Interesting Times

By FTI Schonbraun McCann Group, Insurance News West, 1-31-2011

While the commercial real estate market is not yet seeing the velocity of transactions it did a few years ago, buyers and sellers are starting to find a happy medium, according to valuation experts at FTI Schonbraun McCann Group (SMG), the real estate advisory practice of FTI Consulting, Inc.

“As the market begins to reset, particularly in gateway cities like New York, Washington, D.C. and San Francisco, for example, we are seeing some closure of the bid/ask spread. This is allowing transactions to occur, and the stalemate of recent years is beginning to loosen,” said Michael P. Hedden, a managing director in the SMG real estate valuation services practice.

“But because there is no large sample of sales to look at for indication of a fair price, the selling process has become more inquisitive and each sale has become sort of a case study of itself,” he explained. “Both parties to a commercial real estate deal are now taking more time to thoroughly understand the transaction and are taking into consideration such factors as their risk tolerance, tenant retention, existing contract income and the prospects for slow income growth. Gone are the days of rapid appreciation and optimistic assumptions.”

In fact, according to a survey conducted in December 2010 by SMG among 170 commercial real estate professionals, when asked which risk factors present the greatest risk to future real estate values, 47% said market condition changes affecting NOI. Another 39% said capital market changes affecting refinancing present the greatest risk to future real estate values.

Marc R. Shapiro, a managing director and head of real estate valuation services at SMG said, “We are also seeing a renewed commitment to the ‘Golden Rule’ -- where he who has the gold, rules. Today cash investments are required and investors are keeping skin in the game, indicative of a return to the fundamentals and a more disciplined approach to real estate investing. As a result, buyers are adopting a longer term view.”

Another trend that SMG’s valuation experts have identified for 2011 is the trifurcation of the commercial real estate market, which includes a growing demand for the top level core assets such as office buildings in global cities; weak but growing demand for second tier assets in secondary markets, and little-to-no demand for tertiary assets in weak markets such as the desert Southwest and Florida.

“But,” Shapiro noted, “discipline might be pushed to the upper limits of reason in the top tier of the market if an investor wants to get into the best properties. As a result, while property values will in general continue to reset to levels below the 2007 peaks, some investors will overpay for premier assets because of increased competition, and we might see a mini asset valuation bubble in some markets that become overheated in 2011.”