Non-Prime Markets Look Good for Investors

By Michael Ryan, Director, Faris Lee Capital

With prime commercial real estate under intense competition, looking outside the major markets could prove profitable for investors who are trying to minimize cap rates.

By Michael Ryan,
Director, Faris Lee Capital

The United States economy continues to slowly chug along. The latest data shows GDP increasing just 1.8 percent in the third quarter of 2011. For this reason, commercial real estate investors have maintained a preference for prime markets such as New York, Washington, Boston, Miami, Chicago, Los Angeles and San Francisco.  The lower risk profile of these core markets, especially for highly sought after stabilized food-and-drug anchored shopping centers, has created intense competition. This, along with record low interest rates, has caused cap rates to compress.  For investors who lack an aggressive appetite to pay up for cap rates, the solution to the competition may be to look outside of the major markets to find attractive value plays.

Secondary and tertiary markets should begin to present greater opportunities for attractive values in 2012, especially for deals under $20 million. This is because they don’t attract as much attention from the major players in the real estate market. On the heels of a record year in lending for life insurance companies, coupled with the increasing volume in CMBS markets in 2011, the industry expects 2012 lending origination levels to meet or exceed 2011 levels.  Life insurance companies and conduit lenders are beginning to expand their lending parameters to include softer debt-service coverage ratios, high loan-to values, and entry into some non-core markets.   This means more financing options will likely be available for product in secondary and tertiary markets that may not have been available the last few years.

More compelling cap rates in smaller markets and accessible financing will encourage investors with a greater risk appetite to be more active in these markets due to the relative attractiveness of available deals.  Underperforming properties that may need some rehabilitation work or a fresh re-tenanting strategy with strong upside may also offer favorable opportunities.

The dark cloud in the room of course is the uncertain direction of the economy. The ever present risks of another economic slowdown, and the seemingly never ending overhang from the European sovereign debt crisis can potentially curtail the amount of financing available — as seen in the summer of 2011. This would likely affect secondary/tertiary markets first and foremost.  These negatives aside, if the economy continues to hang on, scouring the non-prime markets will likely serve up the best deals in 2012.

Michael Ryan is director in the New York, New York  office of Faris Lee Capital, a division of Faris Lee Investments, the nation’s largest retail-specialized investment advisory firm.