Why Buyers Should Buy Today

Two weeks ago, the title of my Streetwise column was, “Why Would a Seller Sell Today if They Didn’t Have to?” This prompted several emails from readers asking me to address the flip side of that coin which is why buyers should buy today.

The general perception is that prices have either hit bottom or may only slide further by another 5 or 10%. As we’ve discussed in several other columns, the timing of the market approaching bottom will likely coincide with the time that unemployment peaks and reverses its trend. Job creation will have a positive impact on our fundamentals and will exert upward pressure on pricing.

There are several reasons why buyers should want to be active today.

Low Supply: The supply of available for sale, particularly in New York City, is never very high. The average holding period here is about 40 years as the average turnover rate, over 26 years, has been only 2.6% of our building stock. This average declined to 0.87% citywide in 2009.

As supply is always low, there is never an abundance of properties to look at. So, if a property is available for sale today, a buyer may want to take the opportunity to act if it is an asset that they consider “core” (for them which differs from investor to investor) as that asset is not likely to be available in the future when the buyer has perceived the market to have bottomed out.

It is Nearly Impossible to Call the Bottom: After all, we only know that we have hit bottom after we are past the bottom. Some investors feel optimistic about the market moving forward, and believe we have already hit bottom. Fearing that they may miss the buying opportunity, they are deciding to jump in today to take advantage of market conditions.

Inflation: With the U.S. Government having doubled the money supply of the country in 2009 (the increase was greater than the aggregate increases over the last 50 years), many investors feel that inflation is likely to follow. During an inflationary period, hard assets are assets of choice as their value will rise in conjunction with inflation. Commercial real estate is a particularly attractive hard asset under these circumstances. The key would be to buy the hard asset before inflation kicks in, locking in long-term, low-interest, fixed-rate debt. As inflation kicks in, it would drive up the value of the asset and the advantageous debt terms create an even better performing investment.

If we are not at the Bottom, we are Very Close: Another reason to buy today is because if we are not at the bottom, we are certainly close to the bottom. Nationally, investment property prices are down 30% to 40% depending upon the marketplace. In New York City, average prices are down 31% from the peak. Whether prices go down another 5% or up another 5%, will it really matter to the long-term investor whether we are slightly above the bottom or not?

It is impossible to accurately time the bottom of the marketplace. If we use an equity market analogy, when Citigroup stock hit $1 per share, if an investor was only willing to pay 95 cents and decided not to purchase because they thought the stock would fall farther, would that investor really care if they had purchased at a $1 with today’s price of $3.92?

One of my very good clients, who has been investing in commercial real estate for over 20 years, told me that his biggest regret is that he did not buy more aggressively. He said he should have offered more for the properties he bid on because, as a long-term investor, it really didn’t matter if he paid a little more.

Values are Likely to Hit Record Highs in a New Peak:  A secret to success in commercial real estate investing is to simply be able to hold-on until the next cycle kicks in. In every new cycle we have seen a new peak in value significantly in excess of the prior peak. The overwhelming majority of participants in the marketplace believe it will be no different this time, particularly in the real estate sector.

The Savings & Loan Crisis in the early 90’s was precipitated mainly by over-speculation and over-building in commercial real estate. When the market rebounded, it rebounded significantly higher than the value levels we saw in the mid to late 80’s.

We entered this cycle without the massive speculative construction that we had before the S&L crisis. Our present crisis was not caused by the real estate industry although commercial real estate has been a casualty of this crisis. Therefore, our fundamentals were in much better shape going into this crisis than it was as we entered previous downturns and it is expected that, when the market does recover, it is going to skyrocket to new heights not seen in the past.

There is still uncertainty in the marketplace, but, after all, that is what makes a market. If everyone knew everything and everyone agreed on everything, the market would be a fairly boring place. Commercial real estate investing has risks associated with it, but, for those who want to be in the game, buying today should prove to be very lucrative over the long-term.

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

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21 Responses to “Why Buyers Should Buy Today”


  1. 1 Marcus Ellison March 14, 2010 at 1:02 pm

    I will first say that I am interested in buying today. That I look at commercial properties and make offers on a regular basis.

    But I don’t think the logic of this post is rooted in investment fundamentals. The real estate market is not analogous to the stock market because they behave under different structures. The bottom in the stock market is difficult to predict because of day-to-day and week to week uncertainty on collective momentum of many transactions. But transactions are made everyday… in seconds. The real estate market is different. Market makers decide to buy or sell over many days, weeks, and months because of the complexities and idiosyncrasies of the transaction itself. The number and frequency of transactions, therefore, are not the main contributors to opacity. Rather, the opacity comes from the increased complexity of each transaction, and knowing how, why, or why not this particular transaction is representative of where the market is headed.

    Low Supply is the calm before the storm.

    The great uncertainty holding seasoned investors on the sidelines is considerations for political uncertainty. The recently released report from the congressional oversight panel on February 11th makes a strong case for far reaching negative effects of distressed commercial properties coming to market in later 2010 through 2013. The panel suggests bluntly on p. 139 of the report, “The Panel is concerned that until Treasury and bank supervisors take coordinated action to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small businesses, and individuals – the financial crisis will not end.” This means that unless the government does something, the panel expects the recession to continue (sounds like indefinitely).

    In addition, Sam Zell recently suggested at the annual REIT conference at NYU that sellers are not selling because they have no equity, which leaves a decreased supply of opportunities for buyers. Interestingly, the fact that sellers have no equity also means that many properties that would not normally be distressed are now underwater due to the likelihood of poor refinancing opportunities through 2013. The oversight panel suggests that many of these properties will not be able to be refinanced, which further indicates that a lot of distressed properties will go into default. How much? They say half of the $1.4 Trillion in debt to be refinanced between now and 2014 is underwater. Half.

    This may suggest that many of the distressed deals we see occurring right now at par are not even appropriately priced.

    It is nearly Impossible to call the bottom.

    I agree with this statement but the reasoning you suggest afterwards for investors who “feel” is purely emotional. It is unlikely that investors will miss the buying opportunity. Actually, the opposite is more likely to be true –that investors jump the real recovery by too much.

    Inflation.

    Inflation is a threat in the medium to long term, but right now the government dollars being spent are for the most part not being circulated throughout the financial system to contribute to multiplier effects. It’s fairly easy to consider that a paralyzed lending system to small businesses will put a hold on some inflationary pressures.

    If we are not at the Bottom, we are Very Close:

    We have hit bottom for the first recession, but if we head into another recession, than the absolute bottom may be both far off in terms of time and price. As far as your client goes. Us investors all have different timelines. If your timeline is 20 years than the marketplace should be your oyster. If, on the other hand, your timeline is more like 5-10 years than you have to be much more careful about when in a market cycle you invest your money. Flat or negative values for the next 3 years is not very beneficial to any present value analysis of future cash flows.

    Values are Likely to Hit Record Highs in a New Peak:

    Why this does strike one has an appropriate rule of thumb, it is disproved in rigorous empirical research. Robert Shiller, infamous author of the notorious Case-Shiller Index has shown that the last two cycle happened pretty smoothly, but look further back than that and you’ll see that there’s really no bottom. Like between the 50s and 70s. If you wait for a true bottom, you might have wasted 20 years. Also, he has shown that as recently as mid 90s, there’s a dead cat bounce. There are also many dead cat bounces between 50s and 70s.

    Robert Shiller demonstrates this by creating a housing index that goes back to the 1890s.

    In summary.

    A lot of investors may “feel” like they need to get in. But the seasoned ones I speak with, who make choices based on 5-10 year horizons, don’t feel like the market is there yet. That is not to say that no one should buy. It’s that the price they would buy at right now is based on the possibility of far worse market conditions in the future. And that price is in many areas a good 30% – 40% lower for most core properties.

    I agree that buyers should buy today. But if they do not consider the context with which they’re buying than they will find themselves wishing they hadn’t.

    Sincerely,

    Marcus J. Ellison

  2. 2 rknakal March 14, 2010 at 1:17 pm

    Hi Marcus, thanks for your post. You make some very good points and I particularly agree that context and time horizon are necessary components to a commercial real estate purchasing decision. As far at the 5 – 10 year horizon you mentioned, we work with many investors who are generational and sometimes purchase for “the grandkids”. It is impossible for institutional capital to compete with this perspective, and it shouldn’t. These buyers are only a thin slice of the market.

    With regard to timing, it is interesting to hear a growing number of participants in the market talking about a double-dip recession. It will be interesting to see what happens.

  3. 3 Christine Glavasich March 15, 2010 at 6:01 am

    I think many good points are made here by you as well as Mr. Ellison. After reading the main post I allowed a lot of what you stated to churn about and when I came back to the blog, I found that many of the things that were “churning” had been addressed in Mr. Ellison’s post.

    I,too, remain extremely skeptical about what the actual “bottom” of this market (be it for real estate or stocks) will be. We have a new (or at least pending new) landscape where broad sectors of the economy are being deliberately moved and shaken (and I for one think a lot of this is quite necessary, as in health care); therefore, the last decade’s “feelers” cannot be counted upon any more.

    Do you believe, for instance, that “the fundamentals” of the economy are good, overall? I don’t. So I think a wait and see attitude is about as good as we can do for now.

    PS … this is a great blog. Keep up the good work!

  4. 4 Harrison K. Long March 15, 2010 at 11:52 am

    I agree with your analysis and argument that now is the time to buy real estate because of current low supply, impossible to call for the bottom of the market, anticipated inflation, values will hit record highs during next peak, and we are now close to the bottom of the market.

    Harrison K. Long
    Realtor and Broker associate, Coldwell Banker Previews, Quail Hill Center, Irvine, CA.

  5. 5 Gerry March 15, 2010 at 12:01 pm

    I like that you make reason for why buyers should buy today. But, a better title might be “Why buyers should buy in 2016”.
    After all…remember the cap rates in the old days? Remember the gross rent multiples at 4xRR just a decade ago? How about the rent to buy ratio which is famously HIGH. The direction here is easy to spot. We are far from bottom. A friend purchased a 30-family in Bayside for 1.3M in 1997. No-one wanted it at 4xRR! Those $1000 apartments now rent for $1200….not much more but what is the building worth today….4-5M?

    DEFLATION DEFLATION DEFLATION….very painful.

  6. 6 JM March 15, 2010 at 9:35 pm

    “collateralized debt obligations, derivatives, sub-prime” was just the begining.

    The real financial doomsday will be arrive in two year’s time. Headlines will speak of “maturity wall” “Corporate loans”, “junk bonds”.

    GoodLuck to sellers.

  7. 7 rknakal March 16, 2010 at 5:55 am

    Hi Christine, thanks for you post. As far as fundamentals go, so many things in our economy, partiularly commercial real estate, are dependent upon employment. Many fundamentals are weak due to high unemployment. These include housing prices, consumer confidence, consumers spending etc. I do not believe our fundamentals will tangibly improve until job creation averages over 200,000 jobs per month, at least. Remember that we need 100,000 jobs created per month just to keep up with population growth. With 100,000 jobs per month created, we are not recouping any of the 8.4 million jobs lost during this downturn.

  8. 8 rknakal March 16, 2010 at 6:00 am

    Hi Harrison, thanks for your post. I hope you are correct. There appears to be two growing schools of thought. The first is that we have hit bottom and the market will start to correct. The other is that what we have seen thus far is just the tip of the iceberg and much more pain will be felt. Sentiment seems to getting stronger in each direction, which is actually good for the market as activity should increase.

  9. 9 rknakal March 16, 2010 at 6:05 am

    Hi Gerry, thanks for your post. Yes, cap rates in “The old days” were much higher but so were interest rates. Back in the mid-1980’s, for instance, the average cap rate on our multifamily transactions was in the 12% to 13% range. The younger people in our office who have only been in the business for less than 5 years have never seen anything but a 5% cap rate envirionment and they cannot believe that caps were so high. I remind them that mortgage rates were double digits in those days as well. A big factor in where our cap rates are headed is dependent upon where interest rates are going.

  10. 10 rknakal March 16, 2010 at 6:07 am

    Hi JM, thanks for your post. I hope you are wrong but there is a lot of data to support your position. Do you own any properties that you want to sell today????

  11. 11 Nate March 16, 2010 at 3:50 pm

    This post is very interesting.

    Everyone seems to be treating all CRE as one big “market” when what I see are many location specific markets that are all sensitive to the environment in which they currently operate. The environment includes interest rates and inflation.

    So the questions are more like ‘Should I buy a FedEx distribution center in Los Alamos returning a 8% cap rate with 40% financed at 6% or not?’ or ‘Should I buy an office complex in Washington DC that is 10% occupied for a 10% cap rate with 70% financed at 7.5% or not?’ rather than the blanket ‘to buy or not buy’.

    The current environment is not one that favors sellers, so if I were to sell today, either me or my investment is in trouble. Determining which is the issue.

    I have seen, since the highs of 2007, a great increase in cap rates and decrease in CRE values nationwide (these 2 things are tied together). As a holder of CRE this is very distressing. Will cap rates go down? I think, some day, yes, but that day is far enough away to hold on for a while and see if the refis of the next 12-18 months are smooth or turbulent.

    Blessings,
    Nate

  12. 12 rknakal March 17, 2010 at 5:08 am

    Hi Nate, thanks for your post. You are correct that we must look at market segments to accurately address this question. There are some submarkets that are clearly under more stress than others. Additionally, different product types will behave differently and classes within those types will also come back on varying timetables.

  13. 13 Paul Meadows March 17, 2010 at 9:06 am

    I believe the reason to buy today is none of the above – though there are many good arguments for either position.

    The reason to buy today is that the market has been disrupted and is currently much less efficient than it has been in recent times. Lenders are trying to figure out how best to sell notes and REO. Some sales timelines are short for banks trying to recapitalize before the FDIC takes them over. There are only so many cash or low leverage buyers out there with the experience and exposure to certain deal flow. My hope is not to buy at the 30% down level – but to best that by 10-20% and have that potential upside or at least safety net if the market goes further south.

    That said, there is still a lot of dumb money (or other peoples money? – irresponsible or over-optimistic syndicators/institutional) in the system………

  14. 14 Alex March 17, 2010 at 2:52 pm

    Robert,

    I am glad that you are mentioning Cap rates. My argument is that interest rates have no way to go but up. Hence capitalization rate will have to increase and the prices will have to go down.

    For that reason I have always had a mixed feeling about the inflation argument as well. Yes, real estate is a hard asset but I suspect it’s inversely correlated to interest rates as well. If hypothetically inflation will increase and will be upward sloping and for the argument sake hits to 5% – 6% in the next year or so, would not Fed be forced to keep up with inflation and increase the rates? That will work against the real estate market.

    Regardless, as an active investor, I feel that there is no wrong time to buy real estate since predicting the future is a futile task. The best way to judge the deals out there is to judge them by the current market conditions.

  15. 15 rknakal March 19, 2010 at 4:18 am

    Hi Paul, thanks for your post. Based upon your feedback, I would assume you are active somewhere other than New York. Here, we have seen an overwhelming percentage of purchasers using low leverage to acquire properties, either for strategic reasons or out of necessity due to the inability to obtain high leverage. As for your “dumb money” comment, I believe that the seemingly strong prices being paid today are due more to an acute supply/demand imbalance rather than as the result of unsophisticated buyers. My Commercial Observer column this week took a look at this imbalance. It can be accessed at http://www.observer.com/term/robert-knakal.

  16. 16 rknakal March 19, 2010 at 4:25 am

    Hi Alex, thank you for your post. You bring up some good points. Inflation will increase the “value” of hard assets as all prices increase. And you are correct that the Fed’s response to inflation, above its comfort zone of 1% to 2%, will be to raise interest rates. The key to riding the inflation wave for commercial real estate is to lock in today’s lower interest rates on a fixed-rate, long-term basis. In this case, rents will rise with inflation resulting in higher net operating incomes. As long as the owner does not have to sell during the high interest rate environment (which would, as you indicate, result in higher cap rates) they will be left holding an asset which has inflated in value.

  17. 17 JMeli March 19, 2010 at 11:23 am

    You need to watch the currencies and productivity.

    High interest rates within 5-8 years are unlikely even with higher inflation (going against historical data). Why? b/c productivity is expected to remain low for at least a decade. The 70’s was different as we came off the gold. Any serious inflation here would tank an already weak US economy.

    As, Europe gets caught in a deflation spiral, the dollar surges as Euro is in a lose/lose scenario with or w/o bailouts anticipated. This allows monetization to remain undetected. Europe needs to monetize and prevent deflation if it wants to prevent a Japan-style lost decade (or two). Exactly as expected by the Fed. The US didn’t outrun the tiger; it’s just that Europe was slower from it.

    Does anyone actualy think the Fed wants a strong dollar policy? This huge global imbalance needs a much weaker dollar (and weaker Euro) for 1st world nations to avoid decades long deflation and/or debt-default risk by nation after nation or state after state.

    All this sloshing of “excess liquidity” will not be inflationary for another reason…. most of it will be used for needed services (municipalities avoiding unpopular cuts, healthcare as it increases in GDP ration, crumbling infrastructure, etc..) It really won’t be chasing any particular one asset class for a while.

    JM

  18. 18 rknakal March 23, 2010 at 7:44 pm

    Hi JM, thanks for your post. The bias in the market is definitely towards inflation even though nothing is a given today. Interest rates will have more of an impact on commercial real estate than almost anything other than employment over the next few years. I believe inflation is more of a potential factor than you think. I, certainly, hope it is in control but I have my doubts.

  19. 19 Giovanni Isaksen March 27, 2010 at 1:47 pm

    Robert, I agree that inflation is in our future given the explosion in the money supply. I saw a good piece on why inflation hasn’t taken off yet. http://bit.ly/9GCazp Essentially the banks are shoring up their balance sheets buying Treasuries instead of lending it which would produce the inflationary pressure.

    Thanks for the great post and discussion.

  20. 20 WD March 28, 2010 at 6:05 pm

    Robert:

    Very interesting discussions, opinions and sentiment with respect to the current CRE market in general, and where exactly people feel/believe it is headed. I think, in this environment that I sleep better at night owning single tenant properties with long lease terms and credit rated tenants. there is certainly merit to owning multi family properties for cash flow, and based on their historical performace, some mild appreciation over time. the key phrase is over time though. any private investot purchasing multi family today has to be prepared to weather a likely prolonged period of increased concessions, affecting effective rents and cash flows. Add to that the cost of capital repairs & maintenance items (which will either have to funded from cash flows assuming cash flows are sufficient to support such line items in the budget), or additional equity funding by the owner is required. We have looked long & hard at the multi family sector for several years, and bid on many,many assets in the southeastern area, perhaps fortunately, we were not the successful winning “bidders” (which I never want to be the high bidder in any environment)-always seemed to be someone enamored with owning multi family in “X” town in Florida too caught up in potential growth prospects. True, demographic projections facor multi family for a long term hold (minimum of 10 years), we are not yet seeing the deep discount Re: pricing correction we deem necessary to be too aggressive in this sector. We’ll continue with the boring but stabile & predictable cash flowing single tenant retail, warehouse/distribution/flex properties where we can still secure non-recourse long term fixed financing. May not get the big appreciation upswings, but we feel these assets act as a nice hedge against inflation, are relatively easy to syndicate or line up outside investors that are risk averse.
    I’m curious as to your opinion and other professionals reading this blog- their opinions as to which CRE sector(s) they like and why for the next 5-7 years.

    Keep up the fantastic insight, and God Bless.

  21. 21 Carl Todd March 28, 2010 at 7:17 pm

    rk
    When I was a pup in the business I had the clearest crystal ball on could obtain. As I aged and now after 68 have past my crystal ball has cracked and has cataracts that make it so cloudy its almost milky white, which means now I must rely on what is happening around me and colleagues now, not what may happen in the future.

    The alert local broker that specializes in a market segment will know when to buy when he places a property on the market for rent and the phone starts ring off the hook. If at the end of the day all he has is a phone bill for cold turkey solicitation calls for his listing – keep your money in your pocket and look elsewhere for that property that the adds and the sign in the widow keep the brokers’ phones ringing.


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