Pricing and sanity in the market

Bloomberg moved a story today citing experts predicting price drops in the US commercial real estate market of up to 15%. The story also says that because of these drops potential sellers are holding deals; additionally, contracts are terminating because of financing issues and increased borrowing costs and yield spreads have increased to up to 200 bps above 10 year Treasuries. Several experts are predicting big price drops and much less activity.

I guess I have to sort of repeat what I have said before. This may be a good thing for many investors, including the types I represent. Yes, some speculators are going to get hosed, and, at the risk of sounding cruel, rightly so in my opinion. As the story says, cap rates in 2002 were at 9.25%. In the 1Q of 2007 that rate was 6.5%, and the EOP deal closed at an amazing 5.3 cap (no wonder Sam got out...what a genius). Also remember that many EOP deals were flipped, perhaps at even lower caps. Let's not forget that rents are still rising in many markets. Finally, take into account the fact that there is money is on the sidelines waiting, just waiting patiently, for cap rates to come back to some level of sanity.

What do I think will happen? There will be deals, even though some sellers will not want to sell, if for no other reason out of necessity or from banks who take back properties, etc. There are always deals to be had for one reason or another, albeit not at the insane breakneck pace we've seen. Smart investors will buy at the right price, finance with traditional loans for the time being and take a hit with higher short term borrowing costs, waiting for rates to decline before refinancing into the most restrictive (but lower-cost) CMBS market. There will probably be fewer portfolio deals and more single-asset transactions. And we can all start acting normally again. And the sky, while at least partly cloudy, will not have fallen.

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