Comments on: Weekend Edition: June 23-24, 2007 http://www.boom2bust.com/2007/06/23/weekend-edition-june-23-24-2007/ "The Most Hated Blog On Wall Street" Fri, 05 Dec 2008 09:42:20 +0000 http://wordpress.org/?v=2.6.2 By: Anonymous http://www.boom2bust.com/2007/06/23/weekend-edition-june-23-24-2007/#comment-5 Anonymous Sun, 24 Jun 2007 06:05:57 +0000 http://boom2bust.com/?p=44#comment-5 Thanks for the information. I am in the money management business specializing in commercial real estate and am based in the San Francisco Bay Area (20 years in the business). I started reading and following this drama unfold about 5 or 6 years ago when it became clear that cap rates on apartment properties were getting ridiculously low, margins squeezed, and the "winning" proformas based on the assumption that the mania would continue forever. (Oh well, it's other people's money.) It went on much longer than I ever expected with the apartment flipper turning into the condo converter and with low cap rates starting in major metropolitan areas and then moving to every corner of the U.S. I have seen what has happened first hand (twice! -- also in 1991 in SFR) and the bubble is not just in the residential real estate market. Cap rates on commercial properties are still at historic lows and they are very much tied to the fall in the interest rates that has occurred (and that has now reversed). Cap rates have not yet adjusted back to their historical norms, but they are starting to, though they may take some time to get there as prices tend to be sticky and everyone keeps up the wishful thinking. The market is correcting right now. Small commercial investors and owner-users that rely on financing have and are leaving the market as the higher interest rates are making the purchase prices unworkable. At last year's prices, those buildings were negative cash flow right out of the box at fully indexed rates, but with an inverted yield curve, the buyer hasn't been able to compensate with short-term teaser rates and the illusion that he/she will be out of the property with a nice bit of appreciation before the rate fully adjusts. And heretofore, the pricing was so aggressive that the buyer has been purchasing property "fully priced". This means the pricing presumes any value-added work is already done. The spread for a buyer's effort and risk in executing a value-added investment are barely compensated for when compared to a NNN investment. Drives a rational person crazy but there is money to be made by understanding the behaviorial trends as well. Thanks for the information. I am in the money management business specializing in commercial real estate and am based in the San Francisco Bay Area (20 years in the business). I started reading and following this drama unfold about 5 or 6 years ago when it became clear that cap rates on apartment properties were getting ridiculously low, margins squeezed, and the “winning” proformas based on the assumption that the mania would continue forever. (Oh well, it’s other people’s money.) It went on much longer than I ever expected with the apartment flipper turning into the condo converter and with low cap rates starting in major metropolitan areas and then moving to every corner of the U.S. I have seen what has happened first hand (twice! — also in 1991 in SFR) and the bubble is not just in the residential real estate market. Cap rates on commercial properties are still at historic lows and they are very much tied to the fall in the interest rates that has occurred (and that has now reversed). Cap rates have not yet adjusted back to their historical norms, but they are starting to, though they may take some time to get there as prices tend to be sticky and everyone keeps up the wishful thinking.

The market is correcting right now. Small commercial investors and owner-users that rely on financing have and are leaving the market as the higher interest rates are making the purchase prices unworkable. At last year’s prices, those buildings were negative cash flow right out of the box at fully indexed rates, but with an inverted yield curve, the buyer hasn’t been able to compensate with short-term teaser rates and the illusion that he/she will be out of the property with a nice bit of appreciation before the rate fully adjusts. And heretofore, the pricing was so aggressive that the buyer has been purchasing property “fully priced”. This means the pricing presumes any value-added work is already done. The spread for a buyer’s effort and risk in executing a value-added investment are barely compensated for when compared to a NNN investment.

Drives a rational person crazy but there is money to be made by understanding the behaviorial trends as well.

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