Cirios Opportunities – Is it Time to Buy Commercial?
This post first appeared in the May edition of: Cirios Trends: In Search of Real Estate Opportunities.
One of the most frequent questions we get here at Cirios is, “Is it time to buy commercial yet?”
Clearly, this is an immensely complex question, particularly because “Commercial Real Estate” means something different for each person you ask. It could be office buildings, hotel chains, apartment buildings, industrial centers or any other piece of real estate that isn’t a single family home or condo.
And while the answer to this question is one which cannot quickly or simply be answered, we believe the time is right to start examining opportunities in certain segments of the commercial market.
Let’s look specifically at small multi-family properties around the Bay Area.
We are defining “small” as anything below 50 units, which may or may not be small depending on who you talk with. We chose this segment because these deals fit nicely between two very crowded markets.
In the Bay Area, the distressed single family residence market is becoming increasingly crowded. As we see each time we list a property, the number of all-cash buyers in the market – in particular foreign nationals – is astounding. As optimism gains steam that the worst is behind us in the housing market, this market will only become more crowded. Investors are out there looking for opportunities, which squeezes profits and makes good deals tougher and tougher to find.
The perception is that buying a single family home and either rehabbing it or renting out is simple, straightforward and carries less risk than buying multi-family or commercial properties. As such, this segment attracts so-called “mom and pop” investors, who may lack the sophistication of larger, more experienced players.
These big players, while sophisticated and often armed with piles of cash and leverage, are forced to look at large deals in order to put the money they raised to work. This means bigger deals are often chased by many well-financed investor groups. And while each investor will have a different minimum investment size, operating in the space between mom and pop and these large institutions can be an attractive proposition.
The question then becomes, at what point should investors steer away from the single family market and refocus on commercial? Again, defining commercial for this exercise as small multi-family properties, we believe the answer is: Sooner than you think.
In the Bay Area, rents have fallen considerably in the past three years, despite the widely held view during the early stages of the downturn that rents would be buoyed by former homeowners moving back into to the rental market. It turns out that rents were in a bubble of their own.
The value of apartment buildings is closely tied to rents, so property values have tumbled along with rents. However, the multi-family market is far less liquid than residential and price discovery has not yet fully gotten underway. In other words, sellers have been holding out for wont of buyers, which have been few and far between. This means prices are yet to have fully corrected to reflect lower rents.
But as sellers become more desperate and buyers gain more confidence, the market will continue shaking out and prices will keep coming down to more sustainable levels.
This dynamic is beginning to play out in other segments of the commercial market as well. And while we do not profess to be experts in all aspects of commercial real estate, from talking to our contacts in the industry, opportunistic investors are looking much more seriously at deals than they were even a couple months ago.
One additional aspect of this opportunity which intrigues us is the widespread belief among old school landlords that operating costs are fixed, and cannot be lowered.
For all the hype surrounding solar panels on houses, tankless hot water heaters and environmentally friendly insulation, the real pop for energy efficient building upgrades is in the commercial space. You could drive a truck through the gap between the understanding of how efficiency upgrades add value to commercial real estate and the actual improvements being done.
And where there are information gaps, opportunity abounds.
Tags: apartment building investment, bay area real estate investment, commercial real estate investment, multi family property investment