Commercial Real Estate – The Three Qs
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Deloitte deems there are five factors impacting commercial real estate in 2011.
- Increasing sales (a good sign)
- Market still has no horizon
- Some banks may never recover declines in property values before the loan comes due
- There remains a mass of loans coming due
- The Economy is recovering tepidly
see Top 5 Issues Affecting Commercial Recovery- Realtor.org
Of the $3.5 trillion of total commercial loans outstanding, approximately $400 billion is due every 12 months in coming years, but there is likely just $100 to 150 billion available to refinance that in the coming 12 months—hence the need to extend loans and pretend that the lender has no loss— i.e. “A rolling loan gathers no loss.”
While this market remains stressed to say the least, it also provides the best opportunity to buy commercial real estate since the late 1980s. Terms for borrowing today, however, are different. Unlike the typical 30 percent down seen in the past decade, buyers now need to think 40 or 50 percent down (since lenders are uncertain if values are at a bottom yet.
I believe, however, that rising energy costs (and I have forecast that oil will be $120 to $140 per barrel by 2013 if not sooner), and a corresponding $5 per gallon for gasoline within 36 to 48 months, will make property location an even more important factor.
Buyers today need to focus on the three Qs:
- Quality Location. And in this includes the location premium that will expand that well located properties will posses as energy costs explode. Both housing and commercial real estate that require a commute will not have the rental nor appreciation rates that readily-accessible properties will have. In the boom, we unfortunately leveled the economic landscape to all properties (think 2007), but in the coming years of high energy costs, property location where critical mass is present will perform even better and outlying properties less so.
- Quality of the Property. While recent cheaper energy prices have diminished the impact of energy costs and hence the benefits of LEED® certification, imminent skyrocketing energy costs will leverage the values of energy efficient properties. The past five years have seen a relatively static demand for oil at 85 million barrels per day global. Oil output can rise in any 12 months by only 1.5 million barrels. Yet when the global economic recovery takes place in the next two to three years, demand for oil will escalate four or five million barrels per day—forcing not a linear increase in oil but an exponential jump.
- Quality of the Tenants. Just like diamonds of an equal weight are not all equal in value (think cut-color-clarity-carats) not all tenants are of equal value. A high-quality tenant of a firm with an outstanding balance sheet, credit rating and management integrity is always more valuable than a company with lesser attributes—even at the same rent rate. I believe that some buyers and owners have systematically undervalued the benefits of top-line property management that did not just obtain good rents and low vacancy rates, but also did so with intrinsically more valuable high-quality tenants.
Think the three Qs as keys that will be even more important in coming years when buying and managing commercial real estate.