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Careful Analysis Is Now Required

there are so many issues now and we are at the top of the cycle, so one needs to underwrite very carefully.

By Joel Ross | Updated on November 22, 2015

It is becoming more apparent that 2015 was the big year for CRE prices to rise, and now there is a topping out beginning. Not a crash, but a leveling off. Prices of all types of buildings in secondary markets are at levels that are now uneconomic in many cases, and a growing number of bids are not closing or are taking much longer to close. We are now near the eight year of the cycle if you start with the start of 2008 as the time the financing markets were already in collapse. Cycles only generally last 7-8 years, and in some cases the longest being 10 years. In many markets multi is beginning to be over built and rents are reaching maximum levels that they are close to unaffordable for a growing number. Wages are simply not growing to the degree that would be needed to afford the projected rents on many new projects. Retail and office rents in some markets are now coming close to that same level where the numbers are simply not economic for the tenants.  That is already happening in Manhattan. Construction costs are much higher now, so my going in cost today on development is far higher than two years ago. To all of this we add that interest rates are about to start rising, even if very slowly. It will make underwriting more cautious when one looks ahead over a 5 year hold. What will rates and cap rates be in five years when I want to exit. Maybe the ten year by then will be back at 5.5% , and cap rates could be back up to more normal levels.  So what is my exit value if the then buyer is looking at debt yields calculated on a loan rate of say 7.5% or 8%., and cap rates 150 basis points higher than today.  My terminal value will be a lot less than if a sale was taking place today so I can’t afford to pay as much today and hold for five years, as I was willing to pay two years ago when things looked less problematic long term, and if I figured to exit in 3 years.

 

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