A Real Estate Investment Strategy for 2010

As we move into 2010 there continues to be very little purchase or sale activity in the US real estate market. The number of transactions in 2009 was at the lowest level since World War II and the stagnation in the market seems to be continuing although the fourth quarter of 2009 did see a slight increase in the number of transactions. The reasons for this situation are fairly obvious – first, an almost total lack of availability of mortgage financing; second, unrealistic pricing expectations by sellers; and third, the almost deliberately slow foreclosure procedures being followed by banks and special servicers that are holding back the number of foreclosed properties coming to market. With an economic recovery underway, Falcon expects that all three of these factors will change positively as the year progresses, as banks gradually begin to make commercial mortgages again, as sellers slowly lower their pricing expectations to levels that might attract buyers and as more foreclosures on defaulted properties occur.

At the same time that relatively few properties are coming to market, there is a surprisingly large demand for quality real estate. This demand is coming from US institutional investors, from sovereign wealth funds and from foreign institutions and high-net-worth individuals. And since the demand is concentrated on a limited number of major American cities – such as New York, Washington, San Francisco, Boston, Los Angeles and Chicago – prices in those cities have returned to the elevated levels that were last realized in late 2006 and early 2007. In Falcon Real Estate’s view, foreign investors coming into the US commercial real estate market today should broaden their investment criteria to consider investment opportunities that do exist in other locations around the country. They should also work with an investment advisor who can access the best investment opportunities nationwide.

The Over-Emphasized Markets

Many US institutional investors, together with foreign investors coming into the US real estate market, quite naturally want to focus on a number of the best-known, major geographic markets. As a result, at the present time, there is an almost unlimited amount of money that is looking for properties in New York, Washington DC, Boston, San Francisco, Chicago and Los Angeles. There is no question that these are excellent office markets, and each of them has particular attributes that provide support to the local market. New York, for example, is one of the premier cities of the world and since Manhattan Island is a limited geographic area, it is difficult for the market to become significantly overbuilt. Washington, being the capital of the country, has an almost unlimited demand for office space by the ever-expanding Federal government and by all of the associations and lobbying groups that must be located in Washington in order to work effectively with the Government. In addition, since no building may be constructed higher than the Capitol Building, this effectively limits the amount of office space within the District of Columbia. Both Boston and San Francisco have similarly constrained markets.

But the demand for properties in these cities dramatically exceeds any possible supply that can be envisioned in the next two or three years. Falcon follows these markets very closely, having offices in New York, Chicago, California and Washington and having extensive contacts in Boston, and we have been reluctant to recommend many of those properties that have become available in these markets since, in our opinion, the pricing has again become excessive. Capitalization rates for office properties in the 4% and 5% range are again being experienced, bringing the market back to the levels that prevailed in 2006 and 2007 before the economic downturn.

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