The Bay Area Real Estate Journal
Colliers: 2010 A Better Year, but Not Great
Submitted February 11, 2010, 7:14 PM
Investors seeking steep discounts from banks on distressed commercial real estate and broken loans will have to lower their expectations if they really want to get deals done, a banking expert told a Silicon Valley audience Feb. 10.
David Sandler, a San Francisco principal with investment banker Sandler O’Neill & Partners, said that for starters, banks are simply too unhealthy to sell at the bottom-bumping prices that many investors seek. There also is too much buyer competition for such discounts to hold. Beyond that, banking regulators are exercising tight control over asset sales.
Citing recent regulatory guidance to banks on how to handle questionable commercial real estate loans, Sandler said regulators are engaged in what might be called willful self-deception: “I think what we are doing with all of this is suggesting to banks and the market in general that we don’t want price discovery because it becomes a daisy chain in the market that would drive more banks out of business,” Sandler said. “It really is that bad out there.”
Consequently, commercial property investors intent on returns of 20 percent or more should revisit their thinking, he added.
Sandler was one of four experts who shared market insight and knowledge with more than 500 landlords, brokers and others at the 11th annual Colliers International commercial real estate trends forecast. A two-hour forum held in downtown San Jose’s restored Fox California Theatre, the forecast also featured Gregory Valliere, chief policy strategist for the Potomac Research Group, an independent Washington, D.C., firm that advises institutional investors on market conditions and government policy; Jeff Fredericks, senior managing partner at Colliers International in San Jose; and Andy Zighelboim, a senior vice president in Colliers Investment Services.
Silicon Valley commercial real estate fundamentals in 2009 were sobering, Fredericks said. At year end, including all sectors of the commercial real estate market—office, industrial, warehouse and research and development buildings—total availability measured 55.3 million square feet, up from 46.5 million square feet at 2008’s end.
Gross absorption, the total square footage sold or leased, fell to 16.1 million square feet, its lowest level since Colliers began tracking absorption in 1988. Worst hit were offices, where availability peaked at more than 25 percent in the third quarter. The brokerage predicts another tough year for offices with another million square feet of negative net absorption.
Still, the second half of 2009 was noticeably stronger than the first, Fredericks said. There was 48 percent more gross absorption in the last six months of 2009 compared to the first six months. “Our brokers feel improvement in the air,” he said.
The sobering conditions did inject some clear-eyed thinking into the investment sales market, Zighelboim said. While the pace of Silicon Valley investment sales fell 92 percent from its 2007 peak of nearly $7 billion to $500 million, investors are turning their attention back to fundamentals.
“Real estate in Palo Alto and Milpitas traded at par during the boom,” Zighelboim said. No more. “Risk is being appropriately priced.” Property in strong infill markets is trading at a 15 percent to 20 percent premium. Aided by the ubiquity of information technology from email to Twitter, sales prices and other data points connected to value are immediately acted upon.
“Out” are such boom-era practices as “pro forma” financial analysis and “high-octane leverage,” he said. “In” are more conservative and traditional measures of real estate value such as current yield, property basis and absolute profit.
That said, Zigehlboim predicted a steady but measured flow of distressed commercial properties will come to market in Silicon Valley in the year ahead as the pace of loan defaults and foreclosures rises. But, by and large, the assets will not be institutional quality, but small and in lesser locations.
For those who missed it, the price bottom has passed, he said, but debt issues will shadow the market until 2018, with estimated commercial real estate mortgage maturities peaking in 2012 at nearly $350 billion.
Meanwhile, Valliere said, despite longer-term worries about federal debt and continuing, huge deficits of as much as $1 trillion a year for at least the next two or three years, U.S. economic conditions should be benign for the next year or so. “There should be low inflation, low interest rates and modest economic growth, which is not a bad scenario,” he said.
In addition, the business sector, with perhaps banks excluded, is breathing a bit easier because President Obama’s “exceptionally activist agenda” has by all appearances been set aside. The Democrats had “scared people with the breadth of what they were trying to do with the expansion of government and increases in taxes,” he said. “That threat has left the market.”
Cap-and-trade is dead, though a new law regulating financial services will happen, but not for some time. When it does, it will not be “onerous,” he said. He also predicted no new taxes for individuals earning less than $200,000 a year and a possible extension of the Bush tax cuts beyond their current expiration at the end of the year.
“I see the Obama agenda as being irrelevant,” he said, and the rising possibility that Obama may be a one-term president.
For all that, the Republicans won’t be the automatic winners, he said. The economy may recover enough before November elections that it will no longer be an issue for the Democrats, and the field of potential Republican presidential candidates at present is fairly empty and unpromising.
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