Benefits of private capital markets and "negative leverage"

[Patrick Zepeda]

In commercial, institutional players don't touch deals sub $20M due to the lack of scale and unfavorable financing (many banks, debt funds and lifeCos won't lend on small deals, or would offer bad terms and full recourse loans). This means that mostly private capital dominates, making it a more imperfect market. Having that said, there is room for huge profits if done right.

Think about a successful dentist that wants to buy the medical office building his practice is in. He has the money to spend, is not a sophisticated investor and will only look at an in-place or stabilized cap rate based on comps. Say this building is renting at below market rates (mark-to-market opportunity). Once the suites roll to market and you lease up with market rents, the NOI will increase and the value will too. Your exit value will drive your profits. You can do this by looking at your IRR / LIRRs in your valuation.

Nonetheless, with interest rates rising so aggressively, many of these commercial private capital deals have "negative leverage". This means that buying on an all-cash basis would yield better returns than with leverage. This obviously puts a huge strain on liquidity in the capital markets because there is less investors that would buy all-cash, and the few that would buy would require lower pricing for the deal to make sense. And this excluding the macroeconomic issues that asset classes are going through. Food for thought.