Real Insight. Real Estate.

Real Questions…

…. and Unintended Consequences

Question 1:

If you are a buyer of real estate (and actually have capital), what sort of IRR are you looking for? 20%? 30%?

Question 2:

If you are an owner of real estate, why on earth would you sell into this market unless you absolutely had to?

These questions succinctly sum up the entire commercial real estate market. Other statements examine facets of the problem, but they all revolve around this problem we’ll call, “The Bid/Offer Spread”.

Every day, the fund managers who still have jobs wake up, read the Wall Street Journal and say to themselves, “If I’m going to buy a property, I deserve a discount.” Any possible ‘green shoots’ notwithstanding, unemployment is high, the economy is in recession, global icons are getting destroyed (or taken over by the government), and the banking system as a whole is only viable because the Feds have stepped in with HUGE assistance programs. You can also throw in the fact that recent liquid market action (rally in gold, commodities and TIPS while the 10yr notes sells off ) is telling us we might even have an inflation problem in the not-so-distant future.

As a result, risk premiums are high across almost all asset classes (cap rates are higher), and deservedly so. So, again, if you’ve got the capital, you almost certainly are not going to be the guy that pays the asking price for a large piece of commercial real estate. You don’t want to be the one who has to live down the consequences of trying to catch a falling knife; it’s just human nature. In trading terms, the buyers of the world are just ’sitting on the bid’ waiting for a seller to come to them.

And why shouldn’t they? We just agreed that the financial world continues to be a mine field and cash is dear. If you want my money, you are going to have to pay through the nose to get it. Not to mention, even if someone hit your bid (came down to the price you are willing to pay), how are you going to finance the deal? Can anyone find a large chunk of reasonably priced debt? Will the bank ask you to pledge your first born child? I think we all know developers who, if given the chance, gladly would!!

Lastly, I wonder, in a word where the 10 year yields 3.75%, is 20% a reasonable return on a cash flowing asset?

We’ll have to address Question 2 in the next installment of “Real Questions…”

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