Commercial Real Estate Values After the Bubble – The Word on the Street

This article was written in December 2008

Recently I spar with my co-managing partner Michael Facchini, of Regent Global Funds, an alternative investment fund, at an Institutional Investor conference on Distressed Real Estate in New York City. The folks at Institutional Investor did a fantastic job putting it together and assembled a group of very knowledgeable and informed speakers from the industry. Usually when you place together people in the upper echelons of the industry, you find that they are out of touch with the reality on the streets. But, what I found to be incredibly fascinating about this event and a bit scary at the same time, was that reality has hit all levels of this market and the individuals that are in charge of pulling the trigger on other people’s money are paying attention.

Of particular note was the general consensus that commercial real estate is going back to realistic levels and maybe just a bit below as a result of the real estate bubble being popped.  We all know that residential has popped and crashed, but commercial has always been a question. I have written several times about valuations on commercial real estate getting back to reality instead of popping, and in my reality I never liked to buy anything less than a 10 cap. So for conservative investors, the bubble popping is just getting back to reality.

What really turned my head was that everyone else at the conference was now living in a 10 CAP reality (for more information on CAP rates see “The Golden Rule of Lending: How Banks Got it Incorrect”). In fact, for this group of professionals a 10 CAP was the new norm. What does it all mean for the average commercial real estate investor? It means that if you are holding commercial real estate, it’s probably not worth what it was 6 months ago and it probably won’t be worth what it is today 6 months from now. The usual suspects that get hit during a downturn are things like office and retail, but this time around due to the overbuilding in some markets, properties like multi-family are also getting hit. For example, rental absorption is pretty devastating in places like San Diego and Las Vegas where there was so much overbuilding, and now the supply of rentals looks never ending. This all goes back to the basic fundamentals of meaningful your market and using your head instead of just a spreadsheet.

The general consensus at the conference about the the makings collapse of the Manhattan real estate market is another example. Consider that Wall Street is NYC and NYC is Wall Street. The bitter reality is that people from all the huge financial names both solvent and insolvent, that no longer have a job, are not result any work in the city. These jobs just conclude to exist. Their only choice is to go out, or look for another line of work. Without all of that money pumping into the local economy, there are going to be a lot of people having to go, and a barrage of properties for sale. Now consider that the general forecast of 250,000 financial services people being out of work in the city has not absolutely hit just yet. Taking into account further lay-offs in the financial industry and other industries that were employing a lot of individuals at higher-end salaries, that is going to turn into a lot of properties for sale. Huge supply, no demand, and you have a the makings crash in the Manhattan real estate market that so far has weathered the storm pretty well.

Where do we go from here? Well, there is something fascinating to ponder for a moment. Economists get paid to analyze the economy, and in more contemporary years, to predict its direction. It is disturbing to note that many economists are now starting to agree on one thing? The agreement is that there is no precedent to look back on, and because there is no precedent they have no thought where we go from here. No precedent means there is no known direction and it is one of those distinctive times in contemporary history when using the word, unprecedented, is really not sensationalism.

Even with all of this said, investing in something like commercial real estate where you can get your mind and your hands around an real asset, looks pretty excellent compared to the alternatives like equity based hedge funds. Hedge fund strategists that had their heads in a Quant Screen found out that it might have been a excellent thought to place some practicality in their strategies. Hedge funds are closing weekly and one that comes to particular note was the closure of Citigroup’s Corporate Unique Opportunities Fund after its value declined 53% in October. To make it worse, it is said that investors are likely to only get about 10 cents on the dollar when they liquidate. If that doesn’t make us a believer in alternative investments based on tangible assets like real estate, I don’t know what will.

With all of the pain and uncertainty in the markets life will go on. Though it sometimes seems as if commerce has grown to a halt, there are subdue ways to profit just as long as you know what you are doing. Which leads me to the broken record that plays in the halls of our fund. When investing in any kind of investment whether it is traditional or an alternative investment, you have to know your investment, the market, and everything that comes along with it. Our markets are too volatile and moving too quick to be deriving strategy by sitting around with your head in a pile of spreadsheets and not meaningful what is happening out in the streets. That’s like thinking it’s safe to run through a minefield with a metal detector. Sorry to say at that kind of speed, it warns you a moment too late before it kills you.

Copyright: Dominic Mazzone, Regent Global Funds 2008

This article was written by Dominic Mazzone, Managing Partner and Fund Manager of Regent Global Funds.

This article and other like it can be viewed at www.investingsymposium.com which is part of the Regent Global Funds Network.

Regent Global Funds, rgfunds.com, is an alternative investment fund that offers its participating investors and asset backed investment through asset based lending.

The Fund Managers of Regent Global Funds have an expertise in commercial real estate lending and have made a successful alternative investment vehicle that is diversified through this structure. They separate themselves from other fund mangers by personally investing their own money side-by-side with their investors in the fund, making an absolute structure of accountability. Dominic Mazzone has written about the need for this type of accountability in an article titled “Fund Managers Need to be Accessible and Personally Invested.”