A Tale of Two Investment Markets

The story has become all too familiar for the commercial real estate investment market: no debt capital to refinance maturing loans on properties that may have no equity left, disappearing tenants and brutal concessions packages. But a new story is emerging.

The story has become all too familiar for the commercial real estate investment market: no debt capital to refinance maturing loans on properties that may have no equity left, disappearing tenants and brutal concessions packages. But a new story is emerging with the following plotline:

Debt and equity capital for commercial real estate has loosened up in the last 60 to 90 days. Loan terms are becoming more generous, sometimes taking even the borrowers by surprise. Property sales volumes, though still low by historic standards, are up substantially from last year. Pricing seems to have stabilized and, for core assets, has begun to rise. Someone has fired the starting gun, and all those investors with cash on the sidelines are taking steps to deploy their capital.

To some extent, this is a tale of trophy assets in primary markets versus everything else. But capital is beginning to focus on somewhat riskier assets such as well-located Class B properties that can be turned into Class A- properties with some investment, or Class A- properties that have location issues. Class B and C properties in secondary and tertiary markets continue to struggle, however.

The Federal Reserve’s strategy encouraging banks to work with borrowers to forestall an ill-timed wave of distressed REO assets seems to have halted the downward pricing spiral. The Moody’s/REAL commercial property price index increased for three consecutive months prior to a slight decline in February, and the National Council of Real Estate Investment Fiduciaries’ database shows a return of 0.76 percent in the first quarter – anemic, but the first positive return in the last seven quarters.

Tenants are back, and more of them are seeking long-term leases. They continue to extract hefty concessions from landlords. Multi-market tenants who have some control over the sequencing of their leases are asking how long they have before the generous concessions begin to disappear. The answer is that, in a few markets, landlords have become bolder already.

Landlords and their agents charged with filling half-empty buildings in a sea of half-empty buildings may not even be aware that a new story is emerging in the industry. Make no mistake – distress continues to mount, and many more losses will have to be taken by owners and lenders. But liquidity has returned to a portion of the industry. It seems like the investment market will be defined by two stories for the foreseeable future.