Invested in the Past? Buyers and Sellers at Opposing Ends of the Bargaining Table

Much has been made of the impact of the credit crunch on the slowdown of commercial real estate investments. But just as impactful as the lack of available credit right now, is that buyers and sellers have not yet come to terms with the the 'new reality' and remain at opposite extremes in terms of pricing, which further exacerbates the current deal paralysis gripping the market.

There is almost no investment real estate market at this time, say industry executives and brokers we surveyed for this story. Some 1031 exchanges are getting done out of necessity to meet tax obligations and some institutional properties are trading due to the flow of foreign capital taking advantage of the depressed dollar but the spread between buyer and seller is far too dramatic for "bread and butter" deals to get done.

"There is a huge disconnect," said Henry Johnson, principal of Henry Johnson Real Estate & Leasing Co. in Bay City, MI. "We're not seeing the buyer in Michigan that wants to expand their business, only the bottom fishers … and the sellers want last year's prices."

(Editor's Note: For comments for this story, we randomly surveyed about 1,200 subscribers to my Watch List, a free weekly e-mail of property opportunities, business expansions and contractions, and market conditions.)

Of respondents to our survey, almost all agreed that if you look at what is happening, it seems sellers are trying to shore up their portfolios by selling weaker performing properties. At the same time, in the last three to six months, buyers seem to prefer stabilized properties.

"That is exactly what they're doing," said Judy Brown, broker/owner of Swan Real Estate in Louisville, KY. "When times are tough, those that can, will try to "hunker down" to weather the storm. Hoarding cash and stabilized properties is a good way to do that."

Using CoStar Analytics, we analyzed more than 17,400 office and industrial properties on the market for sale and compared them to more than 3,000 such properties purchased in the last three months.

For the office properties currently listed for sale, the vacancy rate of the buildings has gone from 20% to 38% percent in the last three years. And vacancy appears to be going higher as the year-to-date net absorption of the properties is a negative 4.5 million square feet.

But that is not what buyers in the last three months have been buying. Buyers have been picking up office properties in which vacancy rates have stabilized around 15% over a three-year period, and since their acquisition, have gone down 1 percentage point. Net absorption year to date for the properties purchased is a positive 1.7 million square feet.

The same disparity holds true for industrial and flex, for sale and purchased, based on CoStar analysis.

"I have been looking for properties for a couple of buyers, and my impression is that some quality properties are being held off the market because of the perception that prices are depressed," said Dennis W. Frodsham, an associate broker for Coldwell Banker Commercial Reehl Properties Inc. in Philadelphia. "Most owners/investors don't need to sell, so it's been hard to find enough good properties to show."

Respondents told us that the multifamily market is also in the same condition.

Said Evan P. Kristol, senior vice president of investments for Marcus & Millichap in Fort Lauderdale: "There is a lot of product for sale, most of which is not going to trade, either from unrealistic pricing or inability of the seller to sell at a realistic price. Also, there are different types of assets being marketed. Stabilized and unstabilized properties, fractured condo deals, short sales (where the owner is offering the asset less than the debt) and REO (lender owned) assets."

Added counterpart Ryan E. Epstein of Marcus & Millichap's national multi housing group in San Antonio, TX: "There are still quality assets being offered for sale, and the ones that are being priced appropriately and marketed by local knowledgeable brokers are still moving."

Respondents weren't faulting the quality of the products being offered as to what is standing in the way of deals getting done. Nor was the lack of money being pinpointed as a reason.

"In general I think there are a few factors contributing to deal flow's starting again (which I am definitely seeing)," said Gabriel Silverstein, SIOR, president of Angelic Real Estate in Chicago. "There is still lots of money, even if some of it is on the sidelines, that is waiting to go into real estate in the U.S., both domestic and foreign money. The California pension funds (CalPERS and CalSTRS) increasing their real estate investment allocations in the past month or so is evidence of that, as is the massive continued influx into private equity real estate funds. Those that have raised large equity funds for real estate can't sit too long on the sideline while that money only makes 3% in a bank. Even if they can't get the yield they were a year ago, they have to do something."

"My take is that there has been so much 'distressed' money accumulating on the sidelines (and for so many years) that they are trying in earnest to effectuate a change in the sellers philosophy that is not grounded in the fundamentals of today's commercial market," said Geoff Tranchina, vice president of Sperry Van Ness' Special Asset Group in Los Angeles. "As a broker, we have been on both sides of this story and I will tell you that we have not seen the types of 'distress' that have characterized cyclical downturns in the past, i.e. large vacancies, crushing debt burdens, oversupply of product. Over the last three years, there have been so many groups waiting for a downturn that once the news started to swing to the bears, they jumped all over it. In fact, it has almost become a joke when you hear about another firm raising a X billion dollar 'distressed debt fund' targeting CRE."

Instead, the major stumbling blocks to deal flow, our survey participants told us, was that the good old days of the past five years are still too fresh in sellers' minds, while a new found conservatism has crept into the buyers' minds.

"Twenty-four months ago, there were a lot of real estate investors who were very happy with the purchases they made 30 months ago - now there are a lot of real estate investors who are very unhappy with the purchases they made six months ago. That said, we are seeing a return to sanity and historical norms," said Mike Carey, national account coordinator for Tranzon Auction Properties in Portland, ME.

"Deal velocity for Class A properties has been very brisk for the past five years; compressed cap rates meant buyers could flip [properties] quickly for a profit," said Carl Trotto, in the Multifamily Capital Markets of Cushman & Wakefield in Miami. "Going forward, these properties simply won't trade hands to the same extent, which is to say, they, will trade based upon property fundamentals but not on expectations (guesses). That is the price impact you see in the investment grade market, not the discounting you see for distressed assets."

"Quality assets are being sold. That's not the problem. The perception of risk might be our biggest problem - brokers are struggling to pitch risk in today's market. The work of the broker in all of this is the depiction of the asset's benefits and problems. If an asset can have an added-value play, that is very appealing in this market and helps with pricing conflicts," said Camille Renshaw, CCIM, a senior investment broker associate with Colliers Arnold Commercial Real Estate Services in Clearwater, FL.

"Before the 'credit repricing,' it seemed to me that Class B and C assets were trading for pricing that was similar to that of Class A assets," said John Thomas, acquisition manager, multifamily, Western states, for BPG Properties Ltd. in El Segundo, CA. "Now it seems that the appetite for risk has fallen and continues to fall. As a result, pricing seems to have improved (fallen) for B assets and further for C assets."

In the rest of this story, using the comments of our respondents, we look at the mindset of sellers and buyers and what is being done to try to bring the two sides to common ground.

Sellers: Still Drunk on the Glorious Wine of the Past Several Years

Seller expectations will vary depending upon the property type (asset class) and the specific market. Of course, brokers want to orchestrate a competition between buyers so that the asset can trade at a higher price, for obvious reasons. Whereas, a direct acquisition may trade at a more realistic market price because the principals may have provided corporate and/or personal guarantees to a lender and just want to trade the asset before a slowing market further affects value. -- Jose Padilla, Partner, AXIS Realty Partners, Miami Beach, FL

Pricing is usually tied to the degree of motivation to move a particular property. The problem here is that many sellers are already leveraged to the max, leaving very little wiggle room. I suspect that a lot of people got aggressive and are stretched farther than is comfortable, especially in markets such as California where negative cash flow property was bought, banking on quick appreciation and sale. -- Jacqueline Ross, President, Investment Strategies Inc., Solana Beach, CA

Sellers are "invested" in the high prices of the past by the way they have their assets financed, by the way they count their personal wealth, and by the false notion that "this will pass, it is only short in duration and, therefore, my asset values will recover." -- Marty Schiffman, Managing Director, Carl Marks & Co. Inc., New York, NY

Sellers are not very realistic in their pricing expectations. They still seem to be drunk on the glorious wine of the past several years, when funding flowed like smooth merlot, and at great terms, driving sale prices up. It will probably take a while longer before they see the effect that tightening of financing sources will surely have on property pricing. -- Judy Brown, Broker/Owner, Swan Real Estate, Louisville, KY

Some sellers are realistic but for the most part they are disappointed in themselves for not selling when the market was at the top. If they need to trade the asset, the expectations will fall in line with the market. That is not to say that good performing assets cannot still command good prices. -- Ryan E. Epstein, National Multi Housing Group, Marcus & Millichap, San Antonio, TX

Buyers are looking for distressed or severely discounted properties and sellers still want "break even" pricing. They don't want to sell anywhere above a 5% cash-on-cash return on a 20% down payment, and buyers are looking for double-digit returns minimum. -- Robert Hullett, NAI The Vaughan Co., Albuquerque, NM

The pricing expectation of sellers is still way out of whack considering the re-pricing of risk caused by the credit crunch. I can't imagine that this negative leverage investment environment can sustain for much longer. I think that the only thing that will bring sellers to lower their pricing expectations is an increase in both interest rates and vacancy as we proceed further into this recessionary cycle. -- Mike Adams, Senior Vice President, Marcus Adams Properties LLC, Los Angeles, CA

Most sellers want to get 2006-2007 prices for their properties. Once their properties sit in the market for a while, then they question their judgment, but it takes them a while. -- Saul Corral, Commercial Sales Specialist, Long & Foster Cos., Vienna, VA

Buyers: Smarter than Sellers?

I wouldn't say investment quality buyers are looking for price discount, rather they are underwriting more conservatively. They will no longer accept unreasonable proformas. Institutional buyers are looking for Class B and/or "value-add." These are their "upside deals" i.e. higher return potential than stabilized assets. -- Carl Trotto, Multifamily Capital Markets, Cushman & Wakefield, Miami, FL

We are seeing much more careful due diligence by buyers, which is being used to help secure those discounts. While it may be prudent, it moves buyer and seller into an even more adversarial relationship which in turn makes getting them together more difficult. -- Graig Griffin, SIOR, Principal, St. George office, Coldwell Banker Commercial KGA, St. George, UT

Buyers have to use today's capital markets for their purchases, which do not accommodate seller's expectations. Terms are exceedingly stingier than when sellers were in their heyday. Henceforth, buyers are "smarter" because they are always more aware of the financing parameters. -- Marty Schiffman, Managing Director, Carl Marks & Co. Inc., New York, NY

We as a company fall into the group of buyers: institutional for a discount. We are hopeful that cap rates will get back up to the 7.5% range for Class A product by year end. There is no doubt that 5% cap deals are not happening anymore. Since we have not acquired anything in the last three years, we encourage a correction. -- Mike Adams, Senior Vice President, Marcus Adams Properties LLC, Los Angeles, CA

Buyers are slow to come to the table because many are anticipating price declines. There are lots of buyers waiting on the sidelines, waiting for a desperate seller. Fortunately for my seller clients, very few are experiencing any sort of distress. -- Peter D. Gillin, Associate, Investment Properties | Private Client Group, CB Richard Ellis | Capital Markets, Anaheim, CA

As far as buyers, they want a deal that "makes sense." But every buyer has a different perception of what "making sense" means. I really think it means a decent spread between the ultimate cap rate and cost of debt. The riskier the deal (meaning lower quality location or asset and more work it needs) the bigger the spread. Buyers are really focused on trailing actual numbers as opposed to 'proforma' or "stabilized" numbers, which was what they focused on in the past. Near term rent growth is very hard to sell in many markets unless it is actually happening or you can truly demonstrate it. When a buyer hears the words "short sale" or "REO" or "foreclosure" they immediately think "rape and pillage the seller". In every case there is a lender involved that is just like any other seller. They want the highest price possible to recoup as much as they can. And in many cases, the loan has not be written down far enough for the lender to have the ability to meet the "market", so they have to keep the asset until they can reappraise it and hopefully get a lower value to justify writing down the book value. Buyers will have to be patient when working with lenders, but will also have to realize that there are going to be other buyers that may pay more. -- Evan P. Kristol, Senior Vice President of Investments, Marcus & Millichap, Fort Lauderdale, FL

New buyers are better able to have both feet on the ground when they evaluate a property's risk profile within their portfolio and set up their debt. Timing is another issue. Many new buyers now have the time to benefit from the asset, given their leverage and the amount of work required by it, while a seller may need to move equity to a new asset for those benefits. That has less to do with the asset and more to do with the placement of property within a portfolio. -- Camille Renshaw, CCIM, Senior Investment Broker Associate,, Colliers Arnold Commercial Real Estate Services, Clearwater, FL

In the multi-unit and shopping center sector, the income and asking price do not match at all. It appears that recently most of the buyers who would have bought some of these properties based on the projected income are holding off and are backing off. -- Armina Ghevian, Keller Williams Commercial, Glendale, CA

Buyers want cash flow and will not settle for negative leverage. They will pay 6.5% to 7% on Class A and 7% plus on B and C. But the only buyers on the market are vultures and a small amount of 1031. -- Fouy Ly, Senior Vice President, Sperry Van Ness, Irvine, CA

I am in the North Atlanta suburbs and I am selling both businesses and commercial real estate. I am finding that business buyers seem to be "coming out of the woodwork" right now. -- Doug Davisson, Commercial Realtor, Atlanta, GA

The Middle Ground: Let the Market Be the Bad Guy

We are able to get deals done for sellers with higher than market pricing expectations as long as they are willing to deal with buyers who have weaker than desired financial strength. This is typically a syndicator who is putting little of his or her own money into the deal, but is able to get the deal financed while at the same time able to raise capital for the equity portion. The property must be purchased at such a price that the buyer can pay debt service plus the preferred return to the investors so the deal must cash flow. In some instances, the sellers are carrying a note or entering into a partnership (small interest) with the buyer to make the deal work. -- David N. Gaines, Senior Associate - Investment Sales, National Multi Housing Group, Marcus & Millichap, Chicago, IL

The key is to manage expectations through the entire process. We counsel sellers on current conditions, get them to more thoroughly prep properties for sale, and teach them to expect harder and more protracted negotiations. We counsel buyers to be sensitive to current seller mentalities, seek out realistic sellers (and brokers), to be patient in the process, and let 'the market' be the bad guy. -- Graig Griffin, SIOR, Principal, St. George office, Coldwell Banker Commercial KGA
St. George, UT

The days of just putting a property out on third-party web sites to sell are over. You need a comprehensive marketing plan that has a foundation in sound underwriting, being in touch with the capital markets and being able to know what is really going on in your marketplace. -- Ryan E. Epstein, National Multi Housing Group, Marcus & Millichap, San Antonio, TX

The key is seller motivation. If they're not really motivated, it won't work. The combination is seller motivation plus low interest rates for the buyers and fixed rates because nobody wants adjustables. -- Mark Squires, Realtor, Coldwell Banker Commercial NRT, Maitland, FL

In the auction world, we spend considerable amounts of upfront time with sellers listening and analyzing their situation in order to make a thoughtful and appropriate recommendation as to whether our services are a good fit. If not, we provide counsel and recommendations as to other exit strategies that might be more successful in reaching the seller's expectation. -- Mike Carey, National Account Coordinator, Tranzon Auction Properties, Portland, ME

You can often achieve the desired results without a cash sale. What is a problem for one person is ideal for someone else. In fact, I think we're going to see a lot more creative equity exchanging in the next little while. It will be up to brokers and other real estate professionals to educate sellers to the opportunities that are available outside the 'all-cash' box. -- Jacqueline Ross, President, Investment Strategies Inc., Solana Beach, CA

Some of the asset classes we are looking at still appear to be overpriced. And, in an increasing number of cases, we have noted that while we may not have been the high bidder, we are being asked back to the party, when the high bidder fails to perform. I think there will be more of this given the current lending environment. The most obvious way to bring buyer and seller to terms is having no financing contingency on an acquisition and a short due diligence period, or pay the seller's asking price, but as all of us know, this is not always possible or prudent. -- Jose Padilla, Partner, AXIS Realty Partners, Miami Beach, FL