CHICAGO, IL, April 1, 2009 - The Real Estate Capital Institute's Scoreboard reports today that commercial and residential income-property values and mortgage underwriting continue readjusting to more conservative levels not seen in more than a decade.
While most buyers and sellers are tangled in a pricing stalemate, funding sources define debt and equity metrics based on refinancing and renegotiating terms.
While most buyers and sellers are tangled in a pricing stalemate, funding sources define debt and equity metrics based on refinancing and renegotiating terms.
However,such metrics substantially vary from the sizing dynamics that many investors have grown accustomed to.
Current underwriting realities mainly include stringent resizing of existing cash flows, higher capitalization rates and lower new-construction costs --all summarized as follows:
Cash Flows Readjustments:* Best case assumes annualized with a careful review of recent trailing three months occupancy and collections.
* "Re Forma" vs. Pro Forma - whereby funding sources expect outright lower income in anticipation of more challenging economic conditions. Numerous lenders expect income levels to drop from 3% to 6% during the year.
* Expense increases - Higher vacancies translate to carrying more common area expenses. Furthermore, few investors expect meaningful lower taxes and operating costs.
Higher Capitalization Rates:
* 8% is the now new valuation benchmark for most commercial properties; Single-tenant, credit deals secured by longer-term leases hover in the 7% range.* Below 7% reserved for prime residential and trophy properties orproperties with substantial contractual upside.
* Full service lodging starts at 9% to low single-digit range asRevPAR and operating cash flow have been substantially reduced since 2008.
* Smaller projects based on 1031X trades may be priced as much as 50bps lower than typical capitalization rates, as demand remains brisk.
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* Substantial widening for C-Properties by at least 150 basis pointsor more -- moving into the double-digit range. Price reductions of 30% ormore are common as compared to Credit and Class-A/B assets, as this segmentof the market remains very illiquid.New Construction Realities:
* Despite public infrastructure spending, construction costs are loweras construction spending has decreased and competition has increased.Commercial building construction costs have fallen by more than 10% duringthe past year.
* Return-on-Cost yields are in the double-digit range. As investorsfocus on purchasing projects well below replacement costs andhigher-leveraged debt is scarce, development yields must be priced 200 basispoints or more above cost of debt.
Observations:
According to Aaron Gruen (top right photo) of the Real Estate Capital Institute AdvisoryBoard, "While declining rents, rising capitalization rates, and challengingeconomic and financial conditions make for black moods for real estateinvestors and developers, this is a good time to prepare for the return ofprosperity."
He adds, "From a longer term perspective, prices are morelikely to be bargains, constructions costs are low, and loans are likely tobe prudently made and taken."
Contact: The Real Estate Capital Institute(r), 3517 West Arthington Street, Chicago, Illinois USA 60624.Nat Zvislo, Research Director, Toll Free 800-994-RECI (7324).
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