Tag Archives: Tampa Commercial Real Estate News

Understanding Cash on Cash Return in Commercial Real Estate

Cash Fow

By: Robert Schmidt
Cash on cash return in commercial real estate is important when you are evaluating investment real estate transactions. What is the cash on cash return and how do you calculate it for a commercial property? What are the limitations of using this method? In this article we’ll tackle these questions and also provide some detailed examples of the cash on cash return.

Cash on Cash Return Formula

Before diving into some cash on cash return examples, it is important to have a sound understanding of exactly what the term means. So, let’s start with the basics. First, here’s the cash on cash return formula:

cash_on_cash_return_formula

As shown in the cash on cash formula above, the cash on cash return is a simple measure of investment performance that is calculated as cash flow before taxes divided by the initial equity investment. The cash flow before tax figure for each year is calculated on the real estate proforma, and the initial equity investment is simply the total purchase price less any loan proceeds.

Cash on Cash Return Example

Next, let’s take a simple example to illustrate the cash on cash return. Suppose you are evaluating an office building with an estimated Year 1 Cash Flow Before Tax of $60,000. Also, assume that the negotiated purchase price of the property is $1,200,000 and you are able to secure a loan for $900,000 (75% Loan to Value). What’s your cash on cash return for year 1?

cash_on_cash_return_example

The calculation itself is pretty simple – your cash on cash return for year 1 would be the Year 1 cash flow divided by your total cash out of pocket, which equals 20%. So what does this simple measure of investment performance tell you? Using only the figures above, the cash on cash return tells you that your year 1 return on investment is 20%. This of course assumes that your initial equity investment figure and also your cash flow projection is correct.

Cash on Cash Return Limitations

The cash on cash return is a simple measure of investment performance that is quick and easy. It can be a good starting point for quickly filtering out potential investment properties. But don’t be fooled by the many limitations of the cash on cash return.

Consider the following series of cash flows:

cash on cash return limitations

The year 1 cash on cash return in the levered example above shows a 3% cash on cash return. To find this simply take the end of year (EOY) 1 cash flow of $15,805 and divide it by the initial equity investment of $515,000.

But as you can see in the table above, the internal rate of return (IRR) is 10.71%. This suggests that according to a discounted cash flow analysis, the investment is actually much better (almost 4x better) than what’s indicated by the cash on cash return. If you were only using the cash on cash return as an investment filter, then you’d pass up this opportunity to earn nearly 11%.

The reason why the cash on cash return is so much lower than the IRR in the example above is because the cash on cash return ignores the other 9 years of operating cash flows in the holding period. Plus, it also ignores the reversion cash flow at the end of year 10 that comes from the sale of the asset. Without taking into account these additional cash flows that occur over the holding period, it’s impossible for the cash on cash return to accurately reflect the return characteristics of the property.

The same is true when looking at the unlevered example above. The cash on cash return in the unlevered series of cash flows above is 6.2% ($95,000 divided by $1,515,000), and the IRR is 7.51%. This series of cash flows doesn’t produce as big of a gap as in the levered example, but it’s still a difference. Without taking into account all cash flows over the holding period, the gap between the cash on cash return and the IRR will be unknown.

As a side note – keep in mind that this can work in reverse too. In the above examples the IRR was higher than the cash on cash return because operating cash flows grow over the holding period and the sales proceeds of the asset are favorable. But it could also be the case that many leases will expire a few years after acquisition, causing operating cash flow to decline and the final reversion cash flow to be lower. This could produce the opposite result where the cash on cash return ends up being more favorable than the IRR.

Discounted Cash Flow Analysis

As shown in the example above, a discounted cash flow analysis provides a much more complete return profile of an investment property. Sure, simple measures of investment performance like the cash on cash return work as a starting point in your evaluation. But as your interest in a property becomes more serious, so should your analysis.

A discounted cash flow analysis uses concepts of the time value of money to value a commercial real estate asset. When looking at a time period extending out over a number of years, a DCF analysis estimates future cash flows and discounts cash flows back to the present. Using the discounted cash flow analysis will require forecasting future cash flows (incoming and outgoing), determining the necessary total return, and then discounting the forecasted cash flows back to the present at the necessary rate of return.

Sourced By: Property Metrics

Top 10 Reasons to Move to Tampa Bay

Image

Top 10 Reasons to Move to Tampa Bay

Sourced By: Image

1. WORKFORCE

Tampa Bay ranked among the top 10 large metro areas for college-educated young talent on the move. The latest Census data reveals that young people aged 25 to 29 are increasingly more mobile and willing to move to new cities, very often in new states, in search of jobs.

2. K-12 EDUCATION

Florida leads the nation in high school seniors taking Advanced Placement exams at nearly 50 percent. Florida also ranks sixth in the nation for the percentage of students who score a 3 or higher on the AP exam at 23.9 percent, compared to the national average of 18.1 percent.

3. PROGRESSIVE TRAINING

An independent analysis of the CareerEdge Funders Collaborative by Urban Market Ventures found that the investments made by the nonprofit workforce-development program is producing millions of dollars in new wages and economic impact for the Tampa Bay region.

4. MILITARY INVESTMENT

Tampa Bay is home to MacDill Air Force Base, the only military installation that hosts two, four-star Combatant Commands, the U.S. Central Command and U.S. Special Operations Command. MacDill contributes $5 billion annually to the greater Tampa Bay economy.

5. AMAZING PARKS AND RECREATION

Tampa’s Curtis Hixon Park was named among America’s Best New Parks by The Atlantic Cities. Completed in 2011, the waterfront park serves as a more natural connection between the water, downtown, and the new Children’s Museum and Tampa Art Museum. Tampa Bay’s beloved public spaces spread throughout the region provide gathering places for families, friends, colleagues, and events from small to large scale.

6. PROMISING AND ADMIRED COMPANIES

Some of America’s most promising companies are located in Tampa Bay. Sarasota-based Internet communication systems and service provider, Star2Star Communications was named among America’s 100 Most Promising Companies by Forbes. The company also made the 2011 Inc. 500 list of fastest growing private companies.

7. INNOVATIVE UNIVERSITIES

The University of South Florida is ranked 50th in the nation for research expenditures by the National Science Foundation among all U.S. universities, public or private, joining the ranks of Johns Hopkins, Stanford, Yale and Harvard.

8. EXPANSIVE MEDIA REACH

The Tampa Bay region is the 14th largest television media market in the country, with 1.79 million TV households, according to Nielsen Media Research. That means Tampa Bay has 1.6 percent of all television households in the United States. It is the largest market in Florida – surpassing Miami. If you’re looking for media exposure, you’ve found it.

9. LOW COST OF DOING BUSINESS

According to a KPMG business cost study, the Tampa Bay market is the nation’s lowest cost large market for Corporate Services, International Financial Services and Shared Services – a testament to strong business, financial and data services sector in Tampa Bay.  KPMG’s 2012 Competitive Alternatives study measured 26 significant cost components over a 10 year planning horizon.  Bottom line – Tampa Bay is a great place for business.

10. HOT ENTREPRENEURIAL ENVIRONMENT

According to FastCompany Magazine, Florida’s start-up environment is soaring high. From the HuB in Sarasota to Tampa Bay WaVE’s First WaVE program to large events such as Start-Up Weekend and initiatives like the Tampa Bay 6/20 Plan, Tampa Bay’s entrepreneurial environment is setting up for start-up success.

Lessons Learned From Outside The Industry

ImageTMC The Mahr Company lessons from outside the industry: [The Seattle Seahawks, Bono and U2, and Bank of America]: (1) Reinvent with CANEI (Constant and Never Ending Improvement), (2) Stay with or ahead of trends, (3) Brand, Promote, Execute, Deliver,(4) Contribute to the greater good, (4) Dare to excel and surround yourself with talented motivated people desiring the same, (5) Do not accept other’s preconceived expectations,(6) Failure is not an option, Take action and act as if it is impossible to fail, (7) Proceed as if limits to your ability do not exist: The Seattle Seahawks Nail it. Nike transforms their uniforms to perhaps the coolest in the NFL, Bono and U2 deliver for the Bank of America in support of RED with “Invisible”, Coach Carroll assembles a team with talent to spare. they execute and deliver…..   Follow this link for U2’s “Invisible” http://bit.ly/1iljxDF

Ever Wonder What The Difference Is Between Rentable Square Feet versus Usable Square Feet

December 19, 2013 By Ben O’Grady
Sourced by: Property Metrics

One of the first steps in evaluating a commercial property is determining the total rentable square feet. While this might seem like a straightforward calculation, it unfortunately doesn’t always end up being so simple. This is particularly true for multi-tenant buildings. In this article we’ll go over how to calculate rentable square feet (RSF), usable square feet (USF), and the load factor, then we’ll tie it all together with a clear example.

Usable Square Feet

In a nutshell, usable square footage is the actual space you occupy from wall to wall. Usable square footage does not include common areas of a building such as lobbies, restrooms, stairwells, storage rooms, and shared hallways. For tenants leasing an entire floor or several floors, the usable square footage would include the hallways and restrooms exclusively serving their floor(s).

Rentable Square Feet

Rentable square footage is your usable square footage PLUS a portion of the building’s shared space. As mentioned above, shared space can be anything that is outside of your occupied space and is of benefit to you (lobbies, restrooms, hallways, etc). As a tenant in a commercial space, you pay for a portion of the shared space and thus your monthly rent is always calculated on RSF.

The increase in the the rentable square footage above your usable square footage is referred to variously as the “load factor,” “common area factor,” or “add-on factor.” This is generally in the 10-15% range and can be higher in some buildings. When evaluating commercial real estate space options, you’ll want to be aware of this factor so you know exactly what you’re getting and what you’re paying for.

How to Calculate Load Factor

Calculating the load factor is pretty straightforward. First, find out how much total floor area a building has. Then, subtract the shared square footage to determine the usable square footage. The owner or owner’s agent should be able to give you these numbers. Then divide the total floor space by the USF to get the load factor.

Rentable Square Feet Load Factor

Example: A 100,000 square foot building has 15,000 square feet of shared space. The usable square footage is 85,000 square feet. The load factor would be 1.176 (100,000 / 85,000). That would also be the same as saying the building has a load factor of 17.6%.

Rentable Square Feet vs Usable Square Feet Example

Let’s look at a quick scenario when comparing load factors and rentable square footage to see why it’s useful.

The situation
A tenant is looking at two different office spaces, both with 5,000 square feet of usable space and the exact same rental rates, but differing load factors.

Option A
The first suite has 5,000 usable square feet and has a 20% building load factor for an additional 1,000 sf (5000 x 20%) of rentable space. Thus, the rentable square feet is 6,000 square feet.

Option B
The second office has 5,000 usable square feet and a 15% load factor. The rentable square footage is 5,750 sf (5,000 x .15 = 750). Option B has less rentable square footage and thus would cost less per month for the same amount of usable space!

With the same rental rate, the tenant would pay more per month on his lease for Option A at 6,000 rentable square feet. However, one factor to consider is with higher load factors, are you getting better shared amenities that justify the cost? In some cases, a fancier lobby and shared kitchen area could be enough of a draw to justify the higher cost for the same amount of usable square footage.

As shown above, rentable square feet is not always so simple. To make matters worse, sometimes landlords will even fudge the load factor and USF numbers to the point where it becomes part of the negotiation process itself. As with all commercial real estate leases, always read the fine print so you understand exactly what you’re paying for and exactly what you’re getting in return.

CRE Market forecast 2014 – Hungry For Returns

Can investors stomach a side order of risk?

by Kenneth P. Riggs Jr., CCIM, CRE, MAI

As investors dealt with so much fiscal uncertainty in 2013 — the budget deficit, potential tax increases, raising of the debt ceiling, and higher health insurance premiums associated with the Affordable Care Act just to name a few — it is almost a relief to get back to worrying about the basics. Concerns such as the economy, capital markets, and monetary policy, as well as geopolitical challenges, have taken a back seat in news reports and day-to-day conversations.

Even so, as investors search for alpha, or above-average expected returns in their real estate holdings, questions remain as they seek to balance their appetite for returns versus their apprehension of risk. Have the Federal Reserve’s extremely accommodative policies created asset price inflation in the commercial real estate market? Are we looking at a potential correction or potentially lower returns? Are we facing another inflection point for commercial real estate or will property values continue to appreciate and provide good annual returns? Which property types and locations have the most opportunity for solid returns in this uncertain climate? Is the risk systemic?

Capital Continues to Flow

Although the U.S. has seen generally positive economic traction since the recovery began, growth continues to stumble along, with little inspiration beyond the addition of the various forms of quantitative easing, including very low short-term interest rates incorporated by the Federal Reserve. Even so, Real Estate Research Corp.’s institutional investment survey respondents projected that the economy would grow at a rate of approximately 2.4 percent in 2014, which is only slightly lower than the 2.6 percent growth projection that the International Monetary Fund issued for the U.S. economy.

In addition, some investors have noted that there is more capital available than solid product in which to invest, and as such, pricing has become quite aggressive for certain top-tier properties in the major markets. Further, as investors’ appetite for returns increases, their willingness to take on a little more risk has been increasing, and we are seeing increasing amounts of capital available for properties in secondary and tertiary markets.

While the availability of capital continues to increase for such properties, the gap between the availability and discipline of capital has been widening. As shown in Figure 1, the availability of capital rose to 7.6 on a scale of 1 to 10, with 10 being high, while the discipline of capital was rated at 6.4, as reported in the 3Q13 RERC Real Estate Report.

Despite repeated reassurance from the Federal Reserve about keeping interest rates low, the fragile markets were taken aback last spring when the Fed first introduced its plan to eventually begin tapering its qualitative easing program. The stock market sank and 10-year Treasury yield rates nearly doubled as investors faced a riskier future. Although the stock market has improved considerably since that time and the major indices have reached new highs, 10-year Treasury yield rates have been steadily increasing, indicating continued risk in the market.

During 3Q13, the 10-year Treasury rate increased 70 basis points to 2.7 percent, which is the fourth consecutive quarter of increases since its historic low in 3Q12. Figure 2 presents the spread between RERC’s required pre-tax yield rates, or internal rates of return, and 10-year Treasurys and also the spread between RERC’s required capitalization rates and 10-year Treasurys. Given the significant increase in the 10-year Treasury rate, the spreads for both the pre-tax yield rate and going-in cap rate over Treasurys have declined to 570 basis points and 400 basis points respectively. Although the spreads have been declining, they are still near their 10-year averages, showing the continued attractiveness of risk-adjusted returns for commercial real estate.

What Are the Trends Showing?

For the most part, commercial real estate investment trends have continued to improve over the past year, although the improvements have been achingly slow. RERC anticipates fundamentals to continue to make measured progress in 2014, in keeping with the slow-growing economy and sluggish job growth, while future risk appears to be primarily associated with increasing fiscal and political maneuvering related to the fall 2014 election.

In general, transaction volume has increased during the past 12 months, with total volume increasing approximately 25 percent on a year-over-year basis to $89.7 billion in 3Q13, according to Real Capital Analytics. Vacancy has decreased slightly for all property types in 2013 as absorption has increased and new construction was minimal, except in the apartment sector, while rents have increased only slightly according to Reis.

From the standpoint of returns, RERC’s required pre-tax yield and going-in and terminal cap rate expectations have continued to decrease in 2013, although they appear to have stabilized somewhat during the last few quarters as depicted in Figure 3. The “All Property Types Average” required pre-tax yield rate and required going-in and terminal cap rates for unleveraged properties further stabilized in 3Q13. RERC’s return expectations have nearly reverted to levels experienced before the credit crisis and Great Recession.

Office. With positive absorption throughout the year, the national office sector’s vacancy rate declined to 16.9 percent in 3Q13 from 17.2 percent a year earlier, according to Reis, and effective rents increased to $23.32 per square foot, an average of 2.3 percent for the year. Total office transaction volume for third quarter was $24.5 billion, a 36-percent increase over the previous year’s volume, per RCA, while the average price increased 12 percent to $233 psf. However, RERC’s average required pre-tax yield rate (discount rate) for unleveraged office properties declined to 8.1 percent in 3Q13, while the required going-in and terminal cap rates decreased to 6.5 percent and 7.2 percent, respectively. As for 2014, Reis projects the vacancy rate to continue to improve, declining to 16.5 percent by the end of the year, and for rental rates to increase 3.4 percent.

Industrial. The availability rate for the industrial sector declined to 11.7 percent during 3Q13, according to CBRE. This was a 30 basis point decline from the previous quarter and a 130 basis point decline from the previous year. According to Newmark Grubb Knight Frank, asking rents for industrial properties increased to $5.72 psf in third quarter. Transaction volume for the industrial sector increased to $14.2 billion in third quarter, a 70 percent increase from 3Q12, while the average price inched up slightly to $65 psf, according to RCA. RERC’s required pre-tax yield rate for unleveraged industrial properties remained flat at 8.1 percent in third quarter, and the required going-in cap rate fell 20 basis points to 6.5 percent as the required terminal cap rate held steady at 7.2 percent. Although absorption is still outpacing completions, both are expected to increase in 2014, according to NGKF data, and asking rent is projected to increase to $5.95 psf.

Retail. Positive absorption continued for the neighborhood/community retail sector, with the average vacancy rate dipping to 10.5 percent in 3Q13 from 10.8 percent in 2012, according to Reis. Effective rents increased to $16.74 psf, which was up only 0.4 percent for the quarter and 1.4 percent YOY. In addition, retail property transactions increased by approximately 25 percent to $19.2 billion in 3Q13, and more than doubled during the past year, according to RCA. Although the average price of retail space declined slightly to $170 psf in 3Q13 from the prior quarter, this was a 13.0 percent increase over year-ago prices. RERC’s required pre-tax yield rate for unleveraged retail properties increased slightly to an average of 8.0 percent in 3Q13, as the required going-in cap rate fell slightly to 6.4 percent and the required terminal cap rate increased 20 basis points to 7.1 percent. In 2014, neighborhood/community retail vacancy is expected to decline to 10.1 percent and effective rents should increase 2.2 percent on an annual basis, per Reis.

Multifamily. With 123,518 completions in 3Q13 — the highest amount since 2009 — the vacancy rate for the apartment sector still managed to decline to 4.2 percent in third quarter from 4.7 percent a year ago, according to Reis. Effective rent growth increased 3.2 percent on an annual basis to $1,074 per unit in third quarter. Although transaction volume increased about 20 percent to $22.1 billion in 3Q13 from the previous quarter, volume was down 20 percent from year-ago figures, according to RCA. In addition, the price for apartment properties has been inching downward over the past year to an average of $107,240 per unit in 3Q13. RERC’s required pre-tax yield and going-in and terminal cap rates for unleveraged apartment properties remained unchanged in third quarter. Reis does not expect vacancy to improve much in 2014, but effective rent should improve approximately 3.3 percent annually for this sector.

Hotel. Fundamentals for the hotel sector, which is generally viewed as slightly more risky than the other property sectors, have been steadily improving over the past year. According to Smith Travel Research, occupancy increased to 67.8 percent in 3Q13, a YOY increase of 5.8 percent. In addition, the average daily rate climbed to $115.47, an increase of 8.3 percent from the previous quarter, while revenue per available room rose 14.5 percent to $78.31. Unlike the other property sectors, transaction volume and pricing declined for the hotel sector in 3Q13 from the previous quarter, but the third-quarter volume of $5.7 billion and the average price of $136,473 per unit was 14.0 percent higher than year-ago volume and price, per RCA. In addition, investors are requiring a slightly higher risk premium for investing in hotel properties, and RERC’s required pre-tax yield rate increased 20 basis points to 10.0 percent in third quarter for unleveraged hotel properties. RERC’s required going-in cap rate remained unchanged at 8.0 percent, while the required terminal cap rate increased slightly to 8.7 percent. After minimal supply growth during the past couple years, hotel construction is expected to begin to increase, with occupancy, ADR, and RevPAR increasing at a similar pace in 2014.

Effects on Alpha

RERC expects appreciation on commercial real estate — and total returns by extension — to slow slightly in 2014 as we gain clarity in monetary policy and other issues. If the Federal Reserve tapers its policy of monthly bond purchases soon, money may be less available and become more expensive in 2014. In addition, appreciation is likely to decline as sales of class B or good-quality assets in second-tier markets become more common.

RERC forecasts aggregate National Council of Real Estate Investment Fiduciaries values as presented in the NCREIF Property Index to increase by approximately 2.75 percent throughout 2014. As of 3Q13, year-to-date values have increased by 3.9 percent and total return has increased by 8.3 percent. RERC’s projection is bracketed by upside and downside scenarios that reflect a projected value change in 2014, with the base case near 2.75 percent for appreciation. Add an income return of 6.0 percent and total returns in 2014 are expected to have a base case near 8.75 percent on an unleveraged basis for the year.

Although commercial real estate returns were mostly favorable in 2013, the risk for commercial real estate is inching up, as demonstrated in Table 1, where the 3Q13 return vs. risk rating for commercial real estate overall declined to 5.6 on a scale of 1 to 10, with 10 being high. The ratings in this table also show that investors anticipate slightly lower near-term returns in comparison to the amount of risk for the office and industrial sectors, and slightly better returns compared to the risk for the retail and apartment sectors.

Further, RERC’s value vs. price rating, also shown in Table 1, declined slightly for commercial real estate overall in third quarter, as well as the ratings for the office, industrial, and retail sectors, indicating that the value is declining slightly in relation to the price. As depicted, the value vs. price rating for the apartment sector has already declined to 4.8 on a scale of 1 to 10, with 10 being high, suggesting that the value for this sector is already generally less than the price of this property sector. Interestingly, the value vs. price rating for the hotel sector was slightly higher, reflecting slightly higher value in relation to the price.

Risk: It’s a Fact of Life

While many wonder whether the return on commercial real estate, particularly in challenged markets, will outweigh its risk, it is important to remember that there is an element of risk in every investment. However, broadly speaking, RERC believes that commercial real estate is still a good investment compared to the alternatives, and that returns are available on a risk-adjusted basis to astute investors.

The investment characteristics for real estate are more transparent than those for many other investments. Part of the value of the asset class is that it is a tangible asset vs. a paper asset. In addition, commercial real estate offers reasonable returns, and although the returns are generally not as high as recent stock market trends, they are not as volatile either. Finally, commercial real estate returns are based on both appreciation and dividends, therefore providing a reliable source of income. And when all is said and done, that may be as good a way to pursue alpha as any.

 

Kenneth P. Riggs Jr., CCIM, CRE, MAI, is president of Real Estate Research Corp. (www.rerc.com) and publisher of the quarterly RERC Real Estate Report. For more information or for a special CCIM discount to the report, contact RERC at publications@rerc.com.

 

2014 Opportunity Markets

Although commercial real estate has generally recovered in many of the major coastal markets and prices have returned to pre-recession levels — and some reports show prices surpassing those levels in some cities — there are still good opportunities to purchase quality properties throughout the U.S.

Seeking Alpha in 2014

•   Both debt and equity will likely be more expensive in 2014, although liquidity should be available for good investments. If you haven’t already done so, lock-in low interest rates soon.

•   The coastal markets are likely to be too expensive for the majority of commercial real estate investors, but there should be good opportunities for pursue solid risk-adjusted returns in the secondary and tertiary markets.

•   Niche properties such as storage, student housing, and medical-related facilities offer diversity from core property selections.

•   Property fundamentals are not expected to increase broadly in 2014, as economic growth is expected to remain sluggish.

•   Total returns are likely to decline slightly in 2014, as the appreciation component of commercial real estate investment is likely to see downward pressure compared to 2013.

•   Generally speaking, look for industrial properties to continue to perform well, along with neighborhood/community retail properties.

– See more at: http://www.ccim.com/cire-magazine/articles/323388/2014/01/hungry-returns#sthash.SKVJpJ2X.dpuf

Market Analysis: “A Stronger Asset” from CCIM Institute

New sources of capital and increased demand have strengthened the commercial real estate market.
by William Hughes

The current economic landscape has assembled an array of factors to structurally change real estate investment standards. The intertwining of the U.S. and global economies, deeper integration of liability and equity markets, and the accelerated adoption of real estate investment trusts and commercial mortgage-backed securities as major components of the sector have all contributed to this evolution. Furthermore, increased access to a variety of capital sources, combined with a multitude of real estate investment vehicles, has resulted in real estate investment earning its place as a mainstream asset class.

For today’s real estate investor, advanced facts and figures, deeper liquidity, and a range of broad investment opportunities that reach beyond merely primary metros have all allowed the further mitigation of risk. As supply cycles continue their two-decade trend of stabilization, the sector remains less volatile as a whole. Convergence of these influences has refined the foundation for attractive real estate cost positioning, resulting generally in falling capitalization rates over the last 20 years.

Cap Rate Movement

Typically, cap rates are inclined to stay range-bound during economic inflection points, with a usual variance of between 100 and 130 basis points. Whereas the length and severity of the the 2009 Great Recession and the 2001 Recession were markedly different, the recovery trends of cap rate performance proved surprisingly similar.

During the peak of the financial crisis, cap rates expanded from 6.9 percent to 8.1 percent between 2007 and 2009 before making a remarkably accelerated recovery, especially given the depth of the recession, according to figures from Real Capital Analytics, CoStar, and Marcus & Millichap Research Services. While the annualized yield on the 10-year Treasury declined 280 basis points to 1.8 percent between 2002 and 2012, the mean annualized cap rate for all property types dropped 150 basis points. Since the end of 2012, the 10-year yield has abruptly expanded 100 basis points to 2.9 percent as of September 2013. In evaluation, the mean cap rate proved more steady, edging down only about 10 basis points to 7.2 percent. While a delayed effect is still a possibility, forecasting the potential magnitude requires deeper analysis.

Throughout the Great Recession, the Federal Reserve has held the federal funds rate to nearly zero while infusing huge volumes of capital into the financial markets. The expanded period of monetary easing and the absence of government-supported distress sales have boosted the national mortgage market. This paved the way for cap rates and real estate values to bounce back far more quickly than in previous recessions and well ahead of an actual operating recovery. The exception to this trend occurred in multifamily properties, which recovered even faster than the other sectors.

Whereas tough credit underwriting continues to be an obstacle for potential borrowers, the Federal Reserve’s accommodative policies aimed at reducing near-term interest rate risk have aided in the refinancing and restructuring of maturing and difficult loans. This has resulted in more capital entering real estate as a comparatively sound alternative to reduced yield bonds and volatile equity markets.

A Hybrid Investment

Since the market bottomed in 2009-10, commercial real estate investors have favored the greater certainty of top-tier markets and properties with proven cash flows, despite their generally lower yields; this focus on prime markets limited meaningful price recovery to coastal and urban core markets, until investor interest began to spread a year-and-a-half ago. With most gateway primary markets having substantially recovered, occupancy and rent growth momentum has expanded to late-recovery secondary and tertiary metros. These areas may garner higher yields and offer room for net operating income gains, but they also carry higher risk. Many of these areas face relatively higher overdevelopment threats, less consistent demand, and more shallow liquidity, all of which could affect investor exit strategies. Reflecting these trends, the maturing primary markets have faced slowing cap rate compression and even rate upticks. Conversely, cap rates in secondary markets have tightened, supported by stronger operational momentum and sales volume. Naturally, investor risk will depend in part upon a market’s position along the arc of the real estate cycle and the investment time horizon.

The hybrid nature of commercial real estate makes it a compelling investment option, with a bond-like cash flow component even during economic downturns, as well as an appreciation component that often acts as a hedge against inflation, considering that property owners benefit from increasing rents and property values when inflation rises. In addition, many long-term leases contain consumer price index rent increases, while shorter-term leases allow investors to quickly adjust to market rates.

Rising Interest Rates

A period of falling cap rates helps elevate returns via appreciation. Rising interest rates — reflecting stronger economic activity — generally exert upward pressure on cap rates, requiring an increased emphasis on income growth to offset slower appreciation and higher financing cost. However, healed and expanding credit markets, strong global investor demand for U.S. real estate, and continued recovery in property fundamentals will help counterbalance the magnitude of rising rates, and lend support to property values. Having already absorbed a significant increase in interest rates, further cap rate changes should tie less to speculation regarding Fed policy and correlate more with measurable economic performance.

Debt and equity markets should remain stable for the foreseeable future. However, the environment is not without risk, and near-term volatility should be expected. The pending appointment of a new Federal Reserve chief, looming debt ceiling discussions, geopolitical tensions in the Middle East, and the effects of sequestration and declines in federal spending will hamper economic growth.

In addition, changes in monetary policy always present a risk to the economy. In this light, the Fed has demonstrated considerable dexterity, and should gradually exit qualitative easing in an orderly manner by slowly decreasing bond purchases and letting some securities mature. The Federal Open Market Committee has issued interest rate guidance, stating that the federal funds will remain range-bound between 0 to .25 percent at least until mid-2015, underscoring that monetary tightening would begin only after an economic and employment recovery has been well established. The Fed also noted that the tightening process would occur at a more gradual pace than historical precedent. 

Surely, higher interest rates will impact investors across the board. As financing costs rise, so will investors’ required returns. At a minimum, increased financing costs will decay some of the cap rate arbitrage of buying into secondary and tertiary markets, or value-add and opportunistic assets. However, the stride of occupancy and lease growth is likely to exceed that of primary markets and core assets for the midterm outlook. Demand for all commercial real estate, sustained by the reinforcing economy, remains solid, and supply risks are negligible for most property types. As a result, performance profits and other components will considerably counteract the effect of rising interesting rates, at least for the near term.  William Hughes

National Flood Insurance Program Update

Posted November 22nd 2013

In 2012, the Biggert-Waters Flood Insurance Reform Act (“the Act”) was enacted. The goal of this legislation was to stabilize and revise the National Flood Insurance Program (NFIP). Provisions of the Act will roll out in stages, including some that have already occurred. On October 1, one portion of the Act went into effect which would require the Federal Emergency Management Agency (FEMA) to remove flood insurance subsidies for certain properties across the country.

Unfortunately, some of the flooding zones were inaccurately tagged so many areas are misrepresented on flood maps used by insurance companies. This has resulted in serious cause for concern by property owners because premiums increased at drastic rates without consistency among insurance providers. One of the Act’s co-authors, Representative Maxine Waters, says “inaccurate mapping” and “incomplete data [have] led to unreasonable and unimaginable increases in premiums.”

Although the Biggert-Waters Flood Insurance Reform Act significantly impacts flood hazard areas, the law poses great risk to property ownership. CCIM Institute is concerned with the significant rate increases impacting members who manage or own multifamily residential and commercial properties.

Legislation titled the “Homeowner Flood Insurance Affordability Act” (S. 1610 / H.R. 3370) has been introduced to address the exorbitant premium rate increases. The legislation would delay the rate increases sparked by the Biggert-Waters Act to allow FEMA time to provide accurate flood maps and to complete an affordability study that would look at the impact of the new rate structure.

The Affordability Act has garnered wide bipartisan support with H.R. 3370 having 138 cosponsors and the senate companion bill, S. 1610, having 23 cosponsors, as of November 21. 

If you have experienced significant rate increases since 2012, please contact the government affairs department at legislative-affairs@ccim.com.

– See more at: http://www.ccim.com/newscenter/323356/2013/11/22/national-flood-insurance-program-update#sthash.hnBZFxAL.dpuf