Buyers Beware!!
Photo by Alex.ch
I read Robert Knakal’s weekly blog post today and thought this would be an excellent post on the kinds of things that should be going through a commercial real estate investor’s head if she is interested in making an offer in today’s market.
Bob’s article is, “Why Buyers Should Buy In Today’s Market”. I’m usually very impressed with his thoughtful and well-researched analysis. But in this post, I couldn’t find very much to hold on to that had substance. Read below for my thoughts or see my comments in the body of the original post:
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.
Shiller Housing Index
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.
