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Commercial Real Estate Values After the Bubble - The Word on the Street by Dominic Mazzone
Recently I spoke with my co-managing partner Michael Facchini, of Regent Global Funds, an alternative investment fund, at an Institutional Investor conference on Distressed Real Estate in New York City. The folks at Institutional Investor did a fantastic job putting it together and assembled a group of very knowledgeable and informed speakers from the industry. Usually when you put together people in the upper echelons of the industry, you find that they are out of touch with the reality on the streets. However, what I found to be incredibly interesting about this event and a bit scary at the same time, was that reality has hit all levels of this market and the individuals that are in charge of pulling the trigger on other people's money are paying attention. Of particular note was the general consensus that commercial real estate is going back to realistic levels and maybe just a bit below as a result of the real estate bubble being popped. We all know that residential has popped and crashed, but commercial has always been a question. I have written several times about valuations on commercial real estate getting back to reality instead of popping, and in my reality I never liked to buy anything less than a 10 cap. So for conservative investors, the bubble popping is just getting back to reality.
What really turned my head was that everyone else at the conference was now living in a 10 CAP reality (for more information on CAP rates see "The Golden Rule of Lending: How Banks Got it Wrong"). In fact,[link widoczny dla zalogowanych], for this group of professionals a 10 CAP was the new norm. What does it all mean for the average commercial real estate investor? It means that if you are holding commercial real estate,[link widoczny dla zalogowanych], it's probably not worth what it was 6 months ago and it probably won't be worth what it is today 6 months from now. The usual suspects that get hit during a downturn are things like office and retail, but this time around due to the overbuilding in some markets, properties like multi-family are also getting hit. For example, rental absorption is pretty devastating in places like San Diego and Las Vegas where there was so much overbuilding, and now the supply of rentals looks never ending. This all goes back to the basic fundamentals of knowing your market and using your head instead of just a spreadsheet.
The general consensus at the conference about the potential collapse of the Manhattan real estate market is another example. Consider that Wall Street is NYC and NYC is Wall Street. The bitter reality is that people from all the big financial names both solvent and insolvent, that no longer have a job, are not finding any work in the city. These jobs just cease to exist. Their only choice is to move out, or look for another line of work. Without all of that money pumping into the local economy,[link widoczny dla zalogowanych], there are going to be a lot of people having to move, and a barrage of properties for sale. Now consider that the general forecast of 250, 000 financial services people being out of work in the city has not completely hit just yet. Taking into account further lay-offs in the financial industry and other industries that were employing a lot of individuals at higher-end salaries, that is going to translate into a lot of properties for sale. Big supply, no demand, and you have a potential crash in the Manhattan real estate market that so far has weathered the storm pretty well.
Where do we go from here? Well, there is something interesting to ponder for a moment. Economists get paid to analyze the economy, and in more recent years, to predict its direction. It is disturbing to note that many economists are now starting to agree on one thing? The agreement is that there is no precedent to look back on, and because there is no precedent they have no idea where we go from here. No precedent means there is no known direction and it is one of those peculiar times in recent history when using the word, unprecedented,[link widoczny dla zalogowanych], is actually not sensationalism.
Even with all of this said, investing in something like commercial real estate where you can get your mind and your hands around an actual asset, looks pretty good compared to the alternatives like equity based hedge funds. Hedge fund strategists that had their heads in a Quant Screen found out that it might have been a good idea to put some practicality in their strategies. Hedge funds are closing weekly and one that comes to particular note was the closure of Citigroup's Corporate Special Opportunities Fund after its value declined 53% in October. To make it worse, it is said that investors are likely to only get about 10 cents on the dollar when they liquidate. If that doesn't make us a believer in alternative investments based on tangible assets like real estate, I don't know what will.
With all of the pain and uncertainty in the markets life will go on. Though it sometimes seems as if commerce has grown to a halt, there are still ways to profit just as long as you know what you are doing. Which leads me to the broken record that plays in the halls of our fund. When investing in any kind of investment whether it is traditional or an alternative investment, you have to understand your investment, the market, and everything that comes along with it. Our markets are too volatile and moving too fast to be deriving strategy by sitting around with your head in a pile of spreadsheets and not knowing what is happening out in the streets. That's like thinking it's safe to run through a minefield with a metal detector. Unfortunately at that kind of speed, it warns you a moment too late before it kills you.
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