Southern California Industrial Real Estate Blog

TECHNOLOGY AND THE DEMAND FOR COMMERCIAL REAL ESTATE

Research Brief - TECHNOLOGY AND THE DEMAND FOR COMMERCIAL REAL ESTATE
 

• Technology will be an increasingly important influence on the demand for commercial real estate, especially as tenant demands for different types of building technology evolve.
 

• Technology, as it drives overall growth in the economy, will have a generally positive impact on commercial real estate demand.
 

• The demand for intelligent building attributes will vary both by property type and geographic market.
 

THE STUDY
This study examines how technology affects the demand for commercial real estate in three primary ways: 1) on overall tenant demand by property type; 2) on tenant demand for particular buildings; and 3) on demand for properties by investors. The analysis in this study is based on
interviews and a review of articles, reports and databases addressing technology change and real estate demand.
 

FINDINGS
There are many attributes of an intelligent building. Depending on the intended use of any particular building, these characteristics will vary in importance. The most important attribute, in general across all property types, is the voice and data communications network. Other important
building attributes include energy efficiency, lighting and security.
 

Among the key conclusions of the report are:
 

• Relatively few industrial owners are interested in intelligent building technology and are instead focused on other characteristics that appeal to the widest possible range of tenants.
 

• The demand for intelligent building technologies for office tenants is in its infancy. Other factors such as overall costs and proximity to employees and customers still dominate.
 

• The most important technology attribute for multifamily is highspeed Internet access, while most other technologies are viewed as less important.
 

• Telecommunications and adaptability of space are key features for retail tenants although technologies that improve energy efficiency, security, and lighting can reduce owners’ expenses.
 

• The demand for many technologies is relatively undeveloped for hotel properties although it is generally not too costly to wire hotel rooms for high-speed Internet access.
 

The demand for intelligent building attributes as well as the overall influence of technology on commercial real estate demand will vary by geographic market.
 

Info courtesy of Scott R. Muldavin, The Muldavin Company, Inc.
 

*The complete report is available at www.realtor.org/research.nsf/pages/NatlcenterforRE
 

Commercial Strength Buffers Slowdown

Study: Commercial Strength Buffers Slowdown

What’s kept the economy perking during the housing slowdown? Look to the commercial real estate market says the National Association of Industrial and Office Properties.

A recent study conducted by Dr. Stephen S. Fuller, director of the Center for Regional Analysis at George Mason University, for NAIOP Research Foundation credits “the thriving commercial development sector” with buffering the slowdown in the residential sector.

The study found that spending related to commercial real estate added $498.4 billion to the GDP in 2005. By comparison, the federal government’s contribution that year was $498.8 billion.

Spending on commercial real estate included:

• $228.93 billion on soft costs (architects, engineering, marketing, legal, management), site development, and tenant improvements
• $265.9 billion on the hard costs, or actual construction outlays
• $3.6 billion on maintenance

“By 2005, all sub-sectors of nonresidential construction were accelerating, helping to offset slowing residential building construction outlays in 2006 and 2007,” Fuller said. “This counterbalance kept the national economy from experiencing a sharper slowdown in the face of rising energy costs and lost output due to Hurricanes Katrina and Rita.”

Most recently, in March 2007, spending costs rose 2.4 percent, which according to Thomas Bisacquino, president of NAIOP, “more than makes up for the 1 percent drop in residential construction.”

Leading States for Commercial Construction Spending

The top 10 states for construction spending are:

1. California
2. Texas
3. Florida
4. Georgia
5. Illinois
6. Indiana
7. New York
8. Ohio
9. Virginia
10. Arizona

In terms of individual sectors, Texas ranked first for industrial spending, while California led the states in spending for office, industrial, warehouse, and retail categories.

— By Camilla McLaughlin for REALTOR® Magazine Online

Where the Millionaires Live, Work + Buy

Where the Millionaires Live, Work + Buy

The number of U.S. millionaire households has risen to a record high of 9.3 million as of mid-2006, up 5 percent from 2005, according to TNS Global’s annual Affluent Market Research Program.

The millionaires’ mean net worth, not including their primary residence, is $2,167,167 with investable assets of $1,442,841. Their median age is 58 and 45 percent are retired.

Forty-six percent of millionaire households own investment real estate such as a second home, third home, rental properties, and undeveloped land. Thirty-four percent have a first mortgage on these residences and 25 percent have second mortgages on these additional residences.

The TNS study identified 10 counties with the highest number of millionaire residents.

• Los Angeles County with 268,136
• Cook County, Ill., 171,118
• Orange County, Calif., 116,157
• Maricopa County, Ariz., 113,414
• San Diego County, Calif., 102,138
• Harris County, Texas, 99,504
• Nassau County, N.Y., 79,704
• Santa Clara County, Calif., 74,824
• Palm Beach County, Fla., 71,221
• King County, Ore., 68,390

Source: Associated Press (05/01/07)

THE MANY WAYS TO DIVERT PAYING TAXES ON THE SALE OF A PROPERTY

 THE MANY WAYS TO DIVERT PAYING TAXES ON THE SALE OF A PROPERTY

Alex owns a couple of income properties in trendy Venice. He bought them way back in undesirable days for $75,000 apiece. Each property is now worth $950,000 or more. Alex is 61 years old. He thinks about selling off some of his holdings and traveling. But he has questions – Alex needs to know what his tax obligations are once he sells a property?
 
Should Alex decide to pay capital gains tax, and pocket the rest of the gain, the terms have become more desirable. For property sales transactions which conclude between May 6, 2003 and December 31, 2008, the capital gains tax rate has been reduced from 20 percent to 15 percent. For taxpayers in the lower brackets of 10 or 15 percent, the tax will only be five percent of the gain.
 
As for what to do with your money, you have a number of options. Before taking any action, be sure to consult your financial advisor. Benny Kass, senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in real estate observed that property options can include:
 
1.     Sell and pay the tax: Assume Alex has depreciated the property by $30,000 over the years. His basis in the property will be $45,000 ($75,000 - $30,000). If he were to sell the property for $1,000,000, he will have made a profit of $955,000 ($1,000,000 - $45,000). This does not take into account other costs and expenses which may reduce his gain - fix-up costs, closing fees, and real estate commissions. For Federal tax purposes, Alex will owe Uncle Sam $143,250 (at the 15 percent rate), not including state taxes and other prizes. Any remaining mortgage fees will have to be paid off at settlement.
 
2.     Do a Like Kind exchange: under section 1031 of the Internal Revenue Code, Alex can exchange his property for another piece of property that will be equal to or more expensive than his current property, deferring his capital gains tax obligation along the way.
 
“If you want to learn how to build your real estate investment wealth without owing capital gains tax as you do so, the secret is tax-deferred exchanges, as authorized by Internal Revenue Code 1031,” confirms noted real estate columnist Bob Bruss. “The simple tax rule for avoiding capital gain tax when disposing of a rental or investment property is that the investor must trade ‘equal or up’ in both price and equity for one or more qualifying “like-kind” properties…”
 
There are specific rules applicable to 1031 exchanges. Net sales proceeds must be held by a neutral intermediary. Replacement properties must be identified within 45 days after the sale of the relinquished property, and the sale must close within 180 days.
 
3.                 Installment Sale: Alex can defer - but not avoid - paying capital gains tax if he sells the property and carries back a mortgage. This is known as an “installment sale”. Under this arrangement, you pay a portion of the capital gains tax as the moneys come in each year.
 
4.       Donate the property to a charity – FYI, there are restrictions and limitations on such donations which Alex should fully understand before you decide to go this route.
 
5.       If the property is worth keeping in the family, Alex can sell it to a family member, and carry back the financing. Let’s say Alex sells the property for $1,000,000 to his children, and agrees to carry back the entire purchase price. His lucky kids sign a promissory note in the amount of $1,000,000 - there will be a deed of trust (mortgage) on the property in this amount. If Alex is married, he and his wife can each gift back $11,000 to each child per year, tax free – that’s $44,000 of the balance of the note each year. Thus, in the first year, the note balance will be reduced down to $956,000 ($1,000,000 - $44,000), and so on each year for the next 22.7 years.
 
There are a number of ways in which you can sell your rental properties. Speak with your financial advisors before making any final decisions.
 
Jodi Summers negotiates investment properties for Sotheby’s International Realty. For your real estate needs, e-mail Jodi Summers at jodis@verizon.net, or call 310.260.8269. Visit her websites at http://www.SoCalInvestmentRealEstate.com or http://www.santamonicalandmarks.com.

Falling Cap Rates Hit the “Red Zone”

Falling Cap Rates Hit the “Red Zone”

With Cap Rates Having Fallen About as Low as They Can Go, Investors Must Be Prepared To Alter Buying Strategies

The spectacular rise in property values that has largely fueled the buying frenzy within commercial real estate over the past three years has resulted in investors flipping properties for big gains, in many cases after buying and holding them for just months instead of years.

At the same time, a new report notes, cap rates for almost all property types have been doing the Limbo, and now they’ve gone about as low as they can go.

Investors and underwriters alike are alarmed at how far cap rates have fallen, driving returns into the “red zone,” the point where the spread between purchase cap rates and 10-year Treasuries falls below 250 basis points.

At this level, Dennis Yeskey of Deloitte Consulting points out, there is no room for error, as real estate values may no longer generate a viable risk-adjusted premium over the cost of borrowing money.

“If an investor is buying a building today at a 5.5 or 6 cap rate and thinks he or she is going to sell it next year at a 4 cap rate, they’re in for a rude awakening,” notes Yeskey, national director of Deloitte’s Real Estate Capital Markets group and principal author of the firm’s 2006 Real Estate Capital Markets Industry Fall Update. “Right now, you need to be very careful you’re not overpaying, because increasing property values aren’t going to bail out investors who overpay.

“They’re going to have to look at the underwriting and see where they can either fill vacant space or increase rental rates in order to get the returns they want. In other words, they’re going to have to earn returns the old-fashioned way,” he added.

The good news, Yeskey said, is that cap rates are finally flattening out.

“They couldn’t go much lower. And investors get that; they realize they shouldn’t be buying buildings at such a thin spread. Real estate is not a liquid asset, there should be a risk premium over Treasuries.”

As a result, Yeskey believes, we’ll see less churning going forward and more investment based on the potential for deriving revenue from raising rents and operating buildings efficiently rather than from cap rate compression.

From a macro perspective, Yeskey said it couldn’t happen at a better time. “It looks like we may time this just right, if fundamentals hold. We’re in really good shape in terms of supply and demand. There hasn’t been a lot of new construction. That may be changing, but right now we’re seeing a nice return in demand. Rents have started to move up in most markets, which is very good news for investors. And in some, like Midtown Manhattan, you’re seeing rent spikes of 15% to 20%.”

Yeskey said commercial real estate markets haven’t always fared so well in the past.

“Usually, when cap rates get this low, alarm bells go off,” he said. “Every time in the past 30 years that we’ve pushed cap rates down near Treasuries, it’s the old story: ‘Houston, we have a problem.’ ”

This time, the industry responded quickly and didn’t keep developing when rents were falling and market fundamentals were going down. Yeskey said there are several reasons to account for this.

“First, there’s a lot more discipline among lenders and investors. And quite frankly, there’s a lot more information available now to make better decisions. You also have to factor in construction costs, materials and supplies, which have soared (in cost) over the past few years. That created further friction that limited new development. And you can chalk up some of it to increased government oversight. In certain areas, instead of taking two years to gain the necessary approvals and put up a building it may take three or four depending on the level of scrutiny and approvals needed.”

The ability of the industry to keep market fundamentals in check is a big reason why commercial real estate has been, and continues to be, among the best-performing investments. Returns have exceeded almost every other investment option over the past five years, and appear likely to continue on that trajectory into 2007.

“We’ve seen an unprecedented flow of capital into real estate, well beyond anything we predicted for 2006,” Yeskey said. “You see funds forming left and right as investors line up in search of returns that only real estate has delivered recently.”

If there is a dark cloud on the horizon, Yeskey said it would be the increasing debt levels creeping up across all property types. Debt offerings are increasing in size and in number, while debt service coverage ratios are dropping.

“People are really starting to leverage up and the competition is such that we’re starting to see underwriting standards sag,” said Yeskey. “If there is one big area of concern it would have to be the dropping debt service coverage,” Yeskey noted. “That ratio was as high as 1.5, but even as rents have risen, the average ratio has dropped down to 1.3. People are leveraging up properties more, debt service is higher, and that means they have less of a cushion should there be a downturn.”

With no end in sight to the amount of capital in competition for real estate deals, Yeskey does not foresee a pullback or curtailment of investor activity in real estate any time soon. Rather, the search for yield is driving more investors to look in smaller tier markets and invest in smaller sized buildings and to seek out property niches that may generate the types of returns they’ve enjoyed in the past.

“There’s still a lot of money coming in and it’s got to find a home. We’re seeing a lot of interest among investors in so-called niche-plays, things like healthcare facilities, medical office buildings or even student housing. We think we’ll see more investors start buying infrastructure, things like airports, toll roads, tunnels and bridges. There’s been more of that overseas but we think it will catch on here as well.”

“Of course, you’ll still see a lot of investors still clamoring for the core, stabilized properties, buying at 5.5 to 6 cap. They may not see a lot of yield, so they’re going to have to work to increase rents. And that means they’ll be holding onto properties longer, waiting for the rents to roll over and lease it up at a higher number. In many ways, investors are going back to basics.”

Written by Tim Trainor

http://www.costar.com/News