Despite economic slowdown, real estate investments look strong
By Larry Feldman President & CEO
Feldman Equities
Despite the current economic slowdown that has gripped much of the nation, commercial real estate in many ways finds itself in a much stronger position today than during the recession of the early 1990s. In fact, given the recent performance of the stock and bond markets, the continuing shakeout in the technology sector and financial scandals involving industry giants like Enron, real estate by comparison looks like a better investment than ever.
Although office and industrial vacancies are on the rise, the supply vs. demand factor is more balanced than a decade ago, as new construction has slowed and many obsolete properties have been taken out of the market. The distressed market of a decade ago that gave rise to many opportunity funds doesn’t exist any longer.
Furthermore, public real estate equities and debt are being more carefully watched than ever before by analysts, rating agents and investors who simply did not exist at such a high level 10 years ago.
The market is still awash with fresh capital to be put to work, and there is no shortage of opportunities in today’s real estate market. While bid/ask spreads remain unusually large, we expect this gap to close between now and the fall, with transaction volume picking up substantially.
"Trophy" property investments still garner tough competition, driving bids higher and causing some buyers to overpay for real estate. The real "opportunities" are the less visible ones, perhaps the not-so-pretty ones, where there is great value and growth potential to be found with the right turnaround strategy.
Smart investors need to take a sensible bricks-and-mortar approach to buying assets. The major source of an investor’s overall yield has to be from cash flow, as opposed to the projected exit price, and investors need to avoid buying real estate where the returns are dependent upon a "back-ended" pot of gold. Investors who chase high priced assets (i.e. above replacement cost) with financially engineered structures are likely to get burned if the economy falters.
We recently completed a renovation and lease up of a grocery anchored neighborhood shopping center in Arizona and decided to market it for sale as a fully stabilized property. The sale drew 30 bidders and our overall returns exceeded an IRR of 35%. In this climate, investors need to look into assets that others may shy away from, possibly assets located in secondary or tertiary markets, which require less financial engineering to succeed.
Without question, the biggest mistake for investors to avoid is doing nothing at all. The real estate market continually offers opportunities to investors, and those who make sound decisions will consistently see returns, especially in the current state of the market.
We are confident that discount retail shopping centers will continue to be successful through a possible recession era, as tightened disposable personal income will migrate to these discount retailers vs. the high-end retailers. Our hands-on approach to turning around distressed assets, combined with deep bricks-and-mortar capability, have earned Feldman Equities a national reputation with investors for being ahead of the market and for producing overall returns averaging in excess of 20 percent.
In the current climate, such returns may not be as prevalent. Despite recessionary trends, sellers are not relaxing their demands significantly. Today’s investment market is similar to the period that we saw in the late 1980s, where there was also a big "bid-ask spread." That cycle ended with the Savings & Loan crisis and the gap closed to the downside. You won’t see a collapse in prices this time, because we don’t have the excessive building and we don’t have as much leverage as we had in the 80s. This time around, I think you will see the reverse; the bid-ask spreads will close to the upside.
Though it is not immune to the cycles of the economy, real estate is a sound, stable alternative to the Nasdaq and to Enron. As a result, there is strong renewed interest in this "old economy" business of real estate.
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