Equity Mortgage

By: Randyl Drummer / CoStar Group
June 1, 2011

With the U.S. hotel sector firmly in recovery mode, the number of large hotel investment sales has continued to rise in the second quarter. More properties are coming onto the market in response to a growing amount of capital seeking hotel investment, with private-equity funds, institutional buyers and other types of buyers joining REITs in the competition for high quality lodging assets.

The already-hot pace of deals seems to have accelerated in recent weeks. According to preliminary CoStar data, approximately $4.21 billion in hospitality properties have sold or gone under contract in 132 sales since April 1 of this year. Nearly a dozen of those deals involve hotel portfolios or high-end properties that have closed at a price of $100 million or more.

“The transaction environment remains extremely competitive,” said Douglas Kessler, president of Ashford Hospitality Trust Inc., which along with joint venture partner Prudential Real Estate Investors took ownership of the 28-hotel Highland Hospitality portfolio earlier this year through a consensual foreclosure for $1.277 billion.

“The depth of the buyer market is increasing and includes REITs, investment funds, insurance companies, pension plans, private equity and offshore buyers,” Kessler said during the Ashford’s recent earnings conference call.

A new survey of hotel investors and lenders also reflects bullishness and optimism in the marketplace. According to the recent Hotel Investors’ Gauge by STR (Smith Travel Research) Analytics and HotelNewsNow.com, 81% of investors surveyed are actively pursuing acquisitions — even though 28% currently hold delinquent assets. More than half of respondant believes that occupancy will return to prior peak levels by 2012, with ADR recovering by 2013.

The results indicate that most investors are predicting a quick recovery for the industry, which is one of the factors driving the increased transaction activity in recent months,

“Moreover, despite the reported dearth of available debt for commercial real estate, roughly two-thirds of the lenders surveyed are willing to finance lodging acquisitions, albeit at more stringent terms than what was offered just a few years ago,” said Stephen Hennis, director of STR Analytics.

The survey found 62% of lenders who responded are willing to fund new acquisitions, despite the fact that 62% have worked out delinquent loans, 38% have foreclosed upon properties, and 60% now control assets that have been foreclosed upon.

As hot as the office investment sales market has been of late, hospitality investment is even hotter, noted CoStar Senior Real Estate Strategist Chris Macke.

“First-quarter 2011 hospitality sales volume was 109% above the same period in 2010, making it the hottest property type based on sales volume increases versus 2010,” Macke said.

“This makes sense as the 24-hour nature of hospitality leases results in hospitality net operating incomes (NOIs) more quickly reflecting improving economic conditions, providing investors with earlier insight into the income growth potential on the horizon than other property types,” Macke continued. “Combined with the dramatic drop in NOIs and valuations during the downturn, this has made for an ideal environment to facilitate increased sales volume.”

Hotel operators are clearly poised to take advantage of those big improvements in fundamentals. As of the first quarter, owners throughout most of the 54 largest U.S. markets tracked by CoStar and its forecasting unit, Property & Portfolio Research (PPR), had already started to push room rates upward.

The recovery remains uneven, with only a handful of metros sporting high occupancies showing consistent rent gains over the past year. Still, with occupancies much improved from their cyclical lows and increasing further, CoStar forecasts that room rates should increase across the board in 2011.

Occupancy gains alone have been enough to stoke sizable growth in revenue per available room (RevPAR) in the top 54 markets, according to CoStar. For the week ending May 21, the U.S. lodging industry reported its strongest weekly performance since early April, said Steve Hood, senior vice president at Smith Travel Research (STR).

The industry recorded an 11.6% gain in RevPAR, rising to $67.52 for the week. National hotel occupancy rose 6.2% to 65.4%, and the average daily rate (ADR) increased 5.1% to $103.23.

The RevPAR pop this year has attracted buyers looking to capitalize on the property type’s relatively quick recovery in asset-level performance, CoStar Real Estate Economist Jeff Myers said in a recent report on hotel fundamentals.

“The market for transactions is heating up rapidly,” confirmed Arthur Adler, managing director and CEO-Americas for Jones Lang LaSalle Hotels, which has closed several large deals this year — most recently the acquisition of two properties totaling 282 rooms by Texas-based FelCor Lodging Trust, Inc. from Morgans Hotel Group for $140 million, or $496,454 per room, on May 23.

With hotels bearing a disproportionate amount of distressed CMBS debt compared to other property types, a significant portion of lodging deals involve troubled properties.

In one of the largest of these transactions, Chatham Lodging Trust and Cerberus Capital Management, LP bought the Innkeepers USA portfolio of 65 properties from Innkeepers and Apollo Investment Corp. in a bankruptcy sale in May for $1.13 billion, or about $124,599 per room. Also last month, private equity fund KSL Capital Partners of Denver bought the 293-room Intercontinental Montelucia Resort & Spa in Paradise Valley, AZ, for $115.6 million, or $394,439 per room, in an REO sale from Eurohypo AG.

Though plenty of buyers are targeting heavily discounted distressed assets, well-located core-quality hotels are also selling regularly and the value of these deals has caused the average price per room in the market to begin trending upward.

“So far this year, there have been more than 35 upscale, full-service hotels traded in large urban areas throughout the U.S., with total transaction volume exceeding $4 billion, marking a staggering 250% increase, from $1.3 billion in the same period last year,” Adler said. “Manhattan is on the forefront of hotel transactions, with year-to-date sales in the city topping $1 billion, representing a quarter of national upscale urban hotel trade volumes.”

Texas based FelCor Lodging Trust, Inc. bought two properties totaling 282 rooms from Morgans Hotel Group for $140 million, or $496,454 per room, on May 23.

Other recent large hospitality transactions include the following:

* Sunstone Hotel Investors of Aliso Viejo, CA, bought the 1,190-room Hilton San Diego Bayfront from sovereign wealth fund Abu Dhabi Investment Authority for $475 million, $532,213 per room in a deal that closed April 15.

* Diamondrock Hospitality announced May 16 that it has entered into an agreement to purchase the Radisson Lexington Hotel, 509-515 Lexington Ave, in New York’s Plaza District, in a deal expected to close within 30 days. The seller, Lexington Hotel Real Estate LLC, listed the deal at $335 million or $477,888 per room.

* DiamondRock Hospitality has reportedly agreed to buy the former Knickerbocker Hotel at 1466 Broadway in New York from Highgate Holdings for between $112.5 million and $135 million, depending on the number of rooms approved for construction.

* Pebblebrook Hotel Trust of Bethesda, MD, has acquired West Hollywood landmark the Mondrian Los Angeles at 8440 W. Sunset Blvd. From Morgans Hotel Group for $137 million, or more than $578,000 per room, in a sale on May 5.

* Chesapeake Lodging Trust acquired Chicago City Center in the Central Loop for $128.8 million, or $350,000 per room, from Starwood Hotels and Resorts Worldwide Inc. on May 10.

* Investment manager Westbrook Partners bought the 182-room St. Regis Hotel in Washington, D.C.’s CBD in a note purchase for $100 million, or $549,451 per room, from equity fund Claret Capital, Ltd on May 12. Westbrook acquired a $125 million note from Barclay’s Capital.

* Pebblebrook acquired the Westin Gaslamp Quarter San Diego in downtown San Diego for $110 million, or $244,444 per room, from Starwood Hotels in a deal on April 6.

* KSL Capital Partners acquired the 409-room Royal Palm Hotel at 1545 Collins Ave. in Miami from Sunstone Hotel Investors in an off-market transaction for $130 million, or $317,848 per room in a sale April 12. The deal traded at a cap rate of 4% and the seller provided $90 million in seller financing, putting the LTV of the deal at about 70%.

KSL Capital, which specializes in the acquisition of resort properties, announced Wednesday it has completed the final closing of its KSL Capital Partners III, L.P fund, which will specialize in investments in travel and leisure businesses.

The fund closed with more than $2 billion in commitments, significantly exceeding the original target amount of $1.5 billion. It’s another sign that the flow of capital to hotels isn’t likely to let up soon – and in fact is spreading from urban core hotels bolstered by business travel to resorts, which rely on recovery in the leisure travel market.

Investors in the fund include public and private pensions, foundations, endowments, institutions and high net worth individuals. KSL currently has more than $3.5 billion in equity commitments under management and has now raised three funds since 2005 for hospitality, recreation, clubs, resort real estate and travel service businesses.

“We believe that this is a unique time in the market to be able to deploy the investment strategy that we have successfully used for more than 20 years,” said Michael Shannon, managing director, who co-founded KSL with managing director Eric Resnick.

By: Michael P. Hedden / CCIM Magazine

May – June, 2011

Activity within the institutional commercial real estate market is picking up as a result of the abundance of capital seeking real estate opportunities. Property sellers who have been holding firm in their asking prices are being rewarded for their patience by buyers who are motivated to procure quality assets at perceived attractive prices. Rather than simply bid the price to unrealistic levels, buyers are analyzing numerous alternatives to achieve ownership positions and obtain attractive returns on their investments.

The Buyer Perspective
From the buyer’s perspective, each acquisition is a case study in strategic methodology, analyzing and pursuing numerous avenues to the transaction. Recently, a trend has emerged in the form of joint venture partnerships where buyers assist in the recapitalization of the assets that are facing loan maturity deadlines on debt with high loan-to-value ratios. Alternatively, purchasers of a property’s debt can foreclose upon its default and obtain title to the property through a loan-to-own strategy.

Another approach is to wait for the lender to foreclose or a bankruptcy procedure to play out when an owner defaults and then purchase the property in court. Of course, for core assets that are highly desirable and attract considerable buyer competition, direct acquisition of the asset from the seller is the most reliable and traditional method.

As evidenced by recent deals, motivated investors have used all of these means to procure core real estate investments in prime markets and this trend is expected to continue through year-end. But as the supply of attractive purchase opportunities shrinks, buyers are starting to take on riskier assets in less-than-prime markets.

Tolerating Risk
With this increase in transaction activity comes the price discovery and transparency of an evolving market. The convergence in the bid-ask conundrum is now coming more from the buy side than from the sell side — more from the bid than the ask. The abundance of available capital, both debt and equity, has been the primary reason for this increased buyer activity.

With the pressure and incentive to put real estate equity capital to work, the risk tolerance and go-forward assumptions regarding cash flow expectations have become more optimistic and are driven more by the need to invest than by market fundamentals. The willingness to take on more risk in real estate transactions combined with increased competition has shortened the due diligence periods for aggressive purchasers of prime super-core assets.

Over the past several years, many investors have raised significant pools of funds with the expectation that distressed sellers facing foreclosures, bankruptcy, or refinancing would be willing to sell prime assets at distressed prices. That has not been the case. In some cases, the institutional buyers have been motivated to invest and have paid premiums rather than allow the raised capital to sit idle causing them not to meet the fund investors’ expectations.

The sellers of real estate or mortgage note holders have seen this increase in volume and upward price movement for certain assets and are content to hold out or kick the can down the road. The strategy of delay and forbearance has enabled sellers to become firmer in their pricing as the market slowly recovers. Since the credit crisis began more than three years ago, sellers were anticipated to follow the same pattern that unfolded during the late 1980s market collapse, with liquidation at distressed prices. However, in many cases, asset owners and debt holders have opted to hold out for a market recovery. As a result, a convergence of market pricing is occurring, with more buyers raising their bids than sellers lowering their asking prices.

The fact that the ample supply of capital chasing too few available core assets has driven the recent price increases is reflective of the basic economic principle of supply and demand.

Buyers have developed a more-strategic approach to making acquisitions that is reliant on a case study approach to each situation. The current environment gives buyers several options to acquire a desired asset. The analytical tools market participants use are the same, but the process differs depending on the competition, market fundamentals, and capital availability. Debt and equity availability in the right proportion cannot be taken for granted. Due diligence and deal structure are more important than ever and the expectations of the future are more circumspect.

In those markets that have become heated, such as New York and Washington, D.C., less time is spent on due diligence. Instead, more-aggressive valuation assumptions are being underwritten in order to beat out the competition, putting upward pressure on bid pricing and limiting the need for sellers to concede on asking prices. In those markets where time is not of the essence, a more-strategic case study approach to the acquisition can be made.

Transactions today reflect the combination of the deal-specific complexities faced by prospective sellers with the bid-ask convergence. The result is the resurgence of risk taking by prospective buyers with the increased availability of debt and equity. The real estate market is showing signs of recovery and, as a result, the pace of transaction activity continues to accelerate; however, the new framework under which real estate transactions are being executed is carefully thought out and very strategic.

By: PW Staff / Property Wire

May 25, 2011

United States commercial property prices fell to a post recession low in March as sales of financially distressed assets weighed on the market, according to Moody’s Investors Service.

The Moody’s/REAL Commercial Property Price Index fell 4.2% from February and is now 47% below the peak of October 2007, Moody’s said its latest report.

But other reports indicate that commercial property values are rising although different indices record and measure prices in different ways so direct comparisons are not helpful. But all recent reports show values are well below peak and that there is little sign of much improvement.

The Moody’s national index has fallen for four straight months and analysts said that sales of distressed properties are hurting real estate values. Investor demand is strongest for well leased buildings in major markets such as New York and Washington DC as vacancy rates decline and the economy grows, it said.

The index ‘continues to bounce along the bottom as a large share of distressed transactions preclude a meaningful recovery of overall market prices,’ said Tad Philipp, Moody’s director of commercial real estate research. ‘Indeed, the post peak low in price has been reached in the same period as a post-peak high in distressed transactions has been recorded,’ he added.

So called trophy properties in New York, Washington DC, Boston, Chicago, Los Angeles and San Francisco are helping those markets avoid the drag caused by distressed asset sales nationwide, Moody’s reported.

Almost a third of all March transactions measured by Moody’s were considered distressed, meaning the properties’ owners faced foreclosure, had difficulty covering their mortgage payments or experienced other financial problems. It was the largest proportion of distressed property sales in the history of the index, Moody’s said.

Price increases for high profile properties in major markets ‘appear to have taken a breather, providing less of a positive effect on overall market results than it has in recent months,’ according to the report. Transactions involving such assets also fell, meaning that those properties that did sell were more likely to be troubled, Moody’s said.

Prices for investment grade properties in the US fell 4.9% in March from the previous month, according to a report from CoStar Group, a real estate data service based in Washington. Values were up 2.2% from March 2010 and down 38% from the peak in June 2007, the report said. CoStar, unlike Moody’s, tracks transactions of less than $2.5 million.

Meanwhile, Green Street Advisors, a real estate research company in California, reported rising prices in April. Commercial property values increased 2% from the previous month and 18% from a year earlier, and are down 13% from the August 2007 peak, the report said.

Green Street’s index includes deals that are in negotiation or under contract, and is weighted by asset value. Moody’s tracks completed sales.

CB Online Staff / Caribbean Business

May 23, 2011

The island government’s Economic Development Bank (EDB) announced Monday $3.5 million in financing for the planned El Blok Hotel in Vieques.
The new 21-room boutique hotel is being built at the entrance to the Malecón La Esperanza oceanfront walk near Sun Bay, one of the most popular beaches on Vieques.

The property will include “green” elements including solar power and water recycling.

“This project is one we had to work with because of all the positive elements it brings to the table: its economic impact on the island town of Vieques; the expansion of the hotel room inventory; and its sustainable development methods that seek to harmonize tourism development with the environment,” EDB President Ivonne Otero Guzmán said during a groundbreaking ceremony Monday.

She was accompanied at the groundbreaking ceremony Monday by Economic Development & Commerce Secretary José Ramón Pérez-Riera and Puerto Rico Tourism Co. Executive Director Mario González Lafuente.

The EDB chief reiterated the Fortuño administration’s commitment to sustainable development in Vieques and Culebra.

“Tourism is a key piece in economic development and we at the EDB are confident that El Blok will be an example of that,” Otero Guzmán said.

The project is expected to create some 25 jobs during the construction phase, which is scheduled to kick off next week.

Once operational in December 2012, the hotel is expected to generate 23 direct jobs and support another 34 indirect jobs on Vieques.

CB Staff / Caribbean Business

May 16, 2011

The Caribbean is, now more than ever, a unique investment opportunity.
That’s the assessment of one top investor, who insists he lives and breathes the Caribbean. David Brillembourg, founder, chairman and CEO of private equity real estate firm, The Brilla Group, is adamant that the region is ripe for investment.

Brillembourg will bring this outlook to next month’s 2011 Invest Caribbean Power Breakfast, presented by Hard Beat Communications and the Caribbean Tourism Organization, in collaboration with the Caribbean American Chamber of Industry & Commerce. The event is scheduled for June 9 in New York City.

Brillembourg is among the top speakers, who include Goldman Sachs Vice President W. Dave Dowrich and will feature top Caribbean ministers of government, investors and entrepreneurs.

Brilla’s investments are focused primarily on luxury beachfront hotels and resorts in the Caribbean.

Foreign direct investment in the Caribbean and Latin American region grew strongly last year, jumping from $5.5 billion in the first semester of 2009 to $20.8 billion in the same period of 2010, according to the Economic Commission for Latin America (ECLAC).

China’s Ministry of Commerce alone reported that foreign direct investment in Caribbean countries by Chinese firms totaled nearly $7 billion in 2009, a more than 300 percent increase from the 2004 foreign direct investment of $1.7 billion.

Brillembourg sees the opportunity.

“The Caribbean is a unique and long-lasting investment,” he said, insisting that anyone serious about investment should get on board.

He reiterated that the region looks solid throughout with lots of opportunities out there.

“For example, Turks & Caicos is coming out of the crisis well. But there is more than one location to look out for; all are maturing and diversifying,” Brillembourg said. “This is a wonderful time to be in the Caribbean.”

The Brilla Group chief is a seasoned entrepreneur with more than 20 years of experience in investing also in South Florida, Mexico, Central America and Colombia.

“As a result of the global financial crisis and dislocation of real estate markets, the hotel sector was seriously affected due to the lack of funds and financing available for this sector. This macroeconomic situation caused the expected supply for new luxury coastal properties in the Caribbean,” he said.

By: Frances Ryan / Caribbean Business

May 11, 2011

Tourism’s efforts represent a $1 billion investment and 2,257 new jobs for the local economy

A list of 20 hotel projects under construction are driving efforts by the Puerto Rico Tourism Co. (PRTC) to increase local room inventory by 1,500 while diversifying the island’s hotel product. The new hotels represent a whopping $1 billion economic injection to the local economy. It will help create 2,257 new direct jobs and push Puerto Rico to the 15,000-room mark after a 30- year lull, according to an official Tourism Co. progress report.

The hotels are scheduled to begin operation later this year or by the third quarter of 2012. The new guestrooms are a welcome addition to the 1,908 hotel rooms (with a combined $799 million investment) that have been added since 2009.

“Now, more than ever, given the still-difficult economic times facing all business sectors, our [the PRTC's] role as facilitator in new hotel development, as well as helping generate new tourism economic activity, is of utmost importance,” said PRTC Executive Director Mario González Lafuente during an exclusive interview.

Industry growth, he said, is expected to come from both new hotel developments and an increase in tourism transactions, yielding greater economic impact per visitor.

“We are paying a great deal of attention to the diversification of the overall hotel product while, recognizing Puerto Rico has some distinctive competitive advantages that need to be explored further,” the PRTC executive said.

González Lafuente noted, for example, that with the opening of the St. Regis Bahía, Puerto Rico’s first five-star resort destination, “we are returning to the high-end product for which we have been known. Most importantly, we are delivering the kind of high-end product that our most influential partners—industry wholesalers like Expedia, Travelocity, American Express’ Travel Impressions and trade publications like Travel + Leisure—had told us we were missing.”

New hotel developments run the gamut—from high-end five-star resorts and golf courses to small country-inns to agro-industry, ecoadventure paradores to facilities catering to the growing medical tourism sector, González Lafuente noted. These developments are distributed throughout the island’s six tourism regions: East, Metro (greater San Juan area), North, Central, Porta del Sol (West) and Porta Caribe (South).

The diversified list of hotel projects under construction includes several five-star-quality hotel projects, chief among them the Dorado Beach Ritz-Carlton Reserve, which is being developed to the tune of $342 million and features 130 guestrooms plus a condo-hotel with 111 residential units.

In keeping with the PRTC’s nature/adventure strategic marketing development, new projects include two Vieques island properties, namely the expansion of Hix Island, with six additional villas for $800,000, and the construction of El Blok, a $5 million hotel that is also the island’s first sustainable ecotourism development. There also are new paradors, including Hacienda Lealtad in Lares, a former coffee-growing plantation, which will receive $2 million in financing for the 11-guestroom property.

A steady growth in the medical tourism and science/business sectors is the reason Hyatt Place & Casino is scheduled to open two locations, in Manatí and Bayamón, while Hotel San Miguel will add 20 rooms and meeting facilities to its Bayamón property, across from San Pablo Hospital.

By: Victor Calanog  / NREI Contributing Columnist

May 10, 2011

Commercial and residential values have generally moved in lockstep over the last three decades. Today, however, home prices continue to remain volatile and close to the bottom while commercial real estate values are generally en route to recovery.

Did the severity of the last recession alter the fundamental relationship between owner-occupied homes and commercial real estate?

Standard theory from urban economics suggests that the same basic forces influence demand for both housing and commercial real estate, according to seminal papers written by economists Sherwin Rosen and Jennifer Roback in 1979 and 1982, respectively.

A white paper written by economist Joseph Gyourko in 2009 confirmed that the two asset classes do exhibit fairly strong correlation. Interestingly, the results were roughly the same, whether returns from commercial real estate investments were measured using different data sets from the National Association of Real Estate Investment Trusts or the National Council of Real Estate Investment Fiduciaries.

Changes in inflation-adjusted home prices were measured using the Federal Housing Finance Agency’s repeat sales house price index. However, the study’s time horizon covered periods from the early 1980s to 2008. It was in 2009 when the recession became particularly severe.

While 2010 was still rocky for commercial real estate, capitalization rates began to stabilize and even fall slightly. Cap rates for office properties declined from 8.2% in late 2009 to approximately 7.1% by the end of 2010. (The cap rate is the initial return to an investor based on the purchase price of a real estate asset and the net operating income. The lower the cap rate, the higher the price.)

Reis recorded the first drop in national vacancies for office properties in the first quarter of 2011, and both asking and effective rents even posted slight increases. Retail properties are still struggling, but vacancies have remained flat at 10.9% for three quarters, indicating that the sector may have bottomed.

Multifamily properties are the belle of the ball, with vacancies declining sharply from a 30-year high of 8% to 6.2% as of the first quarter of this year. Cap rates for apartment properties, which rose by 100 basis points from a low of 6.3% in 2007, are now back down to 6.7%.

By contrast, home prices have remained close to the bottom, and recent data suggest that uncertainty about recovery remains. Year-over-year changes in the latest S&P/Case-Shiller Home Price Indices through February 2011 register a decline of 3.3% for the 20-city composite.

A page-one story in The Wall Street Journal on May 9 highlighted an 8.2% drop in median U.S. home values in March 2011 from the year prior, using data released by Zillow.

Cyclical factors still at play

While it is tempting to assert that home prices and commercial property values will now follow different structural paths, it is important to consider cyclical factors that are still playing out.

A bust in home prices and the resulting contraction in credit caused the recession. It may take at least a year for the demand for homes to soak up excess supply from overbuilding and foreclosures, assuming the economy continues to recover at its measured pace. Home prices will remain volatile and close to the bottom as a result.

There was far less overbuilding in most commercial real estate sectors. The office sector, in particular, experienced a dramatic pullback in the most recent cycle, when inventory growth only averaged 0.54% from 2004 to 2008. That is only about one-fifth of the inventory growth rate from 1998 to 2003.

In other words, while this recession was characterized primarily by an unprecedented reduction in aggregate demand, commercial real estate sectors like office properties had to contend with far less of a supply glut that would have made matters worse.

This is not to understate the profound distress that office properties went through in 2009, when effective rents fell by a record 8.9% in a single year. At the epicenter of the crash in financial services was New York City, where effective rents fell by 19.8%, more than twice the decline recorded in the 12 months following 9/11.

Still, had there been significantly more overbuilding as in the early 1980s, conditions would have been much worse.

What about the popular notion that national home prices never fell until the housing bust in 2006? Doesn’t that suggest that simple correlations are suspect, and that owner-occupied, single-family homes don’t really follow cycles, unlike commercial properties that have experienced at least three boom and bust periods since the late 1970s?

True, nominal home prices from the Federal Housing Finance Agency index show a steady march upward from 1975 until 2007. However, the inflation-adjusted series clearly shows that home prices experienced a decline of about 12% from 1979 and 1982, and encountered a more modest dip of about 6% between 1989 and 1994. These bust periods roughly correspond to the years when NCREIF’s total returns index also was negative.

A distinction worth reviewing

It is important to differentiate between structural factors and cyclical factors when thinking about gauging the health of one sector in the economy, like commercial real estate, by using a correlated sector such as single-family, owner-occupied homes. The cyclical factors we just discussed imply that commercial real estate values will recover more quickly than home prices.

Structural factors influence long-term changes in demand and supply. For example, if a city like Detroit continues to lose population and employment given structural changes in the economy, then expect demand for both housing and commercial real estate to contract.

At the regional level, some developers are still keen on several markets in the Sunbelt, betting that better weather will continue to prompt population shifts to the area fleeing the cold Northeast. These are bets on structural changes. But these developers are understandably waiting for cyclical factors like the current slump in prices to imply an upturn in demand before diving in.

Structural change may imply inexorable decline for some areas, but the fate of cities and sectors is not written in stone. Pittsburgh reinvented itself from a manufacturing center to a city more dependent on health and education jobs, which served both its residential and commercial sectors well in the last downturn.

There may not be as much demand for housing in Detroit, but recent plans from both the government and private sector players like Bank of America to demolish abandoned homes and “right-size” the city imply that policy can attempt to alter structural decline.

There are, of course, fundamental differences in investing in income-producing properties like office buildings, and owner-occupied homes that do not yield rental income. However, the divorce between residential and commercial properties appears to be a cyclical, and not a structural, phenomenon.

This relationship implies that despite the optimism for commercial real estate, it still behooves the astute investor to look at related residential sectors for clues that specific metros as a whole might not be completely out of the woods just yet.

By: Beth Mattson / CCIM Institute May 5, 2011 The chasm between bid and ask prices that emerged after the commercial real estate market plummeted in 2008 has narrowed significantly, and in some cases, disappeared altogether.“In 2008 and 2009, there was a definitive disconnect in pricing. At the end of 2010 and now into 2011, there is a lot more reality from the seller’s perspective,” says Craig Thomas, CCIM, a senior associate and associate director of the National Retail Group at Marcus & Millichap in Jacksonville, Fla. Buyers also have had a reality check, because the tidal wave of distressed sales that many anticipated never emerged. Some buyers had hoped to cherry pick A properties for B, C, or even D prices, and that simply hasn’t happened, Thomas notes. “Buyers have realized that they are going to have to step up to the table a little more if they actually want to acquire any of these different types of properties,” he adds. The increase in transaction activity is one clear indication that the price gap has shrunk. That is most evident in properties that are trading at the upper end of the market. Demand for class A properties in major metros is creating competitive bidding scenarios for properties across property types from grocery-anchored shopping centers to high-rise apartments. That being said, the pricing gap still presents a challenge in some markets. Multitenant retail properties in particular still have a fairly significant bid-ask gap between buyers and sellers, especially among the B and C properties in older non-core shopping centers with no anchor tenant. “Those are the ones that you are seeing where there is a significant difference in asking and actual selling pricing,” Thomas says. Class A shopping centers are commanding capitalization rates as low as 6 percent, while non-core distressed shopping centers are garnering cap rates in the double digits. In addition, the pricing gap is typically more pronounced in smaller markets that don’t have the competitive buying or the strong economic fundamentals that exist in major markets. For example, there is still a sizable spread between bid and ask prices in Kansas City, but that spread is narrowing as time wears on, notes Ronald D. Jury, CCIM, president of Jury & Associates in Shawnee Mission, Kan. “The buyers are really looking for discounts in today’s marketplace,” Jury says. “Part of that is because lending is so tight right now that you need at least 40 percent down on most investments, which takes a lot of capital to get into a property.”