Fire Sale Not Forthcoming, Banker Says recently interviewed investment banker Russ Hancock, a vice president with KeyBanc Capital Markets, to get his take on the current deal-making environment in commercial real estate. Investors expecting to pick and choose from a flood of quality assets on the cheap shouldn't get their hopes up, according to Hancock. When can we expect transaction activity in the commercial real estate market to pick up, if at all?
Russ Hancock: We started to see transaction activity increase, albeit very modestly, in the third and fourth quarters of last year, creeping up from trough levels in the first half of the year. We don't expect a flood of new transaction activity in the short term, but rather a continued gradual increase that will start to accelerate in the second half of 2010 and into 2011.
Compared to last year, when most investors were on the sidelines given the uncertainty in the markets, we are now starting to see genuine interest in new transaction activity, with investors rolling up their sleeves and really taking a close look at prospective deals. There's been a shift from looking at deals just to stay in touch with the market, to looking at deals with a genuine intent to buy. Given the lack of palatable debt options in the market, do you foresee potential acquirers taking advantage of less common financing options to complete deals going forward?
Hancock: It is still a very difficult credit environment and real estate owners and developers will need to continue to be creative in sourcing attractive financing.
Some investors are closing all-cash deals to take advantage of opportunities today, with the expectation that better debt financing will be available tomorrow. Others are navigating the various government-sponsored programs that have been created to inject liquidity into the capital markets. Meanwhile, you are starting to see some of the "traditional" sources of real estate capital, like insurance companies, and even a handful of CMBS deals, come back into the market, a trend that is likely to continue. Which market sectors appear particularly likely to see an increase in distressed asset transactions?
Hancock: So far, the menu of distressed asset transactions has not been nearly as large or as palatable as investors had hoped. And while the inventory of distressed buying opportunities will likely grow alongside increasing defaults in the commercial real estate sector, the broad fire sale of distressed assets that many had expected is unlikely.
While there will no doubt be distressed transactions across all asset classes, retail and hospitality, which were hit particularly hard by the recession, are among the most likely to see an increase in distressed transactions. What is your take on commercial real estate property pricing? Have we reached a bottom yet?
Hancock: Though the lack of deal flow makes it hard to pinpoint a bottom, I think commercial real estate property pricing, overall, reached a trough sometime in mid-2009 and has been inching up ever since. Within that, there are some markets that bottomed before that and are further along in their recovery, and other markets that haven't hit bottom yet. Generally, primary markets, like the larger coastal cities, are the first to recover, given the greater attention from institutional buyers and higher deal volume, while less-liquid secondary and tertiary markets often take longer to rebound.
We are starting to see significant demand for high-quality deals in top markets, with long lines of bidders and cap rates approaching levels not seen since before the credit crisis. Will private portfolios generally stay that way, or should we expect to see more going public in the near future?
Hancock: The importance of having access to capital has been a recurring theme for real estate owners throughout the turmoil of the last 18 months, and in many cases the ability to access the capital markets has separated the winners from the losers over that time frame.
With over $20 billion of equity raised in 2009, the publicly traded REITs have demonstrated a distinct advantage in terms of access to capital relative to their private competitors. This availability of capital has allowed the majority of REITs to manage through the downturn by addressing balance sheet issues and puts them in a strong position to take advantage of attractive acquisition opportunities going forward.
Meanwhile, many of the private owners and developers are still struggling to recapitalize their portfolios as their traditional sources of equity capital have dried up, a situation that is made more painful by the fact that we are in an environment where stricter lending standards now typically require more equity in deals. And as these private owners and developers go out to find new equity partners, they find themselves at the back of a long line. Many of the private players who have portfolios that are appropriate for a public company in terms of size and quality are now taking much more serious looks at the IPO alternative. We expect to see the REIT IPO market gather some momentum in the second half of 2010 and into 2011, as these larger private real estate owners, frustrated by the lack of privately available financing, recognize and pursue the capital advantage of being a publicly traded company.