Monday, June 02, 2008

Reflections on the Real Estate Market from a meeting in California

I have just returned from my first Lusk Center Retreat, which took place in gorgeous Santa Barbara. The group at the retreat included among the most successful real estate developers and financiers in California, as well as guests from Wall Street. The weather was sunny; the mood of the group was not. Some takeaways:

(1) Every person in the room but one thought that the country was either in or headed into a recession. This may have reflected more about current conditions in California--and in particular in the Inland Empire--than the country as a whole. Then again, California is by itself an awfully large part of the country.

(2) Commercial real estate transactions have dropped precipitously. One person did report closing on a deal with a 4.9 percent capitalization rate, but many in the room were saying that transactions were off by as much as two-thirds from a year earlier. The story: bid-ask spreads are very wide, and because market fundamentals are good, sellers do not feel pressure to sell at a fire sale price.

The implication to me is that capitalization rates have risen. Given that spreads have risen in other financial markets, it seems to me that cap rates should be at least 100 basis points higher than a year ago, and perhaps 200 basis points higher. This would imply shadow values falling by between 15 and 40 percent. This will begin to create a problem when commercial mortgages, which usually feature balloon payments, begin getting refinanced in large numbers over the next few years.

(3) Raw land in the inland empire has less than zero value.

6 comments:

Duke of Moral Hazard said...

What type of property was the 4.9% cap rate? When I left the business a few years ago, cap rates on grade A office buildings here in Los Angeles County were in the 7-8 cap range, industrial was in the 6-7 range, retail in the 4-5 range and multifamily approached 0 or went negative in some of the nicer areas.

"The implication is that caprates have risen."

Would be interesting to check this with costar/loopnet/cushman & wakefield (accessible at Lusk)/cbre, etc.?

If I remember correctly, calculatedrisk.blogspot.com has visited this a few times and reports that commercial is tanking. Many articles out there detail the stresses on commercial property lenders. It will be especially interesting to see how many defaults there will be in light of the lax underwriting by many lenders. 95% ltv on commercial properties? Yep... they were doing that too.

brokers said...

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Anonymous said...

What's the point in spamming if you don't leave contact information? Then again, I haven't heard that spammers are the most intelligent creatures in nature.

Relevant CR link:

http://calculatedrisk.blogspot.com/2008/06/wachovia-cre-slump-is-here.html

We're running a model currently on clustered core2quads with 8 GB's of memory, that runs out to the "boinc" network. It is revealing that next year, if Prof. Green opts to skip the Lusk retreat, and instead spends a weekend with CR and Tanta, down in Tijuana -- they will be able to build an economy that runs smoothly.

Zachary said...

The commercial real estate market is hurting but has not been hit the same way the residential market has. We are seeing a shift where the youth are moving from the outskirts back into the city. Los Angeles is some major changes.

Ryan said...

Can you please explain how the land could possibly have a negative value?

If anyone wants to give me inland empire land that has a negative value, I'll gladly take it off your hands.

Seriously, though, I'm intrigued. Is it because the property tax negates any value of the land?

Richard K. Green said...

Developers are telling me that improved land is selling for less than the cost of improving it. Impact fees are part of that cost. So the raw land is worth less than zero.

If there are holdings costs associated with owning raw land, and the option value of developing it is extremely low, it can be worth less than zero.