Are Investment Properties Selling for More Than They Should Sell For?

 

The title of this piece makes you wonder what is meant by “they should sell for”. What, after all, is value? Many people (particularly appraisers) feel that value is a very different thing than the price someone is willing to pay for a property. There are all types of qualifiers such as “an arms length transaction” between a “willing buyer and willing seller”, etc. As a broker who only represents sellers, I see value as the highest price that the most aggressive buyer will pay for a property. Whether the property is “worth it” or not is completely dependent upon the perspective of the buyer.

Arguments about value versus price versus worth can go on for quite a while. This column will not attempt to define the differences between these terms, but will merely look at the relative price levels investment properties are selling for today and try to figure out why.

One of the most evident trends in the investment sales market today is the acute imbalance between supply and demand. While I spend all of my time selling in the New York Metro area, it appears that these imbalances exit nationwide. Whenever I attend conferences across the country or speak with brokers working in major cities in the U.S., the story seems to be the same: Buyers are plentiful, there is a ton of capital on the sidelines and there is not much available for sale. Forget the infamous “bid / ask spread”. There is just not enough product on the market to meet existing demand.

In the New York City market, for example, the sales volume in 2009 was abysmal. We always view volume based upon the number of properties sold each year (as opposed to total dollar volume which can be skewed by a few mega-sales in excess of $1 billion). Using the Manhattan submarket as an example, we track a statistical sample of 27,649 properties south of 96th Street on the eastside and south of 110th Street on the Westside (north of these streets is considered the Northern Manhattan submarket).

Over a 25 year history, the average turnover rate within that sample has been 2.6%. The lowest turnover rate we had ever seen was 1.6% observed in 1992 and 2003. These were both years at the end of recessionary periods and were also years in which we hit peaks in cyclical unemployment.

We had always assumed that 1.6% was a baseline for turnover, below which the numbers could not reach. After all, in 1992 and 2003, the only people who were selling did so because they, essentially, had no choice. Death, divorce, taxes, insolvency, partnership disputes, what have you. Our baseline assumption was blown out of the water in 2009 as turnover hit, at least, a 26 year low of 1.17% (our statistics do not go back further than 1984 so we do not know whether this was a historic low or not).

To the causal observer, a lack of buying demand could explain the low activity level. However, if we look carefully at market dynamics, we see that the major contributor to the cobwebs which paralyzed the market was constrained supply.

Typically, the supply of properties for sale is fed by discretionary sellers. As these sellers pull back, as happens when values fall (on average in New York, prices per square foot have fallen in value by 32% from their peak in 2007), distressed sellers will normally step in to fill the void in the supply chain. Thus far in this cycle, those distressed sellers have not appeared in a meaningful way to normalize the available supply. Everything that has happened from a regulatory perspective has allowed the distress, for the most part, to stay camouflaged on lender’s balance sheets as a highly accommodative Fed monetary policy provides a recapitalization mechanism for the banking industry.

This has left brokers and buyers in need of magnifying glasses and Basset hounds to locate buildings for sale.

Simultaneously, the demand side has been strengthened and is growing. When we started to tangibly feel the effects of the credit crisis in mid-2007, institutional capital, which was a main inflator of the 2005-2007 bubble, evaporated from the market. From the summer of 2007 through the fall of 2009, the overwhelming majority of our properties were purchased by high-net-worth individuals and the old-line New York families which have been investing in the city for decades. Many of the institutions which were sidelined, had plenty of time to form distressed asset buying funds and began to reenter the market last fall joining the individuals and families in the battle for assets.

Additionally, we saw a substantial increase in the amount of capital emanating from overseas. This was mainly in the form of foreign high-net-worth individuals who, surprisingly, were not real estate investors back home. They had made money in other businesses and decided now was a good time to invest in a market where values have fallen sharply, the political climate was relatively stable and the U.S. dollar was relatively weak. We have not seen this level of foreign demand since the mid-1980s.

This has created a dynamic in which we have many frustrated buyers fighting over relatively few assets. Impatient investors are pressuring fund managers to whom they have given capital, to show some activity and the individuals do not want to miss an opportunity so they have been jumping in. Foreigners are transparently in the market and the confluence of all of this demand is causing bidding to be aggressive. Because of this imbalance, we actually saw prices per square foot increase in the second half of 2009 versus the first half of the year. There is no other explanation for this increase (other than excessive demand versus low supply) as our fundamentals continue to be under stress given continued elevated unemployment levels.

We believe prices are higher than economic fundamentals indicate they should be. This is particularly noticeable in our note sales. We are showing recovery rates of about 95% to 100% of collateral value (as opposed to par, from which discounts can be substantial) meaning that by the time the note buyer goes through the foreclosure process and obtains the deed, they will be into the asset for more than 100% of its value. This dynamic is not sustainable.

No, we do not believe the second half of 2009’s increase in values indicate that we have bottomed. We believe they will continue to slide until we have a tangible reversal in unemployment trends and that the upward trend in the second half of 2009 was only an upward bump on a downward trend toward a natural bottom. It is for this reason we have been encouraging sellers to act now to take advantage of these odd circumstances in which demand is extraordinarily greater than supply (this is a difficult thing for a broker to say without sounding completely self-serving). We believe this dynamic could change rapidly if something, probably a modification to bank regulations, changes the inertia in the distressed asset pipeline. Even without a regulatory or legislative change, we have already seen things begin to loosen up. Thus far, it has, unfortunately, only been a drop in the bucket compared to what exists in the market as we embark on the massive de-leveraging process that we must inevitably go through on the way to recovery.

Mr. Knakal is the Chairman of Massey Knakal Realty Services and has brokered the sale of over 1,050 properties in his career.

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26 Responses to “Are Investment Properties Selling for More Than They Should Sell For?”


  1. 1 Steve February 21, 2010 at 10:25 am

    Bob, this is a great overview of the investment sales market and reflects exactly what we are seeing here in Chicago. The only difference is that we are not seeing quite so much foreign capital coming into the market. What do you think are the things that could unclog the logjam of properties coming on the market ?

  2. 2 rknakal February 21, 2010 at 10:40 am

    Hi Steve, Thanks for your post. There are several things that could affect flow. Capital gains increases could add to the supply as sellers rush to take advantage of 2010’s low rates. If bank regulators change mark to market guidelines, the supply could increase substantially (it would also put hundreds of banks out of business over night so this is not so likely, at least in the short term). Also, rate increases could pressure lenders to weed out the losses imbedded in their balance sheets by moving those assets. We also expect to see some assets come to market as discretionary sellers realize that holding on for another year or two is not likely to provide a significant increase in value.

  3. 3 Mark February 21, 2010 at 1:27 pm

    Bob-

    Contrary to your concerns about seeming self serving telling sellers to be self served, I think the tenor of this blog post is exactly right. And kudos to you for offering an honest assessment of what’s driving pricing.

    Just competed on an auction for a note secured by a 100k sf class B office bldg in Connecticut. $26m at par, 30+ bids in round 1; we made the cut to the second round with 6 groups in total. To say pricing got frothier than anticipated is an understatement. There’s so much messed up intrigue in that deal I can’t even do it justice in this post.

    Anyway, all the best. I hope we get to do a deal in 2010.

  4. 4 rknakal February 21, 2010 at 1:41 pm

    Hi Mark, thanks for your post. I think we are seeing situations like this across the board. I am looking forward to seeing how 2010 will pan out as the year progresses.

  5. 5 Bay Area Com RE February 21, 2010 at 9:37 pm

    Great post Bob, We have seen the same kind of foreign investment in San Francisco, especially from Asia. Interestingly however, as we focus on tenant representation in the office market, this has been a demand driven recession here in SF and too much supply. As far as investments go, there has been a dearth of deals, but we have yet to see the lack of supply drive up prices. We have covered the major transactions on our blog. We encourage you to check them out and let us know how they correlate to your market. – @bayareacomre

  6. 6 rknakal February 22, 2010 at 8:01 am

    Hi Jon, Thanks for your post. I always enjoy hearing what is going on around the country. I look forward to checking out your blog.

  7. 7 marcojelli February 22, 2010 at 9:22 am

    Hi Bob,

    Thanks for another thought-provoking post.

    I was just thinking about this as an interesting development property came across my desk. It was listed by you guys more than two years ago for $25 million and has since been re-listed by another firm at 12 million. It’s a better opportunity than I’ve seen in awhile, but I find myself questioning if it is be a good deal in light of the tidal wave of distressed properties yet to come to the market.

    What do you think the floor of the market will be for prime ground up development? Do you think we will reach a point when market averages approach $200 PSF? $150 PSF? $100 PSF?

    Thanks,

    Marcus

  8. 8 David Schaiman February 22, 2010 at 9:55 am

    Bob, Good article. Right on point.

  9. 9 Peter Nikic February 22, 2010 at 10:47 am

    Bob, as always, I agree with your analysis. Though I’m not sure that this is a compliment to you since I do not have your education and experience 🙂

    I am running into this problem including with one of your own listings in the Bronx. A small, dishevelled building which requires quite a bit of work. Your listing broker told me that he already has several offers at or close to the asking price. The asking price is only too high because of the location and condition of the building.

    Do you think the average turnover rate for 2005 – 2007 may also be a cause? I think many of those turn-overs are the cause of many “stuck” properties (effect) of 2009 – 2010.

  10. 10 Barry Smith February 23, 2010 at 11:02 am

    Hi Bob, one point that you failed to mention is the trend of the FDIC entering into Loss Sharing Agreements with buyers of failed banks. Lately many of the bank closures have resulted in these arrangements; keeping the problem assets out of the public hands ( at least for now ). I beleive this type of transaction is helping to slow the de-leveraging process you refer to in your article.

    Barry Smith
    LoanSaleCorp.com

  11. 11 chris hauser February 23, 2010 at 4:19 pm

    We’ll just continue to putter along, and the investors of bubble yore have just renamed themselves as workout specialists. Hey, its a job.

    Keep brokering!

  12. 12 rknakal February 24, 2010 at 8:16 am

    Hi Marcus, thanks for your post. Land is the most difficult product type to evaluate. It is so dependent upon exact location, tenancy, as-of-right circumstances, etc. We have seen the number of development sites sold fall significantly. In some areas, it would not be surprising to see land values fall by 50% to 75%. In other areas, value may have fallen by only 25%. It is VERY difficult to generalize about land.

  13. 13 rknakal February 24, 2010 at 8:17 am

    Hi David, thanks for your post. It was good to see you at the REBNY finance committee luncheon last week.

  14. 14 rknakal February 24, 2010 at 8:20 am

    Hi Peter, thanks for your post. The reason prices seem to be higher than expected is because of the acute imbalance in supply and demand presently.

    The high prices of 2005 to 2007 are responsible for the massive amounts of negative equity today and the fact that the foreclosure process takes so long is why the system is clogged.

  15. 15 rknakal February 24, 2010 at 9:18 pm

    Hi Barry, thanks for the post. I agree with this dynamic stalling the deleveraging process. Just another speed bump along the way. Thanks for pointing this out.

  16. 16 rknakal February 24, 2010 at 9:49 pm

    Hi Chris, thanks for your post. Puttering along or “slogging” will be the nature of things for a while to come.

  17. 17 Carl Todd February 25, 2010 at 6:06 pm

    rk
    Great accurate report on current market conditions and their comparison to past statistically similar ones.

    Brokers deal in “Price” appraisers in “Value”. Selling price is the winning bid for the time allocated by the seller to depose of the property.

    When I asked my lawyer/broker/builder/speculator father what is value and why isn’t the selling price. His answer was: “At times the selling price may be equal to the value of the property but most at the times, for personal reasons, there is usual some one who needs or wants the property more than anyone else’s and is is willing to pay a premium for it. It could be a user who competed against investors for it but mostly there are usually income tax considerations that drive the buyer to pay the premium”. As you know that income tax considerations are a strong motivating force behind many winning bids by the buyers because he is not paying for it – the tax collector is and as Pogo said of the tax collector: “He is us”.

    Dad also clarified his definition with this example: “Assume the property was sold at an open public auction. The winning bid was the price of the property, the second highest bid was in most cases the value of the property”.

    Real Estate is the platform were all human activities take place. As long as we are in a capitalistic market – value in exchange for value – depending on the velocity of the activity especially based on need – physical or physiological – there will always be a market for real estate with the price, no matter how high of low that will match that demand against supply. I use the term demand in he economic sense – the desire with the ability to pay and like water its seeks its own level.

  18. 18 Marcello Del Monte February 26, 2010 at 4:47 am

    Hi Bob,let me give you a borader perspective.
    I am a professional real estate manager and investor orginally italian, living in Israel and with a long track record in institutional quality development deals in Eastern Europe.
    I have been trying to buy deals in Europe for the past 2 years and it is almost impossible to find decent one (I am not talking about killings…) exactly for the same reasons that you have pointed out in your article.
    We manage to buy only small deals in distressed markets (Latvia, Hungary etc) but it is difficult for more institutional type of plays.
    I have been looking around in New York for the past 6 monts and despite all the difficulties you mentioned I believe that in the next 24 months we would able to close significant investments in Manhattan with our local partner.

    I really like your posts and I must say that my learning curve of the Manhattan market has been steep thanks to your insight that you share with the public.

    take care
    Marcello

  19. 19 JWB February 26, 2010 at 9:29 am

    Bob,

    As usual, a great article. It would seem in today’s market, most sellers are unwilling to accept today’s reality as the market has shifted dramatically in a relatively short time frame. Whether it be inflated ownership pride or realizing losses on aggressive purchases, it’s a hard pill for them to swallow. Most sellers seem to be willing to wait if they can.

    A broker, a buyer, a seller, an appraiser and a lender are all going to have different valuations that are further apart than ever. All of these valuations are driven by separate motivations as there isn’t really an equilibrium in a market that is less commoditized (today). The question today is not at what level can we do this deal, but can we do this deal at all? It’s definitely not a market to dictate terms or be picky.

    As transaction activity across the board has decreased the bigger question I would love for you to write an article on is; “Why would a seller sell today if they don’t have to?”

  20. 20 rknakal February 26, 2010 at 9:48 am

    Hi Carl, thanks for your post. I always enjoy hearing your experienced perspective. There is something to be said for the water that has passed under the bridge of those who have been there and done that.

  21. 21 rknakal February 26, 2010 at 9:51 am

    Hi Marcello, thanks for your post. It is interesting to hear that things are similar overseas as well. I agree that the number of opportunities will increase over the next couple of years as the develeraging process gets traction. We are seeing a tangible uptick in the supply of distressed assets. Please email me at rknakal@masseyknakal.com if you would like to take a look at some of these opportunities.

  22. 22 rknakal February 26, 2010 at 9:54 am

    Hi JWB, thanks for your post. Also, thanks for the story idea. I was pondering this morning what I would write about this weekend and you gave me a great idea. Sunday’s piece will deal with the issue: Why would a seller sell today if they don’t have to?

  23. 23 JWB February 26, 2010 at 10:50 am

    I can’t wait! I think we can all benefit from some advice as to how to get the indecisive off the fence.

  24. 24 rknakal February 27, 2010 at 5:57 pm

    JWB, the new post will be up at 10am EST tomorrow. Thanks again for the feedback.


  1. 1 Are Buyers Overpaying For Investment Properties? « Aminoff & Co. Real Estate Market News Trackback on February 22, 2010 at 4:33 am
  2. 2 Are Investment Properties Selling For More Than They Should Sell For? | A Student of the Real Estate Game Trackback on February 22, 2010 at 10:56 am

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