Why Sellers Should Sell and Buyers Should Buy

Whose kidding whom? Sellers will only sell if they want or need to and buyers will only buy if they believe they see a good opportunity. Brokers can’t “sell” a client into acting but I wanted to discuss some reasons why sellers might want to sell today and buyers might want to buy today.

Clearly, there is tremendous uncertainty in today’s investment sales market. Values are far below their peak and are expected to continue dropping. The volume of sales is also far below its record peaks as activity has ground to a halt. As a broker who sells buildings, the level of sales activity is far more important than the direction of prices. The activity just has not been there in 2009.

I am asked several times each day by clients who would like to purchase properties if the time is right to buy. They think prices will continue to drop so the inevitable question is, “Why not wait until prices hit bottom?”. Potential sellers constantly ask when the optimal time to sell is ( I rarely suggest that sometime in 2006 or 2007 would have been optimal). “If I wait a few months will prices be better?” and “How long do I have to wait until my value will be higher?” are the most frequently asked questions from them. As uncertainty rules the day, how do I answer these difficult questions without sounding self-serving? 

Let’s take a look at current market conditions to set the stage for the discussion of perspectives relayed to buyers and sellers. I will discuss conditions in the New York City market as that is the only market I know. I assume most markets around the country are experiencing similar dynamics, to differing degrees perhaps, but still heading in the same direction.  

Using the Manhattan marketplace, for example, in the first three-quarters of 2009, there were 209 investment property sales having an aggregate sales value of $3.2 billion. The $3.2 billion in sales represents a 92% reduction from the activity in the peak three-quarters of 2007 in which there were $40 billion in sales. The 209 properties sold represents a reduction of 74% from the peak number of properties sold in the first three-quarters of 2007 which totaled 803.

The Manhattan market has a total of 27,649 investment properties (south of 96th Street on the eastside and south of 110th Street on the westside). Over the past 25 years, the average turnover of this stock has been 2.6% or approximately 719 sales. The lowest turnover we have ever seen was 1.6% in 1992 and 2003, both years were at the end of recessionary periods and both years experienced cyclical peaks in unemployment.

If we annualized the activity in the first three-quarters of 2009, turnover was running at 1.0%. (It is actually trending up as, in the first quarter, the volume was running at 0.7%, in the first half it was 0.9% and 1.0% for the first three-quarters). We believe turnover will finish the year at 1.1% to 1.2%, establishing a new low since we began tracking this data in 1984. 

In the Manhattan market, the average sales price in the first three-quarters of 2009 dropped an average of 32% from the peak prices achieved. In order to understand this reduction more clearly, we need to look at how different property types are performing. 

Multifamily properties have performed best with walk-up properties having lost only 16% from the peak with elevatored properties dropping 20%. Given the fact that consumer spending has been greatly reduced, retailers have had a difficult time which has resulted in large reductions in retail rents. It is, therefore, not surprising that mixed-use properties (those having at least 20% of their square footage occupied by retail tenants with apartments above) have lost 46% of value while retail properties have lost 49% of value from their cyclical peak.

Office buildings have lost 62% of their value from the peak. However, if we look at office properties which are well-leased on a long-term basis without market exposure, average values have dropped only 25%. Those with significant vacancy, or a large percentage of leases rolling in the short-term, have seen values fall by 70%.

We believe that value will continue to fall into 2010 as unemployment continues to rise. As unemployment rises, real estate fundamentals become stressed and as fundamentals become stressed, value falls. Economists expect unemployment to peak in the first half of 2010. It is at this point that fundamentals will be at their weakest and value will, presumably, be at its lowest.

Why should sellers sell today?

With values well below their peak and expected to fall a little more, why should a seller sell today? As counterintuitive as it may be, there are several reasons why a seller could benefit from selling today. This, of course, assumes that an owner is compelled to sell or has some external pressure motivating them to sell within the next year or two.

The first thing to consider is that the extremely low volume of sales has been caused by supply constraint not a lack of demand. The fact is that demand is significant. We have received dozens of offers on each of the income producing properties we are selling and have received over 50 offers on each of the notes we have sold this year.

Additionally, there is a massive amount of capital sitting on the sidelines waiting for an opportunity. We can refer to this patient capital as “shadow demand”. Much of this is from institutional distressed asset funds which are currently being pressured by their investors to show some activity. The lack of supply has created frustration for these funds and their appetite is currently very large.

Another reason to put a property on the market today is that the supply of properties available for sale is extraordinarily low. The massive demand that is chasing few assets is actually driving property prices above the level that fundamentals would dictate (notwithstanding the price reductions we have already seen). It is anticipated that distressed assets will be coming onto the market in significant numbers over the next couple of years which will provide more choice for investors, placing downward pressure on prices.

Potential sellers should also consider that prices have not yet hit bottom and they may be able to get out prior to the market hitting its bottom. Value will be lower in the future before it increases.

Financing, particularly for smaller multifamily properties, is plentiful from portfolio lenders for cash flowing properties. Community banks and small regional banks have remained very active and continue to look for additional opportunities.

Additionally, mortgage rates are very low by historical standards providing buyers with the ability to pay a relatively aggressive price. Given how much the Fed has increased the money supply and has increased spending, there is nowhere for rates to go but up. We will have to pay for these policies in the form of higher long-term interest rates , higher taxes or, most likely, a combination of both. As mortgage rates increase, values will face additional downward pressure.

Today’s market also provides an opportunity for portfolio reallocation. Several clients are looking to sell “maxed out” properties or smaller, non-core assets in order to take advantage of the more reasonable pricing of core assets.

Why should buyers buy today?

So, with value expected to drop further, why should buyers look to purchase now. The first reason is that it is nearly impossible to time the exact bottom of the market. Value has fallen so much already that it is expected to bottom out in the short-term, only falling another 10% or so. If this is the case, and a buyer has a long-term investment strategy, buying today may not be such a bad move.

The supply of available properties in New York is always very low. If you consider that the average turnover rate during a 25 year period has been 2.6% of the total stock, this means the average holding period is 40 years. Yes, some properties like the GM building have traded several times within the past 15 years but properties like that are offset by properties which have been owned for over 100 years by the same family. For these reasons, when an asset becomes available, if an investor wants to own that asset, they should move on it because is will likely not be for sale when the buyer decides the market has hit bottom. (We will only really know we have hit bottom after we have emerged from it.)

If a buyer believes that the government’s reaction to the recession will lead to inflation, hard assets are great things to own in an inflationary environment. Commercial investment properties are excellent hard assets. Investors would want to ride the upswing in inflation but with inflation comes Fed tightening and higher interest rates. However, if properties are purchased now, locking in today’s low rates on a long-term, fixed-rate basis, they will be sitting pretty when inflation hits.

After the market hits bottom, we expect value to just bounce along the bottom for 2 or 3 years as the market goes through deleveraging. Whether, and to what extent, properties appreciate will be dependent upon a fight between upward pricing pressure created by excessive buying demand and downward pressure created by the massive deleveraging that will be necessary as 2006 and 2007 vintage loans mature in 2011 and 2012.

Regardless of the incentives created by the dynamics mentioned above, we still believe the volume of sales in New York City will be lower than the 1.6% level in 2010. We hope that we are wrong but the congestion in the distressed pipeline is not expected to loosen up until the later half of the year.

So, should sellers sell and should buyers buy? The answers to these questions will be decided by participants in the market and the timing of these decisions will determine who the winners will be coming out of this downturn. One thing is clear, a significant transfer of wealth will occur over the next few years and the results for each individual (other than those who are forced out of positions by lenders or note buyers foreclosing on them) will be based upon how they answer those two questions and the timing of the decisions they make.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

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32 Responses to “Why Sellers Should Sell and Buyers Should Buy”


  1. 1 nathan isikoff November 15, 2009 at 11:09 am

    Bob
    I really enjoy your blogs.

  2. 2 rknakal November 15, 2009 at 11:33 am

    Hi Nathan, I always appreciate your feedback. Thanks for the post.

  3. 3 Elliot Horowitz November 15, 2009 at 11:38 am

    Bob:

    You’re the only broker in the city telling it like it is.
    Keep up the good work.

  4. 4 rknakal November 15, 2009 at 11:45 am

    Hi Elliot, Thanks for the post. The market will ultimately come back, but until then, it is what it is.

  5. 5 dgaines November 16, 2009 at 12:05 am

    Bob
    This is a very good (and timely) post. I always enjoy your take on the market.

  6. 6 Isaac Dayan November 16, 2009 at 9:42 am

    Bob,

    While I agree with you, to a certain degree that there is pent up capital among distress funds totaling in the billions – ie Demand – this Demand is extremely opportunistic in the type of investment property they will even look at, but even more so at WHAT PRICE they will consider it. This substantial amount of “pent-up demand” is only present in the market/available, up to a very fine point of what any cash-rich investor, or a fund is willing to accept today. While sales activity this year has diminished considerably, this can be attributed to two factors: lack of supply, but more importantly, the unwillingness of the Demand to transact or acquire, at prices to yield that supply to the market.

    Granted, there are tremendous pools of cash being sat on by fund managers – those that still exist today as a result of having the patience to hold off and not purchase at the pinnacle of the market. That very patience which has thus far proven to be their survival card, is setting the tone/standard across the commercial real estate investment industry, of what an acceptable return is in today’s market.

    The lack of supply is being caused by the LACK of demand at the price to yield that supply to the market.

    Yes, the industry standards have changed considerably.

    Great Blog.
    Isaac

  7. 7 Garry Rodgers November 16, 2009 at 10:35 am

    Bob,
    This is a great bit of information. I’m a small market commercial broker in Cleveland, TN. All brokers could learn something from your efforts and apply them to their market.

    Garry Rodgers, Cleveland, TN

  8. 8 hummbumm November 16, 2009 at 12:02 pm

    Great post, and great insight.

  9. 9 JM November 16, 2009 at 12:51 pm

    I think it is the worst time to buy and the worst time to sell.

  10. 10 Thomas Leeman November 16, 2009 at 1:18 pm

    While I agree that interest rates at the index level are at historic lows I do observe that at least in the hotel enviroment that overall rates driven by wider spreads are pushing above 8% level with constants are now approaching 10%.

    So although I do not pretend to know what rates will be in the future it does make it more difficult accept that creating long term fixed rate in the current enviorment is as attractive as it sounds here.

    I do however believe that an asset with any type of existing long term fixed rate debt would fit that bill and could prove to be something of an asset in a sell scenario in the case where the borrower could assume that debt and/or even modify the terms in exchange for an infusion of capital to pay down the loan balance to a more comfortable level for all parties.

  11. 11 Richard November 17, 2009 at 9:13 am

    Bob, how would you describe the Section 8 system in NYC?
    In historical terms, do you invision funding drying up for it and a 1970’s style return of landlords abandoning these buildings or do you see otherwise?

    Richard

  12. 12 Jerry Anderson, CCIM November 17, 2009 at 9:40 am

    Well written Bob, and I couldn’t agree more. In fact, a few days ago I wrote a piece about investing in Florida that is conceptually on the same page as your opinion. http://svnflorida.wordpress.com/

    Keep the controversial thoughts coming – commercial real estate needs leaders like you stimulating the minds of professionals in the industry.
    Jerry Anderson, CCIM
    Sperry Van Ness Florida

  13. 13 jstamp02 November 17, 2009 at 11:19 am

    Bob,

    I’ve really enjoyed your posts and insight into the market. It’s great to have someone as accomplished and respected as yourself involved in the blogging community.

    I agree with most of your points in this post. However, for people coming into the market trying to buy real estate at below replacement costs, the big unknown is when it will get back to replacement costs. If they expect to get their money back in 2-3 years, they may be surprised. Many investors considering buying in this market don’t have a long-term appetite.

    Also, you mentioned the tremendous amount of cash sitting on the sideline. However, when you consider that borrowers will default on approximately $500-$750 billion of debt (about 50% of the $1.4 trillion of loans coming due over the next 4 years) in the next few years, the amount of pooled capital seems insignificant.

    Thanks for your great insights.

    @joestampone1

  14. 14 Benny B November 17, 2009 at 12:45 pm

    While interest rates are extremely low right now. Banks are generally not willing to loan out money without a large down payment. Banks are asking for 50% down – if someone walked into a bank four years ago and was told they needed to put 50% down on a loan they would have laughed their way out the door.

    Have you noticed that the demand has been generated by individuals that own few properties already and high net worth individuals who have pulled their money out of the stock market – looking for safe investments?

  15. 15 rknakal November 18, 2009 at 6:58 am

    Hi David, thanks for the post. I hope all is well out in Chicagoland.

  16. 16 rknakal November 18, 2009 at 7:09 am

    Hi Isaac, thanks for your post. You bring up some interesting points. I believe that the perception that now is not the time to sell has impacted owner’s “hold decision” more than the realities of the market. For instance, in the multifamily market in New York, values are only off 20% from their peak. Most of the headlines discuss the 50%-70% reductions in other segments. Owners who really want to sell shouldn’t be dissuaded from selling based on a small reduction in value, particularly if the expectation is that prices will continue to fall and appreciation won’t tangibly come back to the market for the short term. Supply should grow organically without “unrealistic prices” being paid by purchasers to stimulate additional supply.

  17. 17 rknakal November 18, 2009 at 7:11 am

    Hi Garry, thanks for the post. I appreciate your feedback. How are conditions in Cleveland, TN these days?

  18. 18 rknakal November 18, 2009 at 7:11 am

    Hi Hummbumm, thanks for the post.

  19. 19 rknakal November 18, 2009 at 7:23 am

    Hi JM, Thanks for your post. Many of the investors I have spoken to are looking at the transactions that have occurred in 2009 and believe these will be among the best purchases in this cycle. Some of those have included office buildings which had sold for over $1,000 per square foot at the peak of the market and we recently resold for $350. People also remember the fortunes that were made during the S & L crisis which is stimulating some of the demand today.

    With regard to selling, many long term investors feel that it is never a good idea to sell. Simply hold for the long term and keep refinancing. However, if you have to sell or are motivated to sell in the short run, you must consider what conditions the market faces in the short run. One of the things I didn’t mention in my post is that the capital gains rate is likly to rise significantly in 2011. The Bush reductions sunset bringing the rate from 15% to 20%. If the present healthcare bill passes, it will add 5.4% to this rate. Additionally, many anticipate the current administration to increase the rate by 3%-5%. This could bring the total rate up to 28.4% to 30.4%. If this occurs, it should stimulate some selling in 2010.

  20. 20 rknakal November 18, 2009 at 7:35 am

    Hi Thomas, thanks for the post. While I agree that 8% is presently a relatively high rate, we must look at what rates are anticipated to be in the future. Questions investors should ask themselves include: What is the probablity that rates will increase? What is the probability that rates will decrease? Will inflation be above trend and when will it kick in? When will the Fed tighten monetary policy? How quickly will the Fed tighten? What will banks do to spreads when the Fed tightens? How each investor answers those questions determine whether they should lock in today’s rates or not.

  21. 21 rknakal November 18, 2009 at 7:42 am

    Hi Richard, thanks for your post. Affordable and subsidized housing is a very hot topic today. I will email you a piece I just wrote in The Commercial Observer dealing with the Mitchell-Lama program in New York. With regard to section 8, it is a highly political program that will provide a lot of inertia. The program has many shortcommings which should be addressed but we really can’t expect any government program to work efficiently.

  22. 22 rknakal November 18, 2009 at 7:46 am

    Hi Joe, thanks for your post. You make some good points. I think that the investors who are active today have a very long term perspective, and must, given the uncertainty in the market today and moving forward. There are many fundamental issues that we must work through before stability returns. It will be very difficult to purchase and sell in the short term successfully until we are over those hurdles.

  23. 23 rknakal November 18, 2009 at 7:51 am

    Hi Benny, thanks for your post. Many of the investors we are selling properties to today have become comfortable with the equity requirements the market calls for and have been willing to put 40% to 50% equity into their transactions. I have really never seen money shift from the stock market into real estate and vice-versa. Many of my clients who own portfolios of real estate do not own even one share of stock. We have seen, however, many foreign buyers, who are not real estate people, purchasing properties here on an all-equity basis as a storage facility for their capital. We have not seen this trend so tangibly since the mid 1980’s.

  24. 24 rknakal November 18, 2009 at 7:59 am

    Hi Jerry, thanks for your post. I’m sure you do not recall this, but back in 1984, you were my teacher in a CCIM class I took in Washington DC as part of CB’s Phase II training program. You taught me how to use an HP-12C which I have been using everyday since. I never forget the people who have helped me along the way and you were one of them. If I didn’t thank you then, “Thank You”! Best of luck to you with SVN in Florida.

  25. 25 Commercial Real Estate Coach November 18, 2009 at 12:39 pm

    Execllent insight. Every commercial real estate professional should apply the same analytical approach to their respective market area. Not only would their ability to articulate the buy/sell decison be greatly enhanced, but the vision of where the opportunities lie would be significantly improved.

  26. 26 chris hauser November 18, 2009 at 9:51 pm

    if you can only get 1% in the bank, 4% cash on cash starts to look tempting. seems like that’s going on right now.

    haven’t we heard this one before? for now, the money hydrant is open.

    as to selling, it’s always a good time to sell, if it works for your operations. buying’s another story.

    i keep feeling people are looking through the rear window.

    very good post, i saved it.

  27. 27 bart November 19, 2009 at 4:45 pm

    great info I understand you are marketing in New Jersey. How is that going so far

  28. 28 Faye November 19, 2009 at 7:40 pm

    Bob,

    I could not agree more about the fact that many real estate investors have never invested in the stock market and are not looking to put their money in stocks any time soon, despite the big mess real estate is in!

    I have to reiterate that I have so enjoyed reading your blog! I have been reading many real estate articles and blog posts, but have already learned so much from experts such as yourself. I even promoted “Streetwise” on my facebook page!

    Thanks for your insights!

    Faye

  29. 29 Craig November 20, 2009 at 12:49 pm

    What are today’s interest rates in apartment buildings these days? And is 25-30% down sufficient?

  30. 30 JM November 20, 2009 at 2:02 pm

    Chris,
    You sound like a seller.

    4% cash on cash is Horrific.
    The deflation we are experiencing will not last for 25 years, as long as the average building buyer turns over his brick and mortar asset.

    If my investment is not returned to me within 10-11 years (9-10% cash on cash), I am not going to buy. I leanred my lessons from the late 80’s.

    Cap rates are steadily increasing and will eventually hit double digits but it won’t be until the fed lifts its rate abruptly in 2011-2012.

  31. 31 lorrainebeato March 23, 2010 at 7:14 pm

    Great article and I learned a lot. Being a former New Yorker, I like to keep up with what is going on in the Big Apple and this certainly put things into perspective. As I start to delve into the commercial market, I will be back for more information and insight.
    Thanks

  32. 32 require December 4, 2012 at 3:46 am

    Spot on with this write-up, I truly feel this website needs a great deal more attention.
    I’ll probably be back again to read more, thanks for the advice!


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