Experts: Commercial Real Estate Has Returned to 2007

It is hard to believe that it was just a few years ago—specifically in 2007—when a perfect storm of positive events was taking place in the financial and real estate markets. The S&P 500 reached record highs, CMBS transactions grew to nearly $770 billion, the Blackstone Group completed its $39 billion purchase of Equity Office Properties Trust and then sold eight buildings in the Equity Office portfolio to Harry Macklowe for $7 billion, foreign investors were purchasing commercial real estate at record levels and everyone was purchasing residential condominiums. In short, happy days were here again.

Suddenly, though, the music stopped and a financial crisis descended upon the nation as well as the residential and commercial real estate market in New York and elsewhere. It began in 2008 and reached its full impact in 2009. The climb out of it has been slow, but this year many consider the real estate market similar, or even better, than those distant days of 2007.

This year, the price of raw land for development is reaching record highs, along with residential rents and luxury condominium price tags. Vacancy rates for office in Midtown South (once considered a second rate location) are at all time lows, with the highest recorded rents. Investors are once again converting office buildings, especially in prime locations, into residential rental and condominium towers with hotel components. The level of financing for commercial real estate is growing each and every day. And this includes a major volume increase in CMBS. Construction financing has rebounded and mezzanine and preferred equity are being offered at lower, reasonable pricing. More and more hotels are opening in the metropolitan market with the city recording the highest occupancy rates ever.

While it looks like the stars are aligned for the days of 2007, industry leaders are not all in agreement that the market has totally improved.

“While cap rates for investment properties in New York City have certainly compressed, our data shows that cap rates, particularly in the multi-family sector are not as low as they were in 2007,” said Robert Knakal, chairman of Massey Knakal Realty Services. “The significance of this becomes magnified when looking at what lending rates and Treasury rates were in 2007. Basically, investors are getting a much better bargain today than they were in 2007.”

Peter Hauspurg, chairman of Eastern Consolidated, has a different view on the multifamily marketplace. “Rental apartment pricing is nearly double 2007,” Mr. Hauspurg told Mortgage Observer. “Rental housing is on fire, especially in Brooklyn, which continues to surprise all real estate leaders. There is almost no neighborhood that is not gentrifying: including areas like Bed-Stuy, Flatbush, Bushwick and even Coney Island.”

“The demand for rental apartments is strong, so prices are high, cap rates are low—even with increasing interest rates—and apartment rents, after being down a bit for a year or to, have recovered to near all-time highs,” noted Robert Ivanhoe, Global Real Estate Practice chair at law firm Greenberg Traurig. “Land prices are at or above their levels in 2007, at least in Manhattan and prime locations in Brooklyn. This is primarily driven by soaring condo prices which have far surpassed the last cycle for new construction high end condos. This phenomenon has distorted land prices, since most people will look at land values for highest and best use, now almost exclusively condo, unless zoning prohibits that.”

Mr. Hauspurg concurred with Mr. Ivanhoe. “Land prices in many cases are double the peak prices set in 2007,” he said, “which is being fueled by the increase in apartment prices which in turn have set records.”

Due to changes in the capital gains and personal income taxes, sales of investment properties grew in 2012, especially in the fourth quarter. “The sales volume numbers this year are lagging last year by a significant margin, on both a dollar volume and number of properties sold basis,” Mr. Knakal added. “We expect things to pick up in the fourth quarter, but not enough to surpass last year’s numbers. Last year’s numbers did not come close to 2007’s totals.”

“Generally, I believe there is a lot less leverage and risk in the real estate system in 2013 versus 2007,” said Thomas Lydon, President of The City Investment Fund. “The banks are in good shape and the CMBS product is better underwritten. However, the low interest rates being artificially induced by the Federal Reserve should cause investors to take a cautious look over the next few years. Capitalization rates could move up significantly if the cost of money increases.”

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