COMMERCIAL REAL ESTATE: It's an Exciting Time
Column by Michael Bright
People always give a sigh of apology when I say I am in the commercial real estate business. With the residential markets taking huge hits and the economy struggling, the assumption is that commercial real estate is too. For those holding grossly overvalued, leveraged commercial properties, times are tough. However, for the commercial broker and investor with their nose to the ground sniffing for great deals, it is an opportune time. With tight lending requirements, the term, "Cash is King" has never been more valid. It truly is an exciting time for commercial real estate in Denver.
Many commercial properties are facing loan renewal deadlines. Those who paid a premium five or more years ago are faced with the reality of not getting a new loan. With lower market lease rates, banks requiring higher debt coverage ratios, and overall declining property values, those who leveraged their investment years ago are left with little to no options today.
This also holds true for developers. A project I am familiar with in Denver was selling for $225 per square foot five years ago, but now is selling for as low as $100 per square foot. Banks have been forced to work with developers to recapture as much capital as possible and cut their losses. This is great news for business owners who have been leasing. For the same monthly obligation, business owners can put a reasonable amount of cash down and take advantage of incredibly low interest rates and own their space. SBA financing is a great way to lock cheap money for the next 20 years without the traditional closing cost fees.
Another example is a property that sold in 2000 for $2.95 million, but was unable to be refinanced last year. A group of local investors were able to purchase the property this year in a short sale for $1.1 million in lieu of the bank foreclosing. The property needs work, but with existing tenancy (which was at 60 percent at the time of purchase), the property was returning a 10 percent CAP rate. Once work is complete and the project is stabilized, the investors should see returns between 12 percent and 15 percent annually even after the capitalization costs.
With the uncertainty of financial markets and the threat of hyper inflation in the next couple of years, investment in hard assets should definitely be considered as part of one's investment portfolio. In an article written by CoStar's Mark Heschmeyer, he quotes Andrew Little, an investment banker with John B. Levy & Co. in Richmond, Va., who said, "Although the downgrade (of the U.S. debt rating) has made market participants more anxious, and the immediate impact is widening spreads, the cost of capital for better quality commercial real estate has not gone up. The bond market certainly doesn't believe there will be any U.S. Treasury default, but prospects of continued political gridlock and further downgrades has investors of all kinds trying to figure out where to put money," Little said. "Commercial real estate doesn't look too shabby when compared to many of the alternatives." Mark goes on to quote Asieh Mansour, Ph.D., and CBRE's head of Americas Research who says, "While we anticipate continued stock market volatility, commercial real estate will not fare as poorly because it remains a preferred asset class, within a well-diversified multi-asset institutional portfolio."
Be a wise and prudent investor. A trusted advisor has always told me, "I don't invest in anything I can't sell for $8.95 with Schwab." Once committed to a commercial asset, it certainly is not as liquid as a stock trade. However, if done right, it can prove to be a very valuable return for the future. Look to those who know and understand the market and seek their advice. Do not invest in something you don't understand. The last thing you want is to be the "one" having to arrange a short sale or face foreclosure down the road.
A friend and I recently sat down to play a game of Monopoly with my 9-year-old son. My friend has a Ph.D. and I being in real estate felt confident in our abilities to school my son. My son is infatuated with Boardwalk and Park Place (who isn't?). He had successfully purchased Boardwalk, but needed Park Place, which my friend had already purchased. For 30 minutes he begged my friend to trade nine of his properties for my friend's one interest in Park Place. My friend would not trade him because he felt guilty of taking advantage of such a naive trade. After repeated requests, I finally encouraged my friend to make the trade, knowing it would give me the opportunity to teach a valuable lesson to my son. It took only another 30 minutes (we all know this game has a painfully long time requirement), but my son successfully purchased the requisite amount of homes, then two hotels and subsequently bankrupted my friend first and myself not long after. No lesson in prudent spending was taught that day, and my 9-year-old has not let myself, my friend or anyone else within ear shot forget his victory.
My point is, many have made a lot of money on real estate. Some make it through wise and prudent purchases and others through dumb luck (no offense to my 9-year-old). I believe in the real estate market in Denver. It has weathered these economic times better than most major cities throughout the country. Be wise, use good judgment and counsel, and you too can end up winning in the game of real estate in Denver.