The Bulls Versus the Bears (Part 4)

This week, we conclude our discussion of the divergent perspectives of the optimists and the pessimists.

11) Cap Rates: Going into this down-cycle, it was expected that cap rates would rise significantly as significant levels of distress were evident in the marketplace. Cap rates had risen anywhere from a low on some product types of 50 to 75 basis points, up to as much as 250 to 300 basis points on others. It appears that, given the constrained supply of available assets and the significant demand chasing those assets, there is presently downward pressure on cap rates as they have not risen nearly as much as had been expected. Is this a temporary phenomenon or does this mark the beginning of a recovery? As usual, it depends upon your perspective.

The Bulls: The bulls believe that we have passed the bottom in terms of a high cap rate environment and that cap rates will continue to stay, essentially, where they are or go down slightly as the significant amounts of capital on the sidelines rush in to create significant demand for properties. They believe that the recovery is upon us and that value is rising. They point to the lack of suitable alternative investments and the low yields available on cash and cash like assets which provides motivation to own real estate yielding modest (by historical standards) returns.

The Bears: The bears believe that, while they have appeared to have plateaued, cap rates have only done so because of the acute supply / demand imbalance that the market is currently experiencing. They believe that when distressed assets come to the marketplace in the numbers that actually exist, the supply will be increased significantly, placing significant upward pressure on cap rates. The bears believe that with interest rates rising, cap rates will rise accordingly and that, if history repeats itself, a period of positive leverage will return to the market.

12) Supply and Demand: We have frequently referenced the significant imbalance between supply and demand in today’s investment sales market. The supply of available properties for sale is normally fed by discretionary sellers who decide that, for whatever reason, now is the time to sell their property. As value falls, as we have seen during this downturn, discretionary sellers withdraw from the market. The supply of available properties then typical gets fed by distressed sellers.

Everything that has happened from a regulatory perspective has allowed many distressed sellers the ability to not have to address their problems. Changes in mark-to-market accounting rules, bank regulators allowing loans to be held on balance sheets at par even though the lenders know the collateral is worth less and modifications to the REMIC guidelines, which address how CMBS loans are dealt with, have allowed lenders and servicers to kick, the proverbial, can down the street.

This has led to a sharply constrained supply and, with significant demand in the marketplace, there are far more buyers than there are properties available for sale. Demand has been seen from many sectors. These include: 1) high net worth individuals, 2) families that have been investing in various markets for decades, 3) institutional capital which was sidelined after the credit crisis started to be felt in the summer in 2007 is now back with distressed asset buying funds and opportunity funds and, 4) foreign investors have come into the marketplace in numbers not seen since the mid 1980’s.

The Bulls: The bulls believe that demand is so significant that it has the ability to absorb even a significant increase in the supply of available properties for sale. They believe that we are past the bottom and that upward pressure on pricing significantly exceeds downward pressure. They feel that the downward pressure on cap rates and the resulting upward pressure on values is not based simply on a supply / demand imbalance at a relatively short period in time, but a fundamental shift in investor perspective. While they believe this imbalance has exacerbated market conditions, they believe the imbalance is given too much credit for present conditions.

The Bears: The bears believe that the supply of distressed assets will eventually create an abundance of properties for sale which will drive prices lower as investors have significantly more options and competition for existing availabilities gets diffused.  They believe the supply / demand imbalance is the primary cause of today’s value levels and that supply can only rise from here. They point to tremendous pent-up demand on the sell side as many discretionary sellers who may have wanted to sell have delayed these decisions based upon soft market conditions. As time goes on, these sellers will decide they no longer will delay their action and many of these properties will come to market. Additionally, the number of distressed assets hitting the market have been minuscule compared to those that exist in the market and this condition will change. As supply increases, downward pressure will be exerted on value.       

 13) The Recovery:  The question here is whether the economic recovery is tangible and sustainable or has unprecedented levels of government intervention propped up the market resulting in seemingly unnatural bottoms being achieved.

The Bulls:  The bulls believe that the worst is behind us, inflation is not a concern, employment will begin to pick up and bank balance sheets are not in as much trouble as everyone thought. The bulls see fundamentals getting healthier. They believe that the stock market is a proxy for this recovery and that there is nothing but blue skies ahead.

The Bears: The bears believe that we are sitting in the eye of a hurricane. They believe all is calm which is providing a false sense of security about our being out of the tough times. They are quick to point out the massive need for refinancing and the still nowhere-to-be-found CMBS market. The bears are very concerned about rising interest rates and what they may do to the market moving forward.

Many of you have sent me emails stating that the issue is not really about the bulls and the bears but rather about the realists and those who cannot see things clearly. While I agree that realism is important, interpretation of statistics is based upon one’s psychology and one’s perspective. Whether a glass is half-full or half-empty is dependent upon perspective and interpretation.

As far as the bulls versus the bears go, time will tell who is correct. Until then, all we can do is take things one day at a time and do the best we can.

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 having a market value in excess of $6.2 billion.

16 Responses to “The Bulls Versus the Bears (Part 4)”

  1. 1 Chris R April 12, 2010 at 11:40 am

    I am an experienced CRE executive and as best I can tell the market turns more bullish everday. Cap rates are compressing and more buyers seem willing to pay up to obtain well located properties. This seems to fly in the face of the fact that we have a very anti-growth administration, higher taxes on productive workers in the offing, hundreds of billions of dollars of over-leveraged real estate sitting on bank balance sheets, overwhelmed special servicers with maxed out credit lines, persistently high unemployment, gas at $3 and rising…need I go on? I am amazed that so many seem so willing to make big bets at low cap rates in this environment. What is the rush? It seems to me the fundamentals are still lousy in terms of plowing money into CRE. Lack of returns elsewhere is no excuse to make big bets on an illiquid asset class. Seems to me that smart money managers would look for sustainable job growth and meaningful growth in GDP (no, I don’t buy the government’s spin on the latest numbers they have released for unemployment and GDP)before marching headlong into this asset class.

  2. 2 Joe April 13, 2010 at 9:52 am


    You’ve done a great job of capturing and explaning the current state of the CRE industry. I’m curious about your view of the current state of CRE and how you see everything playing out.

  3. 3 Realist April 13, 2010 at 5:39 pm

    I agree with the poster above. At some point, the extend and pretend process can’t last forever and it seems like 2011-2014 is where any anticipated blood-bath will occur.

  4. 4 Frank April 14, 2010 at 6:17 pm

    Cap rates may have moved, but going from OUTRAGEOUSLY PRICED to just VERY OVERPRICED does not mean now is the time to buy.

    Cap rates are irrelevant without the content of financing, what is more relevant is the historical positive leverage spread.

    With the institutional players (AKA BID UP EVERY Shanty in Town) in the market it seems that the days of buying real estate for returns is over…. Yes, if you have tons of cash you can buy outrageously expensive items, just the same you can buy a 300k watch, but if you want to make a real competitive return, I think real estate is over, at least in the major “core” markets. I would challenge you Mr. Knakal to show me deals in the NYC metro area that investors are making real current cash yields (8%+) that have exchanged hands recently. I don’t want to hear stories about condo conversions or this broke and that broke and you can’t factor that in. I’m talking old school buy the brick and run it and collect the rent. Real Estate is purely financial arbitrage at this point.

  5. 5 rknakal April 14, 2010 at 8:47 pm

    Hi Chris, thanks for your post. I agree with many of your points. The government’s spin on job growth is a snow job. Wait until the census workers have come and gone and look at job creation in the private sector to know how to feel about real estate fundamental moving forward. Don’t forget that we need 100,000 jobs created per month just to keep up with population growth. We need to substantively chip away at the 8.5 million jobs lost in this downturn.

  6. 6 rknakal April 14, 2010 at 8:50 pm

    Hi Joe, thanks for your post. How I see things moving forward is really dependent upon my perspective on job growth, interest rates and financial sector regulation. Any of these factors could have significant ramification on our short-term and mid-term future. I am leaning toward the bullish side but need to see 250,000 to 350,000 jobs create per month to really feel good. Also, the recent surge in the 10-year T-bill has me concerned as it is a reaction to the most benign option the Fed has to exit the market. Time will tell.

  7. 7 rknakal April 14, 2010 at 8:52 pm

    Hi Realist, thanks for your post. I believe 2011 and 2012 will be the bell-weather years. Probably 2011 moreso than 2012. You can’t argue with the fact that the 2006 and 2007 loans are the most distressed and ’11 and ’12 is when most of them mature.

  8. 8 rknakal April 14, 2010 at 8:59 pm

    Hi Frank, thanks for your post. If you want to challenge me to show you +8% cap rates on NYC properties you are speaking to the wrong guy. I havent seen 8% caps for many, many years let alone recently. Most of the transactions we have closed since the early 2000’s have been at sub-6% caps. No stories here. Most investors in NY buy for appreciation, not cash flow. In my business I only represent sellers, therefore, I am always trying to push value as hard as I can. I really don’t care why people decide to pay what they do, I just want to maximize the prices my sellers receive.

  9. 9 Frank April 15, 2010 at 11:26 am

    rknakal, I understand most investors in NY “think” they are buying for appreciation. The reality is over long time periods I’m not sure their returns will be better than buying in a second tier market in which there is positive cash flow. Bottom Line is New York is a market for people that do not care about returns, bc most likely there will be none for 10+ years….. If you want to make money in real estate, by that I mean real returns, seek secondary markets. I understand you are ambivalent as you are a middle man… thats why I advise people in NY if they want to make money in real estate, go broker it bc there is none in the building in the short- medium term…. You can tell me about all the old school families, Lefrak etc… they were born into the buildings they have 50+ years ago, just like TRUMP, show me person or a firm who has built up a sizable portfolio in the last 15 years starting from zero?

  10. 10 Frank April 15, 2010 at 11:27 am


    Here’s a link to all the Genius Harvard MBAs… they don’t realize real estate is hands on, its not financial engineering…

  11. 11 JMeli April 16, 2010 at 11:13 am

    Realist has it right….

    The early 90’s was a tumble.
    This time, the govt gave it a safety net with artificial propping. “extend and pretend”, “kick the can down the road”. This is the new reality. All it means is that the later half of this decade will be really bloody.

  12. 12 Carl Todd April 18, 2010 at 4:16 pm


    My sixth sense agree with you.

    Gas at $3.00/gal. with oil prices creeping up. Is your wife’s family shopping bill cheaper or higher?

    California is negotiating with Chinese manufacturers for the rail cars for their high speed rail line – whose manufacturing jobs are benefiting from that infrastructure stimulus package?

    62% of the coal mined here is metallurgical coal, scarce world wide, and is used for manufacturing steel not fuel. The bulk of it is exported to China and the Pittsburgh mills are a ghost town and their downtown resembles Detroit’s. Our remaining mills mostly use scrap to recycle – good but far from the needed domestic quantity for new products that should be manufactured here.

    Our up-tick in manufacturing is producing more efficient machines to manufacture consumer goods and they are being exported and with them go the jobs that should be using those machines in USA and we should then export the consumer goods not the bulk of those consumer products manufacturing machines.

    All leads to continuing low employment and as FDR said there can no prosperity in America until the man in the street has money in his pocket. Unless he’s Dillinger where is his going to get the money to fuel prosperity? When I asked my deceased manufacturing kid brother, who employed 500 people world wide before his passing, how could you afford to pay 14.5% interest during the Carter years answer to me was that I still can make money on it if I couldn’t you could offer it to me for 1% interest and I’ll tell you where to stick it.

    Real estate is the platform where all human activity takes place. The end supporter of commercial real estate is the consumer. The local domestic consumer is the foundation all other businesses are built upon. Its not a trickle down economy but a trickle up economy. Given a good steady well paying job the consumer will become a demand factor for more goods and services that will stimulate the demand for more commercial space to produce the goods and provide the services the consumer and producer need.

    My father agreed with only one aspect of the trickle down economy and his example of the proof of where it was working involved the horse and the sparrow. He knew of no other example.

    Please give me the formula to become to big to fail so if even if it is too late for me I could give it to my grand kids to insure the future economic success in America unless we come to our senses and respect the basics of prosperity, namely, education, modern up to date production facilities and secure middle income domestic employment.

  13. 13 Bay Area Com RE April 24, 2010 at 3:49 pm

    Some argue the inflation rates will hurt commercial real estate in the short term and help in the long run. Do you agree? In San Francisco, we still feel there is more downward pressure in the leasing market. There is a bubble occuring in the capital markets because the low supply from a dearth of new construction, new sales or foreclosures articifically inflates the amount of buyers and drives up prices. If there was a sudden influx of supply, the demand would dissipate and the prices would fall to recession levels again.

    -Justin, BayAreaComRE

  14. 14 rknakal April 25, 2010 at 10:14 am

    Hi Justin, thanks for your post. Inflation is a double edged sword and how it impacts participants depends upon their position. If you own property and have long-term fixed rate debt, inflation is great as the value of your property will increase as inflation goes up. If you are buying, you will pay less because inflation will cause mortgage rates to rise which will in turn create the need for additional yield on the purchase. Inflation also has differing impacts depending upon whether an owner has fixed or floating rate debt.

  15. 15 salary December 10, 2012 at 10:23 am

    Hi mates, how is all, and what you desire to say about this post, in my
    view its really remarkable in favor of me.

  1. 1 Streetwise: The Bulls Vs. The Bears of Commercial Real Estate « Robert S. "Bob" Lowery Trackback on April 15, 2010 at 7:09 am

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