I am confident in stating that we are clearly seeing the foundation for a sustained commercial property recovery. The geographic results may vary, but there seems to be a consistent positive outlook. Nobody is saying they expect prices to skyrocket anytime soon but a fundamental floor is evident.
In a sign of the new times, the Mortgage Bankers Association recently sold its Washington D.C. headquarters to an investor group for $41.3 million. In February 2011, that same investor group sold the building for $101 million. This is just one example and I can add another recent example: one of our own deals that was acquired as a distressed note acquisition. The market stalled for the developer and we were able to complete the project and sell the property with multiple offers. These examples illustrate how, over the past couple of years, commercial real estate values have appreciated as much as 30% in some markets.
At the height of the mortgage meltdown, while economists, Federal officials, lending institutions, and investors held their collective breath waiting for the other shoe to drop - the collapse of the commercial property markets - it never materialized to be the end-all collapse most had forecasted. Due to more stringent underwriting and higher capital levels required for investments, commercial real estate held steady. Today, with the resurgence of securities collateralized by commercial loans, major financial institutions’ actions underscore investor confidence. Analysts project $13 billion in commercial-mortgage-backed securities (“CMBS”) will have been issued in the first quarter of 2011 alone. We are seeing a consistent stream of lenders who pulled out, re-enter the lending arena with large capital commitments for this sector. Commercial real estate is enduring the economic turmoil and remains a sound choice for many investors.
Thawing credit markets are breathing life into small and medium-size business growth which is fueling an increased demand for office space. Although vacancy rates remain historically high in many markets, the trend is clearly going to the side of absorption. This increased demand for office space combined with a decline in new office building construction, has lowered overall vacancy rates, stabilized rents, and generated dependable returns.
Profitability in the multi-family sector is directly related to developments in the single-family housing sector. For the average consumer or first-time homebuyer, stiffer underwriting guidelines, higher loan-to-value requirements, and higher interest rates have made it more difficult to afford a home. Despite favorable “buyers market” conditions, only investors with cash in hand are truly taking advantage of market opportunities. Many Americans, for the first time, are questioning the long-term value of homeownership. Recent surveys indicate that the numbers of Americans who believe homeownership is a safe investment is decreasing annually. Moreover, homeowners displaced as a result of foreclosure or other loss mitigation activities such as short sales and deeds-in-lieu have created a new class of renter. The outcome: vacancy rates for apartment rentals are plummeting and rents are increasing accordingly based on simple supply and demand. Analysts predict a mere 5% rental vacancy rate by 2012 with an increase in rental charges as much as 10% or more in major U.S. markets.
Capitalization rates further underscore the increased value of commercial property. The lower the “cap” rate, the higher the projected rental revenue. In a recent Fannie Mae report, capitalization rates on multi-family properties remained low through 2010 indicating strong returns for the sector. And, as the Federal government seeks to end government involvement in insuring mortgages, current proposals include continued government backing of multi-family loans due to their low default rates. The multi-family sector has been recognized as the first to recover.
All the signs point toward the commercial sector as being the one to watch: unlike their single-family counterparts, commercial properties are appreciating in value; markets for commercial-backed securities are returning to favor; the resurgence of small business signals an increased demand for office space; factors stifling a recovery in the housing industry are generating revenue for apartment owners; and the government’s assessment of the stability of commercial mortgages is positive enough to keep it in the game of insuring them.
At the Peak Corporate Network, we believe that in a hindsight scenario, 2010-11 will be viewed as the “turnaround.” We are seeing this firsthand with increasing demand for space and the improving performance of our properties after several years of decline. We are actively seeking to acquire investments and JV opportunities in this market.
The handwriting on the wall is clear - commercial real estate, for the savvy and patient investor, continues to be the smart investment.
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