Armed with Cash but Nothing to Buy

Green shoots in commercial real estate are showing abroad, and perhaps this will bode well for the U.S. As reported in National Real Estate Investor, London now outranks both New York and Washington D.C. as the number one city for investment based on results of the Association of Foreign Investors in Real Estate (AFIRE) survey. There was more than 4 billion Euros of investment in the fourth quarter of 2009 – up from 1.6 billion in the third quarter of 2009.

Velocity of transactions may improve in 2010, according to FTI Schonbraun McCann Group in the U.S. “Despite weak fundamentals, I believe the real estate industry has moved beyond survival mode and is once again forward thinking about emerging opportunities,” the firm’s head said in a press release on March 3rd, 2010. They believe that the upswing in equity markets is an early indicator, and that REIT investment will lead the recovery. REITs will be chosen by institutional investors, they believe.

In fact, REITs are flush with cash. Public REITs sold $25 billion dollars in new stock last year, as reported in the Wall Street Journal on February 3rd, 2010, but they are having a hard time deploying the cash. “Today I’m sitting with $125 million in cash that I can’t find investments for,” said Stephen Richter, CFO of Weingarten Realty Investors, in the Wall Street Journal.

It is widely reported in the U.S. and abroad that the true challenge for investors with cash is finding inventory of property. Many building owners are holding on to their good properties instead of selling, since commercial values dropped. Moody’s estimates an average drop of 43% in values across the board (Moody’s/REAL Commercial Property Price Index, published January 2010). Property owners with performing properties don’t want to let them go at a discount if they can help it. The property that does sell tends to be distressed. But will property repricing be necessary?

“Property valuations are generally very fair today,” says Ewen Hills, head of international investment at Colliers in London. “During the crisis when transactional information was minimal, it took time for the falls to be recognized. But now there are sufficient comparable transactions to give everyone an accurate idea of where the market is.” (NREI. “London Property Valuations”, by Jennifer Duell Popovec. March 22, 2010). Repricing downwards helped in the U.K. However, except for distressed properties, it is not necessarily happening on a large scale in the U.S. yet.

Today, valuation is difficult in the U.S. using the traditional three approaches. The ‘sales approach’ depends on recent comparable sales to help value property. However, sales velocity is down by as much as 90% in some markets, and the only sales may be distressed properties. The second approach is the ‘income method’, but this approach is also difficult to use when some building owners have lost many tenants or have had to reduce rents drastically in the recessionary period. The third method is the ‘replacement cost’ (or ‘cost approach’), which assesses the cost to rebuild. Typically it is only the real estate operator who is comfortable with this approach.

Because there is not much inventory of prime properties for sale, price bubbles may occur as cash buyers bid for class A properties. As an example, sited in the Wall Street Journal, Equity Residential paid $100 million for a 326 unit apartment complex in Arlington, Virginia last October. There were 160 interested parties and 40 offers, which was a surprisingly high number, said the listing broker.

Key points for cash buyers today are to not overpay for prime properties or seek out opportunity buys of distressed properties.

Not all buyers have a war chest of cash. Those buyers may run into financing issues. More private equity is in play now, since banks are nervous and credit markets are tight.

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