IRVINE, CA—It's a good time to be a seller in the Western US, especially in Arizona, California, and Nevada. As the economy continues its progressive recovery, strong demand for product is driving significant increases in sale prices in these markets due to lack of supply.

With limited inventory of quality investment properties on the market, assets are selling quickly, which is keeping cap rates compressed.

Buyers Are Getting Creative

Currently, there is a high volume of buyers on the hunt for properties in the $1 million to $5 million range, many of whom are finding it very difficult to acquire quality class B/C properties in 2014.

In Southern California, especially, we are seeing class B/C properties selling at higher prices and lower cap rates than 18 months ago. This trend is directly impacting Arizona and Nevada, as Southern California buyers once again extend their reach into these markets in search of higher yields.

Another trend emerging in Southern California is increased buyer interest in older properties - age and condition of a property are no longer impacting pricing as much as they have in the past several years.

A main factor driving these trends is that investors in California are now acquiring lower quality industrial assets and converting them into creative office space. The fact is, acquiring an industrial asset and converting it can be significantly cheaper than acquiring a traditional office building.

This activity is well-aligned with the demand of today's tenants and owner-users.

Throughout the industry, traditional office layouts are increasingly less desirable, especially for small to mid-size firms. Today's tenants and owner-users are seeking minimalistic design with polished concrete and open rafter ceilings with exposed ducts, as well as wood and glass accents.

In Arizona, this shift in office layout is driving a new demand for parking. As office floor plans continue to allow for more people in less square footage, more parking will be required than was originally planned for in older, class B/C office product.

As a result, spec office development is beginning to emerge for the first time in many years.

For example, Wentworth Property Company in Phoenix is building a three-story, 158,000-square-foot class A office building as part of the Discovery Business Campus in South Tempe.

The project, which will be the first of its kind in Phoenix according to Jim Wentworth, Jr., a Principal of Wentworth Property Company, will be parked at 7 per 1,000 to accommodate the lack of supply of properly parked Class-A office space.

In addition, this project will incorporate many of the design elements that today's next-generation worker is seeking, including showcasing 17 feet from deck to deck, allowing for a 12-foot drop ceiling or an open 17-foot ceiling.

Lenders Compete With Creative Solutions

Interest rates remain incredibly low, and continued rate pressure is being fueled by large institutions chasing high quality assets and extended fixed-rate periods.

In addition to rate pressure, some banks are reducing or waiving origination fees and transaction costs. Many banks are also beginning to provide more concessions in order to get deals done.

This activity has forced other lenders to move up the credit spectrum, pushing loan to values higher in order to compete. Non-bank lenders are re-emerging in the higher yield mid-credit space, while smaller lenders are becoming more creative on loan structure, recourse and prepays in order to close deals.

As financing costs are going down, availability of capital continues to increase.

As a result, owner-users are taking advantage of the ability to move up to larger and higher quality facilities without negatively impacting balance sheets, while investors are willing to pay more for assets.

In the owner-user space, lenders are aggressively pursuing SBA financing opportunities.

Coming out of the recession, many owner-occupied loans that may be difficult to qualify for conventional financing are being funded under the SBA 7(a) or 504 loan programs. These programs are attractive to lenders due to the reduced exposure or credit enhancement delivered by the 504 and 7(a) loans, respectively.

Additionally, both bank and non-bank lenders are benefitting from aggressive pricing (premiums) in the secondary market for guaranteed portions of 7(a) loans. Recently, in the non-bank arena, Voit was engaged on behalf of a court-appointed receiver to market and sell loan portfolios containing interests in both 504 (FMLP) and 7(a) loans. In addition to the loans, the offering also includes an SBLC License which, for approved buyers, provides SBA Lending Authority to operate as a Small Business Lending Company. Further information on this sale is available at www.sbcloansale.com.

Navigating the Terrain for Best Results

It's important that brokers and their clients become more hands-on with investment assets in the current market in order to best leverage each opportunity. Limited inventory means more of the assets on market have “hair,” requiring deeper analysis, so it's important to be more detailed with underwriting and due diligence.

In addition, brokers in the current market climate must manage client expectations and provide a longer-term view on investments. It's important to be strategic and creative in order to find the best deals out there for clients.

For example, one strategy that retail investors should consider is a focus on tenant mix.

Many neighborhood retail centers currently on the market have an inferior tenant mix in place. This creates a value-add opportunity for landlords who are willing to re-tenant with a more appropriate mix that aligns with the property's submarket.

By identifying strategic, creative solutions and taking a long-term approach to investments, brokers and clients can work together to create deep value in the current market.

Pete Beauchamp is a SVP in Voit Real Estate Services' Irvine office. Contact him at [email protected]. Darren Tappen is a SVP in Voit Real Estate Services' Phoenix office. Contact him at [email protected]. The views expressed in this column are the author's own.

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