Thanks to the Fed, the workout business and restructure business is almost done and people engaged in those endeavors are moving on. The major advisory groups focused on restructuring advice, bankruptcy and related matters are being disbanded and reassigned to other roles. Bankruptcy attorneys focused on real estate are idle and looking for new litigation to occupy their time. Funds and investors seeking distressed deals are struggling to find anything that makes economic sense or is worth buying. Mostly properties are now over priced, too old and costly to renovate, or just badly located and hopeless. If you want exterior corridor roadside motels there are some, but who wants them. Office buildings in very secondary cities that cannot command decent rent can be found, but who wants them unless the price is very low and you are a local operator. In summary, the distressed game is essentially done and now it is mainly foreign capital paying cash at too high cap rates in new York, San Francisco, LA and Washington that drives many large transactions. Other deals are heavily dependant on the Fed keeping rates unrealistically low.
Most investors I speak to say they buy things where they can get 4% or sometimes lower debt, buy at an 8% cap and make a spread on current return. Most of the more sophisticated understand there is not a lot of likelihood of a big capital gain when they sell since rates will go up and cap rates will follow. They are seeking a current return in the 12%-15% range, and maybe a tiny pop at sales. At least we seem to have gotten over the legend of everything needs to make a 20% IRR or it is not acceptable, now that many learned just because their model says 20%+ return does not make it so, I continue to enjoy talking to my clients and friends who do deals on experience getting their hands dirty, and not based on some MBA's version of spreadsheets based on unreality.
Luckily for many real estate investors, there is little chance fiscal and regulatory policies are going to change before next year and then only if the Republicans get control of the Senate and eliminate the senility of harry Reid blocking any hope of any compromise on anything. If the Republicans do get control of the Senate, and if they can tamp down their right wing, then maybe there is a chance that there might be some sort of bipartisan compromises on taxes, regulation and other things which have negatively impacted the fiscal side of the economy.
For the near term, the Fed is going to leave rates low because if they do not the economy could risk falling back to 1% growth. Housing would decline further than it has over the past couple of months, commercial real estate deals would slow as the arbitrage of super low rates would disappear, and new development would slow to an even lower level than it already is at.
Just be aware that the election might cause some changes, or not. 2015 might bring higher rates later in the year, thereby setting off a shift to higher cap rates as buyers change their calculations for exit and current return arbitrage is no longer generating 12%-14% current cash returns. It will not take a lot of movement on rates to shift the modeling and decision making for commercial real estate investors, so think carefully about your going in price now in anticipation of what is likely to be the exit price when rates are higher. The period for high current returns might end by mid 2015 making your overall return calculations very different than they were last year.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
