Top Cities: Hessam Nadji

CPE asked a number of investment sales brokerage executives about the cities they recommend that their clients consider. Excerpts of their responses appeared in the September 2013 Special Report. Following is the full response from Hessam Nadji, senior vice president & managing director for Marcus & Millichap Real Estate Investment Services. Be sure to read the full responses of the other executives, as well!

As the recession bottomed and the economic recovery began, investors targeted primary large metros such as Chicago, New York, Los Angeles, San Francisco, Washington D.C., Dallas and Houston. The more diverse economies of the major metros underpin strong performance of all commercial property sectors and created sustainable recoveries in vacancy and rents. New York, San Francisco and, to a lesser degree, Los Angeles are also viewed as having some level of constraint on adding new supply, which is a consistent attraction for investors. Miami and the metros in the northwest also fit the profile of supply-constrained markets. As the economy has gathered momentum, prices in primary metros have escalated, pushing investors to consider not only lower-quality properties but also a wider range of markets to support yield requirements.

Larger private investors, equity funds and several institutional-grade investors continue to rebalance portfolios. Many investors successfully repositioned into primary markets early in the recovery and reaped significant rewards. Gateway markets such as Los Angeles, New York City and Washington, D.C., performed well, as did energy markets such as Dallas and Houston. Tech markets Seattle, San Francisco and San Jose also attracted a lot of investment capital.

Although the large institutional transactions command headlines, most investment is done by local investors and is concentrated in price points from $1 million to $10 million. Virtually all metros, whether top performing or still struggling to gain traction after the recession, continue to see strong activity among local investors in this price segment. This is occurring because acquisition financing has generally improved for all property types, interest rates remain low, and the availability of many assets at prices less than replacement cost provide solid upside opportunities.

As investor activity in primary markets escalated over the last five years, yields tightened dramatically. This trend recently aligned with a lift in interest rates, compressing spreads and encouraging investors to consider a wider range of alternatives. Markets showing promising trends include many of the areas hurt worst by the housing crisis such as Phoenix, Las Vegas and several Florida metros. Salt Lake City and Denver, two markets with particularly strong employment trends this year, are also capturing a lot of attention. Several Midwest markets remain popular with investors that favor steady performance and higher yields, though upside appreciation opportunities tend not to be as strong in these areas.

In the first half of 2013, commercial real estate transactions in tertiary markets increased by an estimated 20 percent from the same time period in 2012. Secondary markets climbed approximately 15 percent, while transactions in primary markets increased by about 12 percent. These activity increases should be sustained through the remainder of the year as investment in all markets maintains momentum.

Large metros and gateway cities generally offer a greater array of demand drivers to sustain commercial property performance, as opposed to smaller metros that may be heavily dependent on a single industry or large employer. Many secondary metros also have diverse economies, but on a smaller scale.

Because development has been very slow to materialize in most secondary and tertiary markets, the supply/demand balance has been generally favorable for investors. Vacancies, particularly for apartments in many of these markets, have tightened dramatically, with metros such as Portland, Pittsburgh, Minneapolis and Milwaukee hovering near record low levels. Although the recovery in performance of retail and office properties has not been as robust, they are beginning to build momentum and are starting to attract greater interest from investors.

As the recession proved, there are always risks involved in any investment. Intense bidding for assets in major metros may push prices beyond operational values into the speculative range as demonstrated by the froth at the peak of the last real estate cycle. Prices can also inflate in secondary and tertiary metros, but the greatest risk in these areas may be a thinner pool of potential buyers, which may make dispositions challenging – particularly following a major market correction. Also, one-off deals outside of the major metros may provide investors with a geographically diverse portfolio, but does not offer a large enough concentration in any single area to gain market expertise and benefit from economies of scale.