 Appleton
office:4824 N. Stargaze Dr. Appleton, WI 54913 920.739.5561 :Tel 920.739.5562 :Fax |
Madison office: 106 E. Doty St. #330 Madison, WI 53703 920.739.5561 :Tel 920.739.5562 :Fax |
Virginia office: 21663 Bronte Pl. Ashburn, VA 20147 203.434.6182 :Tel 605.237.2144 :Fax |
 |
Commercial real estate is still fundamentally strong, with record low default rates, and provides an excellent diversification from the stock market.
The past three months has seen increased turbulence in the financial markets. There has been increased inflation concerns with oil going over $110/barrel and record high grain prices The Dow Jones is down 20% year to date, and more lenders going out of business, or taking mulit-billion dollar write downs, due to the sub prime mortgage debacle. Where does this leave the commercial real estate market in 2008 and in the future?
To begin with, the Federal Reserve has done several things to help ease the situation. They have lowered key interest rates by 200 basis points in the past two months and have recently injected $200 billion of liquidity into the financial markets. They also backed JPMorgan on a rescue buy out of Bear Stearns. The US government has approved a $170 billion stimulus package, with tax rebate checks coming out in May. While these measures will all help ease the economic pains in 2008, the country will still likely slide into a soft recession, if we aren't already in one.
We all know that supply and demand determines price. Thus, we will look at supply and demand for both the rental market and the sales market to try to determine where the rental and sales prices will go over the next 12-24 months for commercial real estate. We must also remember that commercial real estate is very localized and each market has different rates of occupancy and new product supply.
The supply side is essentially the same for rental and sales, which determines current occupancy rates and how much new product will be delivered to the market place in the near future. Unlike the recession we had in the early 1990's, commercial real estate in most markets is not overbuilt today. For example, in the commercial office market between 1988-90, an average of about 100,000,000 square feet per year of office space was added to the market and vacancy rates soared to nearly 20% in the early 1990's. Commercial lenders turned sharply against lending for commercial construction projects in the early 1990's and construction slowed by 90% to approximately 10,000,000 feet of office space by 1994. As supply slowed, vacancy rates dropped to a low of 8% by 1998.
Supply of office space once again increased in 1998-2001, but not to the peak levels in the late 1980's. Supply started to decrease by 2003. Between 2005-07, an average of about 40,000,000 square feet per year of office was delivered to the market place. Obviously, this was much less than in the late 1980's, especially when considering the overall commercial office market had increased greatly over the past fifteen years.
We expect that supply will slow even more in late 2008 and 2009 due to tightening of banking lending policies and a slower economy (Since it takes several years to take a commercial project from start to finish, the supply of new product will still be similar in most of 2008 as it was in 2007). For example; three years ago banks would lend 80-95% LTV on spec office new construction projects with 30-40% of the property pre-leased. These terms have changed to 70-80% LTV, with 60%+ pre-leased.
With the economy slowing, there should be a decrease in demand for commercial space. Thus, there may be a small increase in vacancy in 2008 as new projects are being completed and the economy is slowing down. By 2009, supply should have slowed enough to stabilize any increase in vacancy rates. Rental rates will probably see small growth increases, less than in years past.
Due to the lack of new product being delivered to the market place in the next several years, when/if the economy starts to recover in 2009-10, we could see extreme shortages in commercial space, resulting in increased occupancy and rental rates.
The sales market is in a very interesting time right now. The conduit debt market has imploded in the past six months, which was the primary lending source for commercial properties over $10 million. The conduit market offered low rates and long periods of interest only payments, allowing investors to buy properties at very low CAP rates. Typical terms for a conduit loan in the spring of 2007 were: 110 basis points over the 10 year treasury (which resulted in an interest rate of 5.5-6.25%), 10 year fixed interest rate, 3-5 years of interest only, then amortizing over 30 years. These types of terms provided very low loan payments, and allowed buyers to be very aggressive when purchasing property. CAP rates varied greatly depending on the property type, class and location. Overall, very few properties in mid/large markets were selling above a 7 CAP, and most well below.
Local and regional commercial banks were having a difficult time competing with these terms. Last spring, most commercial banks were offering terms of 3-5 year fixed rate, 0-3 years of interest only and interest rates between 6.5-7.25%. This has changed dramatically. The conduit market is now virtually non-existent due to the sub-prime fall out. Insurance companies are still doing some larger loans, but they will not come close to making enough loans to offset the fall out in the conduit market.
At the same time, local and regional banks have seen their cost of funds go down in the past three months, and have lowered their lending rates on commercial properties. We are now seeing banks loan at rates between 5.5-6.5% for a 5 year fixed rate loan. However, banks have been forced to tighten their underwriting standards from federal regulators and to focus more on stabilized, income producing commercial real estate versus new construction or rehab projects. Also, due to the fall out of their competition in the conduit market, banks have seen loan requests go up dramatically, which allows them to be more selective as to whom they loan money to.
From an equity stand point, there will still be strong demand for good quality, income producing commercial real estate. Commercial real estate is still fundamentally strong, with record low default rates, and provides an excellent diversification from the stock market, which probably will not do well in the next 12-24 months. Many pension funds have increased the percentage of their total portfolio allocated to commercial real estate, and with the weakening dollar, we will see an increase of activity from overseas buyers.
In conclusion, there will still be a relatively strong demand to buy commercial real estate and there will be debt available. However, there will be a strong shift towards stabilized, income producing property versus new construction and rehab properties. CAP rates will increase 25-75+ basis points on larger properties due to a lack of conduit debt available, and poorer terms now being offered by commercial banks. On properties under $10 million, that were typically financed by banks in the past, there will be very little change in CAP rates.
an educational seminar on Section 1031 (Tax Deferred Exchange)
Tenants in Common Exchanges.
In Common properties that retain all of the traditional benefits of investing in real estate without the
headaches of personally managed properties. The event will be held at Beefeaters restaurant in Appleton,
Wisconsin on Wednesday June 4th at noon. Lunch will be provided.
For more information and to reserve your seat please call Amber Senne with White Cap Real Estate at
(920) 739-5561 or e-mail at: Amber@WhiteCapRealEstate.com, we hope to see you there.
Dear Real Estate Investors,
We have successfully closed on another Tenant in Common (TIC) medical office building in Hales Corners, Wisconsin which is located about 10 miles from Milwaukee. We are very pleased with the offering price at $5.8 million given the quality we acquired as we believe this property will offer our investors stable cash flow for years to come...with better then average on the back end returns.
Another Winner!
If you would like to learn more about White Cap Real Estate please contact us or visit our website.
Sincerely,
Amber K. Senne
Investor Services/Principal
White Cap Real Estate LLC
We are pleased to announce we have recently teamed up with Empire Securities based out of Southern California to be our managing Broker - Dealer. Empire Securities excels in providing their clients a broad range of alternative investments options, from Real Estate TIC Investments to Oil/Gas Exploration, Hollywood Motion Picture investments, to the other side of the spectrum with the more mainstream Mutual Funds.
We liked that broad approach Empire offers and the more choices available to their clients the better. We feel our investments will continue to fit their needs for growing demand from their "accredited investors" seeking higher monthly returns with lower principal risk in real estate especially while Wall Street continues to float in choppy and unchartered waters.
This alliance with Empire Securities will give us more back office support as we continue to grow and it will provide us with a national distribution channel. We felt that it is important as it will allow us to keep our primary attention on: finding the best properties available, negotiating the best terms, keeping our cost down, handle the day to day management, and package each individual deal with the the best financing available so that we can ensure that we will continue to offer our clients Higher Returns. Lower Risk.