With the exception of cash transactions, investment activity in commercial real estate sectors is essentially at a standstill. This is due to the fact that financing is difficult to secure while job losses and diminished consumer confidence are curtailing the demand for space, according to real estate experts who spoke at the 7th Annual Commercial Real Estate Forecast Conference held in Chicago in January, 2009.
Hosted by Warady & Davis LLP, Illinois Real Estate Journal, Crain’s Chicago Business, and DePaul University, among other sponsors, the event attracted a sizable crowd of CEOs, presidents, owners and other senior management of Chicago-area real estate, construction and financial businesses. The conference focused on what to expect in 2009 and when to anticipate recovery.
“In 2008, the players started to disappear. The cost for doing a loan was huge, and many layers of brokers appeared. You had to go to five or more sources of equity or debt to have a chance to be funded. Your institutional players seemed to evaporate completely. Real estate loan areas of banks disappeared and bankers were changing banks daily. You still could make a loan in 2008, but the sources were few and far between,” said Norm Nagel, CPA, Partner with Warady & Davis LLP, a Deerfield-based certified public accounting and consulting firm.
“The current financing players are smaller, the due diligence periods are longer and the terms are stricter and more expensive. The loan to value or cost can range from 50 to 75 percent,” Nagel added.
“Amateur hour is over,” said Duane Lund, Founder and CEO of Geneva, a Chicago-based real estate investment firm. “In 2007, there were as many as 60 sponsors running 1031 exchanges. Now, there are only about 10 left. Many went bankrupt. There is a huge consolidation of the 1031 exchange environment, with lots of pull-back and few deals getting done.”
“In 2008, after Labor Day, you couldn’t fund a deal over $20 million. If you were lucky enough to get a transaction financed, it often took four to five participants,” said Chad Firsel, Executive Vice President of NAI Hiffman, the largest private real estate services firm in the Midwest.
“Big banks are no longer on the playing field, and sources are few and far between. In all likelihood, this will continue well into 2009 and 2010,” Nagel noted.
“We have seen a rise in ‘Main Street’ or local banks participating in lending activity. Last year, it was national banks, in 2009, small banks are the ones getting deals done,” said Lund. “Even so, we don’t intend to buy a building in 2009. Instead, our focus is on paper, not bricks.”
Instead of purchasing new properties and/or land for development, many real estate developers and builders have formed groups or located financing sources to buy down notes receivable and mortgages for foreclosed or troubled properties from banks. Hence, there are tremendous opportunities to cherry pick prime projects at large discounts, said Nagel.
“Opportunities exist for controlling assets versus. buying assets. Our strategy is to control as much capital as possible by taking over failed transactions with upside potential – particularly 1031 and 721 capital that is trapped,” Weiss said.
Additionally, “investment property sales are way down -as much as two-thirds lower in 2008 compared to 2007,” said Nagel. “There are opportunities for investors to obtain foreclosures for cash, but they are hard to get financed.”
“You will be hard pressed to see any REIT acquisitions in 2009. Instead, many if not all, will repurchase their own stock or debt,” said Gary Weiss of First Industrial Realty Trust, An established REIT and owner of industrial real estate serving thousands of corporate clients with nearly 100 million s.f. of industrial space in more than 30 industrial markets across North America.
“We are also looking to paper, not bricks,” commented Firsel. “Investors are very nervous about a property’s amount of use. Due diligence has increased exponentially, and buyers are asking for financials from every single tenant.”
Even if you can obtain the financing, there has to be something for investors to buy, added Nagel.
“The bid-ask is the widest I’ve ever seen,” said Firsel. “We currently have 300 properties listed and two under contract. People are holding on to property.”
REITs are more concerned about asset preservation than disposition, Weiss noted. “Historically, REITs would sell strong performing properties. Now they need to hold onto them for cash flow. For poor performers, the question is how big of a hit do you want to take?”
If you want a 15 to 20 percent rate of return with debt of 50 percent or less, you have to find properties being sold at a 10 to 15 percent capitalization rate, said Weiss. Until there is pressure to get things moving again,” there won’t be sellers,” he added.
Panelists also discussed the investment outlook in various niches of the real estate market.
“The industrial market is the benefactor – or victim -of consumer spending. There were a couple of large industrial deals done in Chicago in 2008, but many of these were already in place before the market downturn. Today, there are not many industrial players looking to go into 10 to 15 year build-to-suit properties. There is enough existing inventory, and until the excess is absorbed there will not be a lot of movement,” said Weiss.
“The only glimmer of hope right now is in multi-family development, which is the only piece getting financed,” said Firsel.
“For the last 18 months, multi-family was our best performing asset,” Lund agreed. Rents were up as much as 30 percent in 2008, and occupancy was around 94 percent. Multi-family is the one last investment play.”
But is it too late to capitalize on multi-family opportunities? Lund said that this sector may start to feel pressure, too. “As the recession continues, we are starting to see a doubling up on occupancy. Roommates are back,”he said.
“Healthcare is also a viable area,” added Nagel, especially with government programs lending up to 100 percent of construction costs for new facilities.”
Aside from residential housing, retail development has been the hardest hit sector, Firsel said. According to the ICSC, as many as 9,000 retailers will file for bankruptcy in 2009. Retail leads office and industrial for vacancies, he noted.
“We can expect downward pressure on rent for all types of commercial real estate. With businesses focusing on running lean and looking at costs, the two biggest line items are personnel and rent. If you are in survival mode, the first-step is to lay-off employees and the second step is to renegotiate your lease terms and rental rate,” said Nagel.
The panelists ended the event by forecasting what to expect in in 2009 and when to expect recovery.
“We will know we have hit the bottom when transactions start to happen again,” said Firsel.
“It is residential real estate that led us into the recession and residential has to lead us out again,” said Nagel. We will know things are starting to turn around when housing prices rise. But I don’t see this happening until 2010.”
For a real estate rebound to occur, a necessary chain of events must happen, Nagel said. First, unemployment needs to decrease, bank deposits must increase and lenders need to be forced to start making loans to give their investors a good return on their money. The government must also demand that banks make loans and mortgages based on certain criteria, if they want more bailout money, he said.
“If banks won’t, or are unable, to make loans to small businesses, the government, either through new agencies, the FHA, SBA, or a combination thereof, must step in and fill the gap by providing the loans that small businesses need to survive and operate, Nagel added. “As part of the bailout, the government should also allocate funds to directly refinance mortgages for selected foreclosures through HUD, Ginnie and Fannie Mae, etcetera.”
The final key ingredients are positive publicity from the media, strong action from the President and Congress regarding strict criteria and accountability, and general easing of the credit market, Nagel concluded.
“Be ready for when things start to turn. This can be a great opportunity to create wealth. Money is made in an up-cycle, and wealth is made in a down-cycle” said Lund. “Tax-deferred equity exchanges may present a perfect storm to make a lot of money.”
Contact: Leslie Flinn, Director of Marketing,
Warady & Davis LLP, Certified Public Accountants & Consultants, one of the top 25 CPA and consulting firms in the Chicago area specializing in real estate and construction. Contact: 847-267-9600, lflinn@waradydavis.com,
http://www.waradydavis.com
[tags]real estate, investment, REIT, financing, acquisition, disposition, commercial, multi-family, retail[/tags]
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