Caution Can Bring Stability and Discipline to a Worried Market

By Marcelo Bermúdez, President, Figueroa Capital Group, a subsidiary of Charles Dunn Co.: Elections are bad for commercial real estate. Too much uncertainty opens the door for delays. But caution has its advantages, creating a disciplined, forward-thinking market.

Six months ago, I wrote an article titled “Looking for the Right Economic Indicators: Is It Time to Bunt or Steal?” and touched on several items that would affect how the commercial real estate market would fare for the rest of 2012. The same five topics I covered then remain very much in the headline forefront today with mostly positive changes even though the market has cooled in some areas throughout the United States and globally.

Similar to the general market, Figueroa Capital Group had some major ramping up of new business that has been off the charts in terms of deal size and volume, but not without its challenges. Transactions have been taking twice, if not, three times as long to close because of lender, borrower, or investor wariness. Even though all of the required approvals are in hand and everyone seems to be giving the green light to wrap it up, the ‘once-burned, twice shy’ spirit of reluctance appears and more delays become inevitable.

With 36 days until the presidential election, there is hope that one more unpredictable item can be removed from the list to consider when buying or selling a property. Elections are bad for commercial real estate. Too much uncertainty opens the door for delays. The rhetoric about the GDP deficit, the fiscal cliff, and the IMF or CBO reports goes on steroids. Everybody becomes an expert about why the sky is falling and why their candidate is better for the economy. Meanwhile, activity slows. Tenants refuse to commit to longer-term leases using the election as an excuse, banks and even buyers worry about their term coverage against the lease, and owners are stuck having to make concessions or stay with an older debt product that doesn’t let them take advantage of the incredibly low rates available in the market.

Let’s remember the good that is going on in this current time of year.

  • Most investors do not have the discretionary depth of an Oaktree Capital or other mega fund to snap up larger core assets at compressed cap rates. Secondary markets are feeling the love and banks are comfortable doing deals with stories. Bridge dollars continue to play a critical role in making deals happen, especially if the investor’s balance sheet and experienced team can justify interest-only lending products. Proformas are showing up, but there’s a lot more due diligence occurring instead of the ‘trust me’ underwriting that occurred a few years ago. This is a good sign. Hopefully, it means that everyone has not forgotten their lesson.
  • China’s global growth continues to cool and GDP numbers are expected later this month. The Eurozone meltdown resolved itself into the European Stability Mechanism instead of a full- blown crisis that would have made all the Mayan calendar hacks jump for joy. While Europe has some amazing unemployment issues to deal with, this reinforces that the United States remains the place to be in terms of quality and return of capital. If you know how to play the SWAP game as a hedge in your portfolio, you can actually be “in the money” if rates rise.
  • If you read in-depth on the 2013 Healthcare Funding Tax, you will see it doesn’t apply to all real estate transactions and it even differentiates business income from investment income, resulting in no change in tax burden for some.
  • QE3 is open-ended until “improvement is achieved in a context of price stability” (as the government puts it). We saw a major bounce back in prices with QE1 and smaller but respectable returns with QE2. QE3 will help rates stay low. We just need to make sure there is advocacy for restructuring to create the necessary job growth to get out of this mess.
  • With the minimal returns you can get with Treasuries, the ability to acquire assets below replacement cost continues while risk adjusted returns (the spread to cap rates over the 10-year Treasury) are trending higher.

All of this caution could lend itself to creating a stable and disciplined forward-thinking market. The result would be increased property investments and business owners investing in people.