Commercial Real Estate: Outlook at the Power Breakfast

A GOOD OUTLOOK FOR COMMERCIAL REAL ESTATE IN 2007 

I had the opportunity to sit in at the International Council of Shopping Centers (ICSC) annual “Power Breakfast” that featured some high powered institutional investors as panelists.  They included Erwin Aullis, the Managing Director of Transwestern Investment Company, Stanley L. Iezman, the President of American Realty Advisors, Inc., and Glen Sonnenberg, the President of Legg Mason Real Estate Services.  The panel was moderated by Mark Schurgin, the president of the Fesitval Companies.

These are some high-powered commercial real estate fund managers who don’t even get out of bed for a deal less than $50 Million!  They were there to give us some of their thoughts on how the economy will impact commercial real estate investment, where interest rates might be headed in the coming year, and how buying and selling parameters have changed for shopping center owners.

Some of the thoughts that came from these guys were fairly insightful.  Here’s what I got from the breakfast that I think you’ll find interesting:

1. Commercial real estate lenders are awash in money thanks to Collateralized Debt Obligations.  These are derivative debt instruments that allow lenders to dramatically increase their ability to raise money at low overall costs.
2. The ageing of the population and the retirement of the Baby Boomers means that there is a large chunk of retirement money looking for alternate income opportunities … think “income property.”
3. Large funds are taking on more real estate, making it a legitimate “investment class” like stocks and bonds.
4. The REIT Index was up 35% last year, trouncing the S&P 500.Large urban areas can expect low cap rates in the months ahead, meaning that there are opportunities in secondary areas, but you still need to beware in “tertiary” markets, like Detroit and St. Louis.
5. Oversupply of commercial properties is not yet in evidence.1031/Tenants-In-Common buyers are drying up, slowing price appreciation.
6. “A” quality commercial properties are becoming “commoditized,” meaning that there are real opportunities in “B” and “C” product.
7. The big players are getting out of condominium product at significant discounts to original asking price (which means you might get a nice home for cheap).  This was in evidence in San Diego and South Florida.  Residential projects are taking a back seat to commercial in the minds of the big investors.

There’s some good intelligence in these observations for anyone serious about investing in commercial property this year.

The final few minutes of the session were devoted to a group consensus on where interest rates and cap rates would be a year from now.  While not a real prediction, the sense of the room was that the Prime Rate would be .75% to 1% lower, commercial mortgage rates for “A” product would be about .25% to .5% higher than today, and cap rates for class “A” properties would be essentially unchanged.

My conclusions are that there will be some opportunities to make money in smaller commercial properties in outlying areas and smaller urban markets.  New construction and other “value added” projects should also do well.  One caveat is do not make the mistake that rents will continue to trend upward, though.  Stay conservative in your projections and you should be able to ride out any recession that might follow in the wake of possible Congressional tax hikes.