FEATURE ARTICLE, APRIL/MAY 2009

THREE’S A CROWD IN TODAY’S INVESTMENT SALES
Capital markets, property valuation and the overall economic malaise are affecting the investment sales market.
Stephanie Mayhew Specht

A trifecta of issues — trouble within the capital markets, a disconnect in property valuation and the overall uncertainty in the national and global economies — is stifling the investment sales market throughout the nation and in the Northeast.

New Jersey

In New Jersey, Michael Fasano, regional manager in Marcus & Millichap’s New Jersey office, notes that the investment sales market has been feeling the pinch across all sectors of the market with velocity dropping considerably in 2008.

The numbers from Fasano’s reports paint a clear picture of the slowdown. In 2007, 305 multifamily properties priced at more than $1 million were sold in New Jersey. But looking at 2008, using the same time period and criteria, there were only 195 multifamily buildings sold, resulting in a 30 percent decrease in velocity from 2007 to 2008. Using the same parameters for the retail sector, in 2007 a little more than 500 retail properties sold in New Jersey for more then $1 million. In the same period in 2008 those numbers drop to 480 retail properties.

The industrial and office markets are showing similar decreases. In 2007, 160 office buildings were sold for more than $5 million in the state, and in 2008, during the same time period and same criteria, there were only 68 buildings sold. In 2007, 250 industrial properties sold for more than $5 million, but in 2008 that number dropped to 195 industrial properties.

The drop in velocity is not the only thing that has changed. The dollar value of deals has changed as well. Fasano notes that of the 195 multifamily buildings that were sold in 2008, only 14 of those were sold for more than $9 million. In the same time period in 2007, there were approximately 30 buildings that exceeded a sales price of $9 million. Certainly, the lack of financing has certainly put higher end properties at a disadvantage.

“The higher end deals are simply more challenging to finance. Certainly the capital markets crunch that we witnessed with the CMBS market had a big impact on some of those higher end deals in 2008, but that only amounts to maybe a third of the reduction in velocity,” says Fasano. “The other two thirds in the reduction of velocity has to do with the market shift in pricing. There are sellers that have 2006 pricing still in mind, but because of the capital markets issues and the issues surrounding the economy, there will be a period of time for sellers to begin to accept where the market is and I think we are working through that.” 

Overall, multifamily properties remain the investment of choice in New Jersey. Properties with strong occupancy rates located in urban submarkets near New York City — Hoboken, Jersey City, Weehawken and Hudson — tend to draw the most attention. However, submarkets such as Passaic, Essex, Mercer and Camden counties, are taking a hit and Fasano says that multifamily sales velocity has dropped significantly.

“There has been more of a significant correction in value on assets in those counties, which of course means there is greater risk,” he says. “Those areas also happen to be the leaders in unemployment rates throughout the state.”

Job loss, lack of consumer confidence, rising vacancy rates and a decrease in rent growth have all greatly affected the retail, office and industrial sectors as landlords struggle to keep occupancy levels up; thus, putting tremendous strain on the value of those assets. For example, according to Fasano, there has been a fair amount of pressure on retail values, which have moved at least 200 basis points in value from 18 to 24 months ago to today. However, despite the downward pressure on the commercial real estate industry, New Jersey’s investment assets are still in the forefront for investors.

“Regardless what cycle we are in, the quality assets will continue to draw attention from investors,” he says. “The more challenging assets that are struggling with vacancy, regardless of where they are located through the state, will be challenged to ride their way through the cycle.”

Fasano adds, “The good news for New Jersey is that we are not overbuilt and while many landlords are feeling the effects of the economy, as the economy stabilizes because we are not overbuilt we will come back stronger than ever.”

New York City

The investment sales market in New York City is being hindered by many of the same issues discussed above. According to Norman Sturner, managing member and co-founder of Murray Hill Properties, the investment sales market in New York City is stuck in a coma of sorts due to the lack of financing.

“Right now there is very little, if anything, being sold. This is not because sellers don’t want to sell or buyers don’t want to buy, but it is because of a lack of credit. And, in our opinion, that is not going to change for a while,” he explains.

Sturner notes that in order to make sales more attractive and feasible, sellers will begin to offer financing. Much like what he and his business partner, Neil Siderow, also managing member and co-founder of Murray Hill Properties, saw when they first went into business back in the early 1970s.

“We are currently working on a property that has legacy financing on it for the next 7 or 8 years that is assignable. That makes the sale at least doable whether the economics are good or bad,” he says. “Without having financing in the 65 percent LTV price ratios you can’t trade.”

As the market continues to correct itself, many are waiting on the sidelines for a flood of prime properties to hit the market for rock bottom prices. Once such transaction was the recent sale of 1540 Broadway, a 44-story, 1.1 million-square-foot office tower located in Manhattan, New York City. The office portion was acquired for $335 million in March by CBRE on behalf of CBRE Strategic Partners U.S. Value 5 Fund, the company’s commingled limited partnership real estate fund.

The building was originally purchased as part of a portfolio of office properties by Macklowe Properties in 2007 in a $7 billion transaction. And while many have hoped that transactions such as this will become more of the norm, Sturner and Siderow do not believe that we will see a deluge of distressed properties hitting the market, noting that although it is tough to get financing from lenders, there are pockets of both private and public capital waiting for the right properties to come onto the market. 

“There is still a great deal of money in sovereign wealth funds, in pension advisory firms, in opportunity funds that have not called on dry value yet,” explains Sturner. Meaning that investors will pounce on prime properties before prices get too low.

There are some positives in the marketplace. In this cycle, unlike downturns in the past, vacancy rates were high, but not so this time around.

“In this cycle, we have been lucky to the extent that the vacancy factor was extremely, extremely low,” says Siderow. Meaning that buildings were 94 to 95 percent rented when the cycle started, and the average office lease in New York is a 10-year lease. When we last had this problem in the 1980s, New York was tremendously overbuilt, so there was a high vacancy factor before the problem started.”

Siderow puts the current office vacancy rate at approximately 7 percent to 7.5 percent, but noted that in a similar type of downturn the vacancy would be in the 14 or 15 percent range.

Many are speculating when the investment sales market will start churning again with guesses ranging from the end of the year to mid-2010 to 2011. Siderow believes that the market won’t see much of a recovery until past the end of 2009, while Sturner, an optimist that see the glass half full, speculates that things might start to change by the fourth quarter of 2009.

“I think that by the fourth quarter of this year some of the things that the administration is putting into the economic stimulus package will stop the increase of foreclosures, stop the growth of unemployment and you will start to see a measure of stimulus occurring in the populous and that will give the perception, not necessarily the reality, but the perception that we have hit bottom. We may drag along the bottom, but at least that we have hit bottom,” Sturner notes. “Unless New York City has some major fall out of double digit vacancy, which I do not see, then you will see buyers come back to the market and negotiate with sellers at 25 percent discounts, rather than the 45 percent discounts that some were hoping to see.”

Sturner adds, “There is money sitting on the sidelines in the Middle East, China, Europe and in other private pockets, and it does not take much to move this market.”

Both do agree that what we will see down the road is inflation.

“The fact is, what the federal government is doing, and I think everybody agrees, is certainly going to cause an inflationary spiral or certainly an inflation decrease,” says Siderow.

Sturner adds, “When you put $3 trillion into this economy over the next 2 years, you are going to see inflation in 2 or 3 years that will compare with Jimmy Carter years. Money will be worth less than it was yesterday and hard assets are going to be worth more.”

Despite the list of growing negatives and fewer positives, there is opportunity out there in the commercial real estate market.

“We have lived through down cycles in 1971, 1981, 1987 and 1992, and seen the worst that the country and the world can throw at us and every time the cycle ends the next one is better,” says Sturner. “When people say that the vacancy rate is edging towards 8 percent, I will tell them that means we have an occupancy of 92 percent; when people talk about the unemployment rate possibly nearing 8.5 percent, I tell them that means that 91.5 percent of us are employed; and when I hear that there are 120 banks of the federal watch list, I will tell them that means there are 9,000 banks, which tells you that 8,700 are not on the watch list. So, it is all according to how you look at it.”

Boston

In Boston, the retail investment sales market is seeing its share of woes too. According to Robert Shannon, managing director for Sperry Van Ness/Income Property Realty Advisors specializing in the sale of retail properties, retail investment sales have gone down about 75 percent in Boston.

“In 2008, the total volume of retail transactions in Boston was about $415 million compared to about $1.5 billion the year before. That is probably based more on the dollar volume. If you look at the number of transactions, it is showing a similar decrease but not as high of a percentage,” he explains. “It is similar to what is being seen on a national basis as well.”

Shannon notes that on a national basis, in January of this year for instance, there was about $876 million traded throughout the country for retail properties. In comparison, in January 2008, about $3 billion traded. The last time that sales exceeded a billion a month was September 2008.

Despite the decrease in sales velocity, more and more retail properties are hitting the market in Boston, and unfortunately that number is far exceeding the number of properties that are being sold. And as far as what is for sale in the retail sector, Shannon says that it is a mixed bag.

“There are some good quality properties that don’t have any type of stress associated with them, as well as single tenanted net lease drug stores. But, there are also portfolios that investors purchased, possibly during the middle of 2008 in bulk,” he explains. “These might be sale/leasebacks of some portfolios of Rite Aids, and they are just having a tough time selling them right now because Rite Aid downgraded their investment status. A lot of people think they are going to end up in bankruptcy so they are just staying away form them. Whereas, the CVS and the Walgreens are still considered safe investments and are still selling, although they are selling at higher cap rates than they were before.”

In addition, there are many empty car dealerships coming to the market for sale and the number seems to be growing on a weekly basis. If it is located on a corner in a good location, Shannon says there might be a buyer and a new use for the site, but if it is located in a secondary area, they are simply not moving.

Despite the growing number of for-sale properties inundating the Boston market, Shannon remarks that he has not seen a great deal of distressed assets coming up for sale, but he expects that to increase. 

“We are seeing more distressed type sales on a national basis, but we are starting to see it more now in the Boston area. As an example, during the last few weeks in the auction section in the Boston Globe, the number of commercial properties has increased. But when you look at other parts of the country there is just so much more good quality distressed properties that are on the market,” he explains.

The major difference between the type of distressed properties coming to the market in Boston and nationally is the class. The majority of distressed assets available in Boston right now are mostly C and D type properties; whereas, nationally the property types are much higher end. Shannon notes that there are some higher end retail properties on the market, but they are not at the stage where they have been foreclosed on.

“If you get a good Class A property that goes up for auction and you have 15 to 20 bidders that are actively bidding on it that is what is going to show what the true value of that property is in this kind of market,” says Shannon. “And I think you will start seeing that as we get further into 2009.”

Due to the economy and the change in pricing, Shannon notes that some buyers are changing their strategy as well. For example, many investors that typically bought strip centers in suburban markets are now turning their attention toward urban areas because they don’t have to worry about a drop in population levels. The composition of buyers has changed in Boston as well as private investors have moved to the forefront.

“When you look at the market in the Boston area before the credit crunch, about 35 percent of the active buyers were private investors, but that has almost doubled now since many of the REITS, public companies, and institutional buyers, while still in the market, have cut back substantially on their acquisitions, leaving the most active buyers right now private, high-net worth individuals or private companies,” Shannon explains.

Like Sturner and Siderow noted above, the properties that are moving the quickest in the Boston investment sales market are those with financing already in place. However, Shannon remarks that even some of those are considered risky if it has a conduit loan for 6 years since it is hard to gauge what the market will be like in that timeframe.

As far as the future is concerned, Shannon does not see a clear path yet.

“The markets that go down the quickest are the last to rebound, but the markets that are in high demand, such as the more populated areas or major metropolitan areas, are the ones that will come back the quickest. Like with everything it is a flight to quality,” he says. “When you look at what is happening in the markets — vacancy rates are rising, rents are going down, and it is still difficult to get financing — those three factors point towards lower selling prices. But at the same time, and I hear this quoted by more and more people — there were more billionaires made during the Depression than any other period of time — and I think that is what people have to focus on. There are a ton of opportunities out there right now, it is just a matter of do you want to take the risk.”

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