Rising CRE Prices May Not Indicate a Bubble

At NBI Properties in Fort Walton Beach, September was the busiest month for closings and listing activity was brisk. Craig Barrett, co-founder and broker, said booming business has more people asking if commercial real estate properties are overvalued and priced too high.

“As prices have continued to surge, some investors are worried that valuations may be overheating,” said Barrett. “Some think the market is reaching bubble levels as a combination of high demand, low interest rates and loosening loan underwriting standards have caused a record spike in prices paid per square foot for commercial properties.”

Although many investors and analysts agree the surging demand for commercial property should be closely scrutinized for signs of overheating, several market indicators appear to justify the uptick in prices. So while peaking prices are a concern, analysts are saying it is premature to characterize the recent valuation increases as a ‘bubble’ that will inevitably lead to a market correction.

“The price increases we’ve seen over the past 12 months appear to be the result of a long period of low interest rates in a low-yield environment,” Barrett said. “We are still seeing a wide pricing gap for taking risk that did not exist in 2006 and 2007 when vacant buildings could fetch premium pricing. Using the term ‘bubble’ to describe current pricing gives the wrong impression that the market is not stable and is ready to burst.”

Showing a measure of caution following recent stock market volatility and swings in August and into September, property investors appear to be taking a pause to assess conditions, with previously acquisition-minded investors now saying, “Not so fast.” Price appreciation has also slowed, both from earlier this year and compared with the early to mid-recovery period from 2010 to 2013.

“Investors and our clients prefer to buy closer to the bottom, although now it seems we’re closer to the top,” Barrett said. “However, market fundamentals are strong and I believe we have some time left due to continued economic growth.”

Medical Office Buildings Attract Investors

Investors are flocking to medical buildings now that the Affordable Care Act (ACA) has added more than 16 million new patients to the health care system. Implemented by the Obama administration, the new rules and millions of additional patients have persuaded many doctors to look for larger practices, which are now moving into more off-campus properties. The demand for larger buildings coupled with millions of Baby Boomers expected to reach retirement age over the next 10 years is resulting in consistent demand for single- and multi-tenant medical office buildings (MOBs) located close to residential neighborhoods and retail areas.

“We’ve been listing more and more medical and professional buildings,” said Craig Barrett, co-founder of NBI Properties in Fort Walton Beach. “So many healthcare procedures are done in outpatient facilities now that there is a demand for more medical office buildings.”

More demand has led to more development. Some experts estimate that construction completions this year will hit 8.8 million sq. ft., significantly higher than the 7.1 million sq. ft. tallied in 2014. The vacancy rate in the MOB sector is currently at 9.7 percent, representing a drop of 20 basis points over the past 12 months.

“Health care systems hope to gain more market share by providing facilities that can be placed near suburban areas,” Barrett said. “These large systems are picking up former individual practice doctors who now find it more profitable to join large groups. This has really pushed up the demand for more medical properties.”

The influx of larger tenants has also boosted property values. Hospital groups have better credit rating, generating strong investor interest. Brand new facilities with leases that extend 10 years or longer in strong urban locations are trading at cap rates in the low-6-percent range, with top tier assets stretching into the 5-percent range. Overall, strong demand and sales activity has pushed up prices to historic highs, reaching an average of roughly $300 per sq. ft. nationally.

Best Opportunities for New CRE Investors

If you’ve had some success with residential real estate investing and have flirted with the idea of investing in commercial properties, now is the time to consider moving up to the major leagues. While residential real estate can be a very rewarding, profitable business, serious investors know the big money is made on the commercial side. While some investors are hesitant to make the transition from residential to commercial because they for it will be too complicated or risky, others have found the rewards too attractive to pass up. Craig Barrett, co-founder of NBI Properties in Fort Walton Beach, says one of the easiest ways to get started in commercial real estate is to invest in apartment complexes.

“Investing in commercial apartments can be a good move if you already have experience with residential properties,” noted Barrett. “You’ll be moving up from dealing with a few tenants to multiple tenants. However, residential is a lot more hands-on than commercial and this is one of the things investors say they don’t miss at all. Most non-residential commercial properties don’t have tenants calling with air conditioning or plumbing problems all the time.”

Those interested in making the switch should know that buildings with four units and less are considered a residential investment by the banking community. Banks require investors to personally guarantee any loans taken out. Five units or more is considered a commercial investment. Loans for these properties are almost always non recourse, meaning they are only secured by the property and personal credit and other assets are not at risk.

Newcomers to commercial investing should consider networking events. Commercial real estate investors benefit by staying in contact with a network of professionals and benefit from getting a stream of referrals and leads. Often the best deals are done without the commercial property ever being listed. These are called “pocket listings”. An experienced realtor is aware these properties are for sale, but they aren’t listed in the MLS. Often this is because the seller doesn’t want a stream of potential but not serious investors constantly touring the operating business. The savvy realtor only brings around the most serious buyers and the property is usually listed at a discount to interest qualified buyers.

In addition to starting commercial real estate investing with apartments, research other positive cash flow properties such as self-storage, mobile home parks, assisted living facilities, and offices parks.

“We encourage our clients to look for investments that appeal to a wide cross section of renters,” added Barrett. “For instance, there can be more profit in specialty use properties such as restaurants, especially in our area. However, there are lots of opportunities available and we are willing to work with investors on what appeals to their interests.”

Crowdfunding Offers Options for Small Investors

While investing in real estate was typically associated with high net worth individuals, it is now considered as a smart investment choice for those in the mid-income range.  Thanks to the power of modern technology, real estate investment companies are now pooling resources from small investors to raise capital for new projects. As a result, more people can now invest in the real estate market and enjoy consistent yields on their investments without incurring a significant amount of risk in the process. The trend known as “crowdfunding” is attracting more people than ever to investing in commercial real estate.

“It’s refreshing that our clients are not all mega millionaires these days,” said Craig Barrett, co-founder of NBI Properties in Fort Walton Beach. “It’s interesting now to see people of all different ages and incomes asking about their options and excited about being first-time investors.”

Real estate equity crowdfunding was legalized under the Jumpstart Our Business Startups (JOBS) Act of 2012. Under the new law, accredited investors (those with a net worth of $1 million or an annual income of at least $200,000) were allowed direct access to the real estate market through crowdfunding and peer-to-peer lending. While lower income groups still don’t have direct access to this opportunity, several firms have started to use online crowdfunding platforms such as The Carlton Group, Prodigy Network, Realty Network, Fundrise and iFunding to raise seed money for a multitude of projects.

“The advantage is that small investors can now get into the real estate market and can choose which projects they are interested in investing in,” said Barrett. “We have worked with a lot of clients who have seen high returns on their investments in as little as one year. With equity crowdfunding, they no longer have to wait and save for years in order to enter the real estate market.”

Possible drawbacks to crowdfunding are that investors typically incur the same amount of risk as developers and there is a lack of liquidity since investors do not have easy selling access to secondary markets.

Smaller CRE Investments Booming With More Lending Options

Small property investment deals are often overlooked over large, trophy property sales that come with hefty price tags. But sales activity for real estate priced below $5 million is proving to be just as hot as it is for those larger assets and the Emerald Coast is a prime example of offering a multitude of these opportunities for investors.

“September has been our busiest month so far for closings on properties valued at $5 million and under,” said Craig Barrett, co-founder of NBI Properties in Fort Walton Beach. “Interest in commercial real estate here is stronger than ever and we’re at the forefront of this amazing growth.”

Nationwide, the total number of real estate transactions across the spectrum is at an all-time high. “Total commercial real estate sales in the U.S. spanned 37,598 individual transactions totaling some $210.3 billion during the first half of the year. Deals priced below $5 million accounted for 21.7 percent of that dollar volume at $45.7 billion, and 82 percent of total sales with 30,831 properties changing hands.

“Overall, there is more demand for investment properties under the $5 million price range, and about 95 percent of that is coming from private capital,” said Barrett. “Smaller value deals are not attractive for most most REITs and institutional investors and tend to be dominated by local and regional buyers such as high-net-worth individuals, family trusts, LLCs and business owners.”

Demand for smaller real estate assets has been on the rise in the past few years as investors preferred alternative investments that generated decent yields. Real estate is also attracting more new capital from high-net worth individuals, as well as owner-occupiers of space looking to buy properties to support their business operations. Sales transactions for properties priced under $5 million hit a record high of $100 million in 2014, and sales for the first half of 2015 are tracking just slightly behind that pace at $45.7 billion, according to industry experts.

A key factor driving sales activity in the sub-$5 million sector is that banks are finally lending again, and a lot of the small deals are bought by people who use leverage.

“We’ve noticed that small and medium bank and even credit unions are lending more now,” said Barrett. “This source of capital was non-existent in 2009, so investors have many options now.”

Public REITs Benefit from Property Management Services

According to a newly released report by CBRE, public REITs can achieve cost savings by outsourcing property-level services. Based on an internal study regarding third-party property management for public REITs, the goal was to discover how expanding external property management services can benefit REITs. The study involved a review of CBRE’s relevant company financial data, internal tools, software, management manuals and online systems used to run properties. As a result of the study, CBRE now believes internal property management for REITS needs a re-examination, according to Drew Genova, CBRE’s executive managing director, based in Washington, D.C.

“It is as much about a study of our property management services and benefits as it is about asking public REITs to consider their property management options, internal or external, on the merits of what is most accretive to their overall strategy,” said Genova. “The message is about providing best in class property management services with a key focus on delivering property level savings, increasing asset value and delivering a great experience for the tenants. The goal is to improve occupancy levels and maintain above market average tenant retention rates.”

Craig Barrett, co-founder of NBI Properties in Fort Walton Beach, said his firm manages the fastest-growing property management service on the Emerald Coast and is responsible for more than 1,000 properties. He said that recommending external property management for REITs would significantly add to NBI’s growing list of properties.

Six of the report’s most important points include:

The public REIT sector is rapidly evolving. It recently crossed the $1 trillion threshold in total capitalization. There are many new REITs in registration under the Jobs Act, and public REITs had record industry index investment returns in 2014. Collectively, these events have raised the profile of a once niche sector—yet public REITs still remain committed to doing things “the way they have been done forever,” including property management to be managed internally.

REITs can save money by outsourcing property management services. In fact, a REIT with less than 10 million sq. ft. in a given market can realize significant efficiencies with professional, third-party, property management.

Smaller REITs actually lose efficiency—and therefore margin—due to excess capacity at some level, or inability to spread costs across enough sq. ft.

REITs with externally managed assets have more flexibility to move capital between property types and locations.

The scale of a large, specialized management company makes it possible to spread costs for training and development for a fraction of what similar functions would cost a REIT.

External property-level IT deployment allows a REIT to focus on its investment and portfolio management business, while the external manager maintains the latest in property management technology and software.

Source: CBRE

Emerald Coast Summer Retail Sales Remain Strong

Retail sales enjoyed solid gains in July as consumers began spending more on new vehicles and dining out. According to a report from the Commerce Department, retail sales rose .06% in July after a disappointing .03% decline in June. On the Emerald Coast, NBI Properties co-founder Craig Barrett said area retailers from Fort Walton Beach to Destin have been pleased with summer sales.

“There’s no doubt that consumer confidence is up, and we always see it during the summer months when locals and tourists give our many shopping areas a boost,” Barrett said.

The uptick matches economists’ forecast of a 0.6% rise in retail sales, according to a survey by FactSet, and surpasses a 0.5% forecast by economists surveyed by Reuters. Other experts noted the retail report “was solid rather than spectacular,” but upward revisions to sales in May and June showed that real consumption growth started the third quarter on a stronger footing previously believed.

Gains reported in July included automobile sales, which rose 1.4%. Home and furniture store sales increased 0.8%, while sales at building supply and gardening retailers such as Lowes and Home Depot rose 0.7%. Restaurants were also popular with consumers with a .07% increase over June. Barrett said the demand for restaurants on the Emerald Coast remains strong and he is working with several investors on new projects.

“We can’t seem to build them fast enough here,” he said. “There has been a lot of interest in restaurants throughout the area and particularly on the waterfront in Fort Walton Beach.”

Investors Explore REC Funds

“RECFunds,” or also commonly called real estate based equity crowdfunding, is rapidly growing in popularity among investors as an alternative. The benefits of RECFunds are obvious, and include access to multiple types of projects, smaller barriers to investment, and portfolio diversification. However, while RECFunds can be a good bet for investors, (especially those who might be unable to obtain financing using traditional methods) it doesn’t come completely risk-free. One of the biggest concerns is that such projects might not be underwritten properly, according to Craig Barrett, co-founder of NBI Properties.

“Many of the of current RECfund portals review and offer projects from across the nation,” he said. “But while the underwriting teams usually have experience in vetting projects, it isn’t possible for these portals to know, or have time to examine all of the critical factors that go into evaluating a potential RECfund project.”

Barrett added that the main problem with RECFunds is the profitability of such projects is highly susceptible to numerous potentially unknown factors, including school district boundaries, spiraling project costs, and unemployment rates. These factors apply to all kinds of investments, but the problem with crowdfunding investment projects is investors often don’t have the time, patience or experience to properly research and evaluate these risks.

“We tell investors that it’s really important to rely on local expertise,” noted Barrett.
“National services, don’t have the necessary local expertise to examine every possible factor that could have an impact on a project’s profitability. Local real estate brokers will know more about school districts, zoning laws, crime rates and other factors that could increase or undermine property values.”

Another way to mitigate risk is to use a more locally-orientated crowdfunding portal. Often run by experienced, local realtors, these sites tend to have more accuracy with important variables such as vacancy rates, demographics, and comparable pricing.

Rent-to-Own Options Attract Investors

Investors are warming up to rent-to-own programs once again as consumers with less-than-stellar credit attempt to qualify for mortgages and get on the path to homeownership. Wall Street firms are offering the option to more consumers, allowing them to rent a home with the option of buying it later.

Popular during the 1990s, rent-to-own programs faded when lenders eventually loosened underwriting standards and allowed more borrowers to qualify for mortgages. With credit tightening in recent years, rent-to-own programs are making a comeback.

“Investors are always investigating trends and looking for opportunities,” said Craig Barrett, co-founder of NBI Properties in Fort Walton Beach, Florida. “Rent-to-own options are attractive to some investors because it offers another way to diversify portfolios.”

Barrett adds that most investors find rent-to-own a win-win. They can get consumers to pay a higher rent in the beginning and usually demand a higher purchase price the longer a tenant waits to move from renting to owning. He said that consumers who would otherwise be shut out of the housing market can ultimately benefit from renting to own.

Typically most programs involve a mortgage brokerage purchasing a home and leasing it to a consumer, usually giving him or her the right to purchase the home within five years. During the rental phase, consumers have the opportunity to work on repairing their credit and saving for a downpayment.

Barrett added that the longer a resident rents, the more they can expect to pay in the end to purchase the home. However, he said consumers can also choose to opt out of purchasing the home if it becomes too expensive for them.

New Loan Disclosure Rules Create Confusion

Recently added consumer disclosure rules are creating confusion, and at least one primary lender is refusing to deal with some loan products. Created by the Consumer Financial Protection Bureau, the rules have not yet gone into effect. However, Wells Fargo, one of the biggest mortgage lenders in the country, has already advised correspondent lenders that based on the proposed changes, after August 1 it will not purchase single-close construction loans used for homebuilding. Craig Barrett, co-founder of NBI Properties in Fort Walton Beach, said he’s keeping an eye on the situation just in case other banks decide to follow Wells Fargo’s lead.

“Since Wells Fargo is one of the biggest investors in single-close construction loans, their decision could significantly impact and reduce the availability of these loans,” Barrett said. “We’re keeping a watchful eye on what develops so we can advise our investors about the best course of action.”

A single-close construction loan allows borrowers to close on short-term construction loans used to cover expenses during the building phase, coupled with a longer term and permanent financing as one transaction. This “all in one” option is not only less expensive, but more convenient than requiring two closings.

Barrett added that it is too early to tell how lenders will handle the loan disclosure under the new regulations along with stand-alone construction loans. He said that typically when new and unproven regulations are introduced, lenders tend to stay away from the margins to ensure no compliance violations occur.

“New disclosures make many lenders skittish,” he said. “Until they have time to adjust to the new regulations and get more comfortable with them, there won’t be nearly as much loan activity.”

On the bright side, Barrett predicted the situation might ease up within the next several months. He said that usually construction loans and other short-term financing is 12 months or less. The issue is that while these loans are not part of the current disclosure requirements, they would definitely fall under the new rules.

“I believe we’ll see some pressure from industry leaders and also from lenders,” he said. “Some lenders have said they have not been given enough time to adapt to the changes, so the consensus seems to be that they will be given a grace period to get used to the new rules.”