Residential Downturns Effect on Commercial

NEW -> Contingent Buyer Assistance Program
<p> Commercial property</p>

<p>View from the top


Oct 11th 2007


From The Economist print edition</p>

<p>It looks a long way down from the peak of the global market for office space</p>

<p>http://www.economist.com/finance/displaystory.cfm?story_id=9954087</p>
 
<p>bishie, </p>

<p>Nice post, enjoyed reading your comments. Your view on retail scores a direct hit. On top of all that you mention regarding the absurd cap rates, a few of the sellers I've recently negotiated with want 50% down. That's just to break-even, forget about the fairy tale rent increases. Well said!</p>
 
<p>Bishie,</p>

<p>Debt certainly should be considered when evaluating a particular property's cap rate, however, from what i understand, especially for large commercial core assets, such as large A quality/locaiton apartments, I believe it has more to do with target returns and investment environment. </p>

<p>The buyers of these assets are typically institutional investors purchasing with low or even no leverage... These institutional investors will typically consider the treasury as a benchmark. Given where treasury rates are today, cap rates and the commensurate returns associated with these properties are still not far off... although sub 5% cap gets me nervous as hell... crazy environment we are in... </p>
 
Actually things are equally bad on an institutional level. The average REIT yield premium to 10Y treasuries over 5, 10, and 15 years is 101 bp, 120 bp, and 100bp. Currently equity REITs are yielding 3.79% and 10Y treasuries are yielding 4.73% for a discount of 94 bp. So to bring REIT valuations back to historical premiums to treasuries would require an increase of REIT yield by 194 bp. If you buy a Class A apartment building in Irvine at a 4% cap rate and finance it at 5.5% at 50% leverage your cash-on-cash return is 0.5(-1.50)+0.5(4.00)=-0.75+2.00=1.25%. I believe this is pretty close to a correct underwriting of a actual Irvine apartment transaction for a 200+ unit Class A bought by a pension fund in 2Q07. Given the nature of the buyer it is unlikely they are thinking of converting this asset to condominium units so you have to believe 1) Rent growth will be sufficient to bring the yield up to an attractive level 2) You can somehow refi this puppy at a lower interest rate down the line or 3) Haven't real estate returns looked pretty good in 2006? I think a combination of choice 1 and 3 is what caused the pension fund to purchase this asset. Several pension funds increased their allocations for 2007 since 2006 was a pretty good year for NAREIT. Once you have your allocation placing it requires you to figure out some way of making these deals work so you tend to pencil in some attractive rent growth to get your front end commission for bringing in deal flow.
 
<p>well your initial assumption that REITs are yielding less than treasuries is a little misleading, as this is purely a cash on cash type return, not taking into consideration appreciation of assets.... besides that point; i completely agree with your analysis of the institutional markets as well... too many players have become overly exhuberant with growth rates... this will truly affect the overall health of the market in the near short term and overall... although it is interesting to see the corroboration among these institutional investors and how their aggresive assumptions are really moving market rents... OC posted 11% rent growth in office rents year to date. </p>

<p>we'll see how these guys weather this downtown going forward... a shakeup certainly seems in order in the near future.</p>
 
<p>As an individual investor a 1.25% cash-on-cash return is brutally low. Are these institutions buying to hold over the long run, i.e cashflow or looking to build value over a few years and then turn the property around? It would seem like their betting on continued appreciation or a dramatic rise in rents.</p>
 
<em>"It would seem like their betting on continued appreciation or a dramatic rise in rents."</em>





That is exactly what they are betting on. Historically, chasing returns has been a great strategy for losing money. It is a great way to buy at the peak.
 
IR is right on. reit investors have been betting on near-term growth to justify ridiculous valuations. blackstone got a lot of praise on their buyout of EOP, by quickly flipping the desirable assets at a premium. but in actuality all they really did was cover their initial investment by selling off the good stuff (midtown manhattan, OC/LA, sf, etc). now they're left with the filler and it remains to be seen whether they can make the deal profitable in the long run. all the other institutional and foreign buyers that pushed up asset values are long-term players and just like re_fan said, it'll be interesting to see how they fair in a downturn. most of the recent RE buyouts have not looked good. ASN, NXL, HLT (not closed)





re: yields -- i don't typically look at div ylds because a significant number of reits do not cover their dividend. nearly all of them will have a 10-yr track record of dividend growth though. its sort of like driving down a street and every store has a sign that says "LOW PRICES!" pretty much means nothing these days.





but bishie's back of the envelope comp makes a fine point -- there's no way these stocks should have yields lower than the risk free rate. even if you looked at reit 12-mo fwd earnings yld (4.3%), its still lower than 10-yr treasuries. on top of that, reits have actually been more volatile the the s&p over the past 3 yrs. so you have lower div and earnings ylds than the risk free rate and higher risk than other equities. only sounds like one way for prices to go...





(is there any way to post a graphs?)
 
" (is there any way to post a graphs?)"





If you have them hosted at a website, you can link to them in the imbed image button above (looks like a mountain). If you have the image you want hosted, you can also email to one of us, and we can host it on IHB and send you a link to the site address.
 
<p>Since you guys are discussing REIT`s I am going to hijack this thead real quick. My business partner is invested in a residential REIT High Yeild. Like 11-12% but its on Second Tust Deeds on California properties. I have been warning him for months that this investment was going to get dangerous as values declined and some of the borrowers walked away. Leaving the REIT holding the second in not a good position to recoup on its colatteral. Well its happened. They told him no more redemtions. So his investment is frozen. The question is. How can this REIT continue to advertise for new investors while having the orginal shareholders unable to redeem their shares. Guess the big money wanted out so they put the "No Redemtions" clause on. Any of you RE/Legal guys have an opinion ? I feel bad for my friend. But my doom and gloom advice he ignored. I just dont see how a REIT like this can recover if the market stays soft or worse yet goes down another 30%. <a href="http://www.rescapfunds.com">www.rescapfunds.com</a></p>
 
Your friend is due for a 100% loss on that investment. We have documented numerous 100% losses on 2nd mortgages, and the price drop is in its early stages. None of these loans will survive.
 
<p>Back in 2000, I recall seeing office space trader in the $100 range after the dot com burst, I am hoping those times will come again by 2010.</p>

<p>Any thoughts of the office condos they are/were selling in the Spectrum area for $500+ psf? I have a few friends who purchased there and highly advised them NOT to do it. </p>
 
this easiest way to spot a bad investment is when their website has testimonials on it. are they selling financial investments or showtime rotisseries? these are all completely irrelevant if not bogus.





http://www.rescapfunds.com/Testimonials.asp





"Residential Capital is very good. I made lots of money and the money is plentiful and smells excellent. Very crisp bills. There was low risk and also the profits are tax free because the company has very smart people working there and their office is very clean."


Real Investor Person, San Diego


<em>


<strong>Can a shareholder withdraw their investment?</strong>


A Member may withdraw as a Member at any time, however, the right to sell shares and realize a return of capital is available under limited circumstances until the termination of the Fund.</em>





This also sounds very sketchy. You're free to withdraw as a member whenever you want... you just can't get your money back whenever you want. What does that mean? You stop getting the newsletter? You have to return your membership card. Oh, but you don't get your money back until... ???

 
<p>Acpme:</p>

<p>Typically these funds allow for advisory boards or investment boards... not sure whether the one you were referring to is a pe fund or what not... but many times they allow investors to participate in the decision making process but are not obligated to remain as an advisory member... so yea basically you get to hold a card saying you're part of that fund... but the money stays in... the operating agrmt locks in investment members for a certain period of time.</p>
 
<p>I just wondered how they can still be advertising for additional investors when this addendum is hidden deeper in the website.</p>

<p><a href="http://www.rescapfunds.com/downloads/Supplementtothe9-13-07OfferingMemorandum-FINAL(1).pdf">http://www.rescapfunds.com/downloads/Supplementtothe9-13-07OfferingMemorandum-FINAL(1).pdf</a> "No Redemtions at this time". Guess everyone wanted out when subprime became a bad word for investors. </p>

<p>Looks like they just got a $ 30M line of credit as well. Saddly my friend put a 6 figure sum into this and now is retiring soon. I wonder what recourse he has if any for his investment. </p>
 
<p>Institutions are accepting the low yields specifically because of expectations for revenue growth. Fundamentals in most property sectors are pretty strong in SoCal. These types of yields are not the norm nationally....only in markets where investors expect to see above average revenue growth. No insitution is buying a 4% cap, 1.25% cash on cash yield apartment deal in St. Louis or Detroit. Those types of cap rates are pretty exclusive to SoCal, NorCal, New York, and maybe DC or Boston.</p>

<p>From what I have seen in the last 60 days in the apartment market, those cap rates are already moving up. Probably 25 basis points for a class A property in an A location (an Irvine Company asset). Probably 50 to 75 basis points for lower quality stuff like a 30 year old property in a B location (a 1970's property in Anaheim) or a 20 year old property in a C location (a 20 year old property in San Bernardino). </p>
 
i was referring to the fund mentioned by bltserv. <a href="http://www.rescapfunds.com/">www.rescapfunds.com</a>


i'm not saying that the business is illegitimate in any way, but my initial reaction from just browsing around the website was any respectable investment mgr does not need testimonials and links to how you can get a free copy of the founders book. web references to the founder, martin goodman, pointed to nationalwealthnetwork.com (website no longer up -- sounds like cheesy get rich quick fodder), the success elevator (ditto), and young athletes of america (???).





i still havent heard any compelling reasons for investing in private reits or other private funds like this considering there are so many liquid alternatives out there. if you have some substantial wealth and want to invest in exclusive private vehicles like PE or hedge funds, go talk with a wealth mgr or fund of funds company to see if you can invest in a feeder fund. any private fund that will take 50k of your money (a lot of money no doubt, but small potatoes for any legitimate money mgmt business) you really dont want any part of. stick the money in a mutual fund.





as far as their returns, an apt reit that returned 12% and 11% in 05 and 06 respectively is terrible considering any of the major reit ETFs returned 50% in that same time horizon. and you wouldn't have any minimums and lockups to worry about.
 
You must log in or register to reply here.
Back
Top