S.E.C. Real Estate Observer

• Tweet

• Tweet

The world of investment real estate has changed. In the 12 short months since the economic recession finally hit Wichita, everything about our commercial real estate market has changed, and those who do not recognize the new environment are destined for frustration and failure.

In the pre-November 2008 world, cash was plentiful and capitalization rates (cap rates) were low and continually declining. Good properties were available and selling at returns on investment of a sub 8%. Many NNN leased properties with “national” tenants were selling at 6.5% to 7.5% rates of return. Cash was readily available at the local lenders at 6-7% interest rates and an 80% loan was fairly easy to obtain. Cash was so plentiful, that so-called creative finance was almost extinct and no one would talk about owner-carry financing or making real honest to goodness exchanges.

An entire generation of real estate investors and brokers has grown up in this environment and almost no one remembers the double digit interest rates of the Carter administration or the incredible inflation in the cost of living that occurred simultaneously. We had been building and never stopped to consider the underlying fundamentals of commercial real estate.

Welcome to the new reality. Banks do have money to loan, but they are being very careful about doling it out. There is a large disconnect between willing buyers and sellers in today’s marketplace. Government regulation of banking institutions has increased to the extent that even veteran bankers do not know what the rules are from one moment to the next. It is a time of uncertainty and fear. Among the investing public, both uncertainty and fear are the enemies of transactions. Many, if not most investors, have left the market to wait for a more predictable time and for the “bottom” to assert itself. So, what are prudent investors to do?

There are still many deals to be made. They are not quite as plentiful as in the past, and there is a significant emphasis on the fundamentals of good real estate investing. By good fundamentals, one must look beyond just the tried and true “location, location, location.” Traffic count, ease of access, visibility, signage, availability of parking, ancillary traffic generators, tenant mix have all gained significant importance in the new reality.

In today’s marketplace, it is not enough to just want to sell a property, and the offering price is not the only determinant as to value. Successful buyers and sellers are working to create win/win transactions where the benefits of a transaction are shared equally. In the absence of readily available mortgage financing, owner-carry financing becomes important if a property is to attract attention in the market. The opportunity to offer alternative down payments is also a significant factor. Would a free and clear house or condo meet the seller’s need for enough security as a down payment? What other equity kickers could be included to sweeten the down payment for the seller? What will the seller do to help sell the property? Can the seller carry back at a reduced interest rate? Can vacant space be leased back for six months or until it is leased? Will the seller accept personal property as part of the down payment?

Thanks to the presence of the Small Business Administration, owner occupied real estate has a newly discovered significance for the sellers of commercial real estate. The loan guarantees offered by the SBA are very significant in unlocking the keys to bank loans as they greatly limit the risk to the lending institution. One needs to remember that owner occupied is a small percent of the available real estate.

Soon, a new form of currency will make itself available in our marketplaces. The escrow contract mortgages or contracts for deed or the first mortgage note will be offered as purchase money becomes harder to find. Many owners will create mortgages backed by their property and use the created paper to purchase equity in properties. They will unlock their under-performing equity to make new transactions and grow their portfolios of investment properties accordingly.

There are many ways to create safe, secure and mutually advantageous real estate transactions. It will be more work than before, and it will require more creativity and innovation than before. It will require more and better due diligence; but there are an infinite number of ways to structure commercial real estate transactions. These creative formulas have fallen into disuse during the era of plentiful cash but will be making their way back into the marketplace. These are but a few of the ideas that will be forthcoming. Are there any takers out there?