The Outlook for 2014

There can be no doubt that 2009 will be a very difficult year for investors. The sub-prime credit crisis in the United States has developed into a global recession and investors throughout the world are now concentrating on the economic problems that will have to be faced as the new year unfolds. However, the dramatic corrections that have already occurred in every stock market of the world, and that are occurring in the real estate markets of virtually every country in the world, appear to have significantly discounted much of the dismal economic news anticipated for 2009.

If investors interested in US real estate expect to take advantage of the buying opportunities that will be presented during the year, they need to be prepared to look beyond 2009. In Falcon Real Estate’s view, buying US commercial real estate in the coming year involves two steps: one, defining what constitutes an attractive investment opportunity by adopting specific absolute investment objectives, and, two, having a view of what the US economy and real estate market will look like beyond the next year or two. Since real estate is essentially a long-term investment, and since most of the investors with which Falcon works generally hold their properties for at least five years, we believe that it is appropriate for investors to look out several years to 2014, for example, since that is about the time at which they are likely to be considering the sale of anything bought in 2009.

In our view, the massive fiscal stimulus being injected into the global economy by the central banks of every major country in the world cannot fail to have the effect of reviving economic activity, and we would expect to see improving economic conditions, at least by the end of 2009 and continuing for two or three years thereafter. But the massive fiscal stimulus will almost certainly reignite inflation, and our expectation is that in two or three years the Federal Reserve Board will be forced to raise interest rates significantly to try to control the inflationary pressures unleashed during the coming year. We will discuss below in more detail how these factors may affect an investor when considering an investment in US commercial real estate in 2009.

top

Defining an Attractive Opportunity

The worst thing that an investor can do at this time is to decide to wait before making any investments until the real estate market reaches bottom. As we have commented before, the bottom of the US real estate market will only be known six months to a year after it has occurred. By waiting for that bottom, the investor is likely to miss many excellent opportunities. Therefore, an investor must define what constitutes an attractive investment opportunity for that particular investor, and must adopt specific absolute investment objectives that set out acceptable capitalization rates, cash-on-cash yields and price per square foot yardsticks. With those investment objectives established, the investor will then be in a position to react quickly as investment opportunities arise.

As to capitalization rates, the average level over the past ten years has been slightly above 8%, and many quality properties are now on the market with cap rates at or above that level today. Acceptable cash-on-cash yields will vary widely from one investor to another, with institutions generally looking for cash yields in the 5% to 7% range, while high-net-worth individuals may have a range of objectives, with some looking for yields of up to 10%, while others will accept relatively small current cash returns. Cash yields will be heavily dependent on the financing that is available at the time of purchase of a property, but obtaining cash yields in the 5% to 7% range appears to be a reasonable expectation in today’s market. Cash yields higher than 7% are generally only available with somewhat lower quality properties in secondary locations. And, even though construction costs have declined considerably in the current global recession, it is still very common to be able to purchase a property that trades at a price per square foot that is well below replacement cost.

top