santa Barbara, Calif., has completed three portfolio deals ranging in price from $9 million to $32 million — all 1031 deals that closed with cash. “When I do use debt, I go to life companies,” he says.

Wright adds that a variety of financing sources are available for investors who want leverage, and CCIMs in most markets con- firm this.

“Smaller investment deals are getting financed through smaller, extremely well-capitalized rural banks flush with farmers’ cash,” says Shad J. Phipps, CCIM, a senior associate with CB Richard Ellis in Columbus, Ohio.

“Very desirable rates, usually in the 60 percent loan-to-value range, can be found for qualified buyers with qualified properties,” says Chris Schreiber, CCIM, an associate broker with Kiemle & Hagood Co. in Coeur d’Alene, Idaho.

NNN Challenges
Despite the availability of money for NNN properties, financing is still a concern, given that most local banks require pre-existing relationships. “All of the smaller community banks require that a borrower has an estab- lished track record of working with them,” says Casey Weiss, CCIM, of Access Com- mercial Real Estate in LaCrosse, Wis. Tey also ofen limit their loans to the local area, he adds.

Another problem is conflicting buyer and seller timelines, Murdocca says. “Sellers need to be prepared to meet buyers’ need for due diligence. Triple-net deals sell well, but buyers still want a feasibility period.”

While lack of supply is a problem in almost every market, a hidden niche may be older net-leased properties, Weiss says. “Investors seem to be more interested in NNN proper- ties that have some age, versus brand-new NNN properties,” he says. “Older NNN properties have a lower per-square-foot price, which means that they don’t require as high of lease rates if they are forced to release.”

In today’s market, he adds, “Investors are putting more emphasis on their back-up plans. They realize that losing a tenant is a real possibility, and buying older properties can help them prepare.”

Even with newly developed NNN properties, investors are not taking as many chances, says Gregg H. Tompson, CCIM, general manager of Ratcliff Facilities, in Alexandria, La. Ratcliff specializes in developing NNN properties, recently for Dollar General. “Since there is no such thing as ‘too big to fail’ anymore, investors are exploring options and worst-case scenarios with their properties,” he says. “We are seeing this hedging early in the negotiating phase of our completed development projects.”

Thompson is also concerned about upcoming FASB changes. “As a developer, we feel that these proposed changes will dec- imate the design-build net-leased market by forcing tenants into shorter lease terms or to revert back to fee-simple ownership of properties. Tis will dramatically decrease the attractiveness of commercial real estate as an investment due to increased manage- ment and risk associated with properties.”

We were honored to have Tim Clay featured this week in the Houston Business Journal’s “Three Shots at a Dealmaker.”

Tim Clay is a 29-year-veteran of the commercial real estate business and founded Clay & Co. in 1991. He has been involved in over $500 million worth of real estate transactions and over 90 commercial real estate auctions. In addition, Clay is an active real estate investor, serving as general partner for over 15 partnerships purchasing multitenant office buildings; retail and industrial buildings on long-term, triple-net leases; and commercial land tracts.

Tell me about the biggest transaction you have been involved with this year.
Our biggest transaction and accomplishment this year has been the creation of the Clay NNN Lease Fund, where I serve as the general partner. The purpose of the fund is to acquire approximately $25 million worth of industrial and retail properties with long-term, triple-net leases in place to strong credit tenants. We currently own four triple-net-leased properties with many of the same partners which led us to establish the fund. We are under contract to purchase the fund’s initial two properties.

What do you predict for the rest of the year in commercial real estate?
We see a tremendous increase in activity, especially in the office/warehouse sector and certain retail sectors. That is where we see the biggest growth coming from for the remainder of 2011.

What has been your greatest professional challenge this year?
It has been financing for transactions. This has been because of the difficult financial markets.

This article written by Annamaria Andriotis and published by SmartMoney Magazine summarizes some of the benefits of REITs or Real Estate Investment Trusts explaining why they have prevailed. Over the last twenty-four months, Clay & Company, as general partner, has acquired four triple-net leased, income-producing properties following many of the same guidelines outlined in this article.

These days, skeptical investors have every right to put “a winning real estate investment” right up there with “a bridge in Brooklyn.” But a surprising corner of the market real estate investment trusts have been surging, making money for anyone who can get past those first two words.

In spite of the worst real estate market in decades and a recent market shake-up, REITs have still soundly beaten most other investments. Year-to-date, U.S. REITs are up 7.3%, versus a 2% return for the Standard & Poor’s 500-stock index and more than double the performance of the Barclays Aggregate bond index. Investors have noticed, plowing almost $22 billion into newly-issued REIT shares during the first five months of the year, almost triple the amount last year at this time. For interested investors, companies have responded with increasingly niche offerings: a campus housing REIT launched late last year; a REIT that leases space to cell phone operators and broadcasters will launch later this year.

Credit commercial real estate. Office buildings, apartment complexes and other commercial buildings haven’t seen the same sustained slump that the residential market has; the supply is tight as the economy shows signs of recovery, and rents have gone up. Apartment REITs in particular have flourished, up 13% this year, as young adults move out of family homes, would-be home buyers delay a purchase, and home owners displaced by foreclosure look for alternatives.

But critics say investors have good reason to be cautious. The recent market tumult brought on by the Greek debt crisis hit REITs along with the rest of the U.S. markets, causing around a 4.5% drop this month. Over the longer term, rising interest rates may be the bigger threat to REIT investors: They make real estate loans more expensive, which can hurt the underlying investments held by a REIT. “There’s a lot to be worried about,” says Jeff Sica, president and chief investment officer at Sica Wealth Management who advises real estate owners and developers among others. And rising yields on bonds offer competition to dividends on REITs.

Even with these risks, REITs have been remarkably resilient, analysts say, managing to outperform both when interest rates rise and when they fall. Over the past three decades, the annual rate of inflation averaged 3.1%, while REITs’ total annual returns, including dividends, averaged 10.5%. Rents also tend to rise with inflation, which is why many investors flock to REITs as an inflation hedge. Those increased rents get passed through to shareholders; by law REITs must pay at least 90% of their taxable income rents less expenses to their shareholders.

Rather than paying top dollar for yesterday’s top performers, Philip Martin, REITs strategist at fund-tracker Morningstar, suggests looking at narrow categories, like health care and some specific niche retail, where consumer demand is less sensitive to the economy. Health care REITs, which include a combination of senior living communities, assisted living facilities and medical office buildings, are expected to see growing demand partly from aging baby boomers and due to longer life spans. Martin recommends Health Care REIT (HCN: 53.42, 0.44, 0.83%), which includes senior living facilities along with medical and lab offices and is up 24% over the past year, and Alexandria Real Estate Equities (ARE: 79.34, 1.16, 1.48%), which leases specialized lab and research & development space to large pharmaceutical and biotech companies and is up 8%. Among the more attractive retail REITs, which include grocery stores, drugstores and discount retailers, he suggests Realty Income Corp. and Federal Realty (FRT: 86.40, 0.93, 1.09%), which are up 8% and 15.5% respectively.