While the commercial real estate market has been cool for some time, it has picked up dramatically in the past six months, says Gary Cooper, president of BGL Realty.
“Pricing and transactions, for example, in Manhattan, are back above peak right now,” he says. “Some of my larger clients are New York-based, and they’re getting unsolicited offers on office buildings and other core buildings they own in the city. They were kicking themselves a year or two ago, saying they should have sold them before the financial crisis. And now they’re getting those unsolicited offers again, and they’re above the pricing that they could have received at the previous market peak.. It’s been a very quick recovery for those folks.”
Smart Business spoke with Cooper about the state of the real estate market in both the core and non-core markets.
What is the state of the non-core markets?
The non-core markets, whether it be any of the Ohio cities or western Pennsylvania, Indiana or even Chicago, for the most part, have been very quiet. A lot of the deals being done are just distress deals from commercial mortgage-backed securities or bank- or foreclosure-type workouts.
When you take a look at the headlines that say commercial real estate’s back, that’s true if you’re in core markets like New York City, Washington, D.C., Los Angeles, Boston or San Francisco. But the good thing is the recovery is finally on the horizon for the non-core markets as well
What happens here, say in the Midwest, is our markets are strongly influenced by the core markets. And we’ll see activity heating up when things get expensive in those markets. Once that starts happening, people will then look outside the marketplace and start expanding their horizons. I think the recovery is going to come to the non-core markets faster than people are expecting.
What sort of activity have you seen in the non-core markets recently?
We’ve seen investors come back to the market. The thing that drives real estate the most is the availability of debt. And during the downturn, investors were passing on deals in the non-core markets because of the low loan-to-value ratios. You had rates that weren’t quite as competitive. And when you have that lack of debt that finances these transactions, you can’t have much activity.
But lenders are seeing the downturn wasn’t as bad in most non-core markets and they’re recovering faster than we thought from an operational perspective. So now there’s availability of debt across the spectrum, and local banks have jumped back into business again. There’s a lot of lending options available once again for non-core market assets now.
Why have the core markets bounced faster than the non-core markets?
One of the biggest reasons is you’ve had stability of demand in a lot of those core markets. What everybody’s trying to do today after the financial crisis is balance the risk/reward continuum. Folks are asking, “Where can I earn a return that offers me the least amount of risk and also an inflation hedge?” And a New York City office building is about as safe as it gets.
And when you look internationally, the value of the dollar declining, so all of a sudden we look cheap and investors are buying into those big-city markets.
What advice would you give to buyers who are looking for properties in the non-core markets?
The most important thing is timing. Right now, we’re seeing a return to height-of-the-market pricing. Cap rates are compressing quite a bit, real estate operations are very strong and occupancy levels are pretty good. The current pricing level when combined with the low cost of debt allows a tremendous amount of cash flow and tremendous protection against risk of operations, and I think we’re going to see some significant valuation increases over the next couple of years in terms of real estate assets in the Midwest. So my advice to buyers right now is timing is critical and now’s the time to act.
Are mortgage rates still low and desirable?
Yes. For example, Fannie Mae has a seven-year fixed-rate product with rates between 3 and 3.2 percent. So you’ve got debt available in the 3 to 4 percent range right now, and if you combine that with pretty attractive pricing, that’s a good mixture.
What do you see happening in the core markets in the next year or so?
They’re going to price themselves out of the market. I think transaction velocity will start to slow down in those markets, and the cap rate compression has almost hit a peak to where if it compresses anymore, they won’t be financeable.
But also I think all of a sudden the non-core markets are going to be much more attractive and you’re going to have a supply/demand imbalance where the core markets are going to lose a little bit of the luster they have and are going to be slowing as the rest of the markets are picking up.
I also think it’s important to note we’re above peak pricing levels for Class-A core markets right now across the different product types. They’ve recovered unbelievably.
How does the current state of the commercial real estate market impact businesses?
There’s a couple of macroeconomic things that are going to influence the commercial real estate market. I think there’s a disconnect right now between valuation and operation. As quickly as asset prices are increasing, rents aren’t necessarily increasing at that same level. So although we’re seeing dramatic pricing increases, we’re not seeing huge gains in rent rates. From a user perspective, whether you be an apartment, office or retail tenant, you’re not seeing unusual price spikes and you’re not being priced out of the market.
So there’s a lot of good deals out there, but they are going to quickly go away because in the next couple of years, I think we’ll see significant upward pressure on rents. So you want to lock in a good deal right now. And owners of assets have been kind of rewarded because valuations are back and there’s a lot of debt and equity available. So now’s a great time to sell.
What advice would you give to businesses regarding the commercial real estate market?
Right now, it’s still a buyer-oriented market. You have pricing power and negotiating leverage. However, I believe as the market expands, that’s going to switch back to a seller market, although none of us are sure exactly when that will be.
So if you’re making leasing decisions, make them soon. You’ve got some negotiating leverage power in the marketplace today that’s going to slowly get taken away.
Gary Cooper is the president of BGL Realty Reach him at (216) 241-2800 or firstname.lastname@example.org.