The Summer of Our Discontent

After ten of the major stock markets in the world fell into bear market territory during July and August, Merrill Lynch (with apologies to Shakespeare) labeled the third quarter of 2011 “the summer of our discontent.” There has certainly been an unending stream of bad economic news coming from all corners of the globe. But as Warren Buffett has said, “Bad news is the investor’s best friend.  It lets you buy a slice of America . . . at a marked-down price.” 

In Falcon Real Estate’s view, investors who are contemplating an investment in US commercial real estate today can do a number of things to contend with the bad news and to minimize the various risks that they currently face.

1. 1.  Think long-term.
2. 2.  Emphasize the strongest locations.
3. 3.  Choose only credit-quality tenants.
4. 4.  Obtain attractive and rising yields.
5. 5.  Insure that leases provide inflation protection.
6. 6.  Utilize conservative financing techniques.

The basic fundamentals of the US commercial real estate market are quite sound as we enter the fourth quarter of 2011. Jones Lang LaSalle, one of the leading brokerage firms in the US, stated in its August newsletter, “The U.S. office sector rings in the summer of 2011 with the strongest quarterly performance in more than four years.” And Cushman & Wakefield reported: “Office markets throughout the country continued to show steady signs of improvement . . .”  Other segments of the market — retail, industrial and rental apartments — are also performing well. 

Commercial real estate as an asset class is not subject to the extreme market volatility that characterizes the stock markets of the world today, nor is it priced at record highs as are most of the bond markets. And US real estate does provide yields that are substantially higher than what can be earned on cash equivalents. Real estate, of course, has risks of its own, but Falcon Real Estate believes that if the six points outlined above are followed, those risks can be controlled.

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Think Long-term

The most fundamental analysis of real estate trends shows that the value of well-located properties has consistently risen over long periods of time. This is partly due to inflation, as the price of building materials and labor continually move higher, and these increased costs translate into higher construction costs. Real estate is one asset that is always considered to be a long-term hedge against inflation since there is a strong correlation between real estate values and increasing price levels in the economy. The long-term rise in the value of real estate is also due to fundamental economic growth, since that growth will translate into increased demand for office, retail and industrial space in prime locations. As that demand grows, rental rates rise correspondingly leading to greater net operating income for a property and therefore to a higher valuation for the building. 

As with other asset classes, there can be periods of over-valuation, such as occurred in 2006 and 2007, but since then the US real estate market has undergone a significant correction and current valuations in most markets have returned to more normal historic levels. Given real estate's history of continually rising prices, long-term investors buying properties at the reasonable pricing levels that are prevalent today should realize excellent investment returns.

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