According to a recent article in the North Bay Business Journal, now is the time to act to take advantage of the bottom of the market:
"The title of the recent Sonoma State University economic outlook conference “The Time is Now” couldn't have more meaning than it does with the current office real estate market. We are at the bottom of the market, and now is the time to take advantage of the current opportunities before it’s too late."
I wish it were true, but as far as I can tell we have a ways to go before the actual bottom is reached in the North Bay or anywhere else. Now, that does not mean that now is not a good time to negotiate a great office deal. Landlords are hungry and hurting and some fabulous lease of purchase deals are available to those willing to dive in. Until the unemploymet rate starts to drop, the bottom is still in the future, probably within a year or maybe even two.
Get help finding a great office deal
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Guest Post: In the past, real estate appreciated consistently, and created a source of wealth because of: appreciation, depreciation, debt relief, and cash flow. Real estate was often acquired with a 20% down payment and the remaining 80% balance was financed. Properties didn’t always provide cash flow at the start of the investment because of the amount of financing that was part of the acquisition equation. However, since properties were generally going up in value, that 80/20 leverage was a good thing; the returns may have increased because of appreciation.
Times certainly have changed. The real estate market is continuing to decline and many believe the bottom of the market seems at least a couple of years away. According to Mike Scott of Dupre + Scott Apartment Advisors (a Puget Sound apartment research firm) appreciation in real estate over the next several years may be nominal. According to their report, getting a decent rate of return on investments isn’t just around the corner. They indicate it could be fifteen to twenty years away.
The question is: if we can’t rely on appreciation in the near term does that mean we should avoid real estate or real estate related investments? Not necessarily. What it does mean, is that we need new investment strategies that make the most of current market conditions.
In the old real estate world when we referred to ROI we meant: RETURN ON INVESTMENT. Today, with the collapsing real estate marketplace, people are more concerned with capital preservation rather than asset growth. In the new economy, ROI has a completely new meaning: RELIABILITY OF INCOME. With the economy changing the playing field, cash flow has become the sought after benefit, rather than appreciation or depreciation. It has become very clear that investment decisions based on the old model may need to be rethought.
Just because the economic landscape has changed doesn’t mean that there aren’t some viable investment options. One of the many opportunities afforded investors using qualified funds (IRA, Roth, etc.) is that of acquiring real estate related products rather than real estate. Real estate related investments include offerings such as private Real Estate Investment Trusts (REITs) and real estate funds.
Since it looks like appreciation may be nominal for a number of years and since one can’t take advantage of depreciation in a retirement account, I think it makes no sense to base investment decisions primarily on investment growth due to appreciation and depreciation. Rather, one should look at investment products that base investment growth on cash flow. This is where real estate related products appear to have an advantage.
A number of real estate related products currently being offered fit nicely in a retirement account. Moreover, since many investment offerings are based on new lower real estate values, they may present cash flow opportunities that may not have been previously available.
I’ll leave you with a parting thought: “Real estate investing may have fundamentally changed for the foreseeable future. Isn’t it worth investing a few minutes of your time to consider the benefits and risks of all of your investment options?” You may be intrigued by what you discover.
If you want to take a look, Contact me.
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Mar 2, 2010 - CRE News
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With property values well below where they were three years ago, borrowers are increasingly trying to negotiate reductions in their loan balances.
But doing so could trigger a substantial tax hit on any forgiveness of debt.
The tax-liability issue became fodder for headlines in recent weeks when the owner of Manhattan's Stuyvesant Town/Peter Cooper Village offered to turn the property over in a deed-in-lieu of foreclosure. Its lenders subsequently filed to foreclose.
The property's owner, a group led by Tishman Speyer Properties, won't face a tax liability on any forgiveness of debt because its cost basis in the property of roughly $5.4 billion, less any possible depreciation and capital improvements, is far greater than the $3 billion of senior debt owed. Another $1.4 billion of mezzanine debt is secured by ownership interests in the entity that owns the property. But the transfer of ownership, either through a deed-in-lieu or an actual foreclosure would trigger New York's onerous transfer tax. That tax is assessed at the rate of 3.025% of the mortgage's face value.
The transfer tax liability - it would likely be borne by the property's lenders in the event of a deed-in-lieu or a foreclosure, both of which assume the property lacks the resources to pay the tax - would total $90.75 million. But it could be reduced if the entity that owns the property, as opposed to the property itself, is transferred, according to Harvey Berenson, managing director and member of the general tax group of FTI Schonbraun McCann Group, a New York advisory firm.
In that case, the value of the underlying property determines the amount of the transfer tax. Given that StuyTown's value is said to be roughly $2 billion, the transfer tax would be about $60.5 million.
Meanwhile, given the decline in property values and the volume of debt that was written at or near the market's peak, the number of loan workouts and debt restructurings is expected to explode.
"This is happening all over the country," said Maury Golbert, tax partner at Berdon LLP, a New York tax adviser.
Most properties purchased at or near the market's peak with high-leverage financing "that's coming due now are underwater," he explained.
If the amount of debt is greater than the property's basis, or cost, the borrower would face a tax hit if any of the debt is forgiven or cancelled. And that tax would be assessed at the ordinary income level of 35%, as opposed to the 15% rate on capital gains.
So say an investor bought a property in 2003 for $50 million and because of the run-up in values was able to borrow $70 million at the market's peak in 2007. If the property is now underwater, meaning it's unable to stay current, the owner could try to negotiate a reduction in the property's debt. If successful, the property would face a tax on the amount of debt forgiven.
"If you bought in 2007 and the cost basis is big, that won't be a terrible tax result," Golbert said. But a number of long-time property investors had taken advantage of the flood of capital during the market's peak to take cash out of their properties with hefty mortgages. If those get written down, "you're looking at a more difficult tax situation," he said.
Meanwhile, owners who live in New York City would face an additional 9% hit. After federal income tax offsets are taken into account, the total tax hit could be roughly 42% on the amount of debt forgiven.
"The basic rule is if debt is forgiven, the reduction is treated as taxable income in the year it happens," Berenson explained.
But property owners facing large tax hits can defer their payments. They can, for instance, reduce the tax basis instead of recognizing income from the property whose debt has been in part forgiven. Taxing authorities are also allowing liabilities to be deferred for five years. After that, 20% of the total tax liability is due annually until it's repaid, Berenson explained.
"Lenders can foreclose, or work something out," Golbert added. In either case, depending on where the property is located, potential tax issues arise. "If you work it out, and some debt goes away," you could see a tax hit if the property's cost basis is low enough, he said.
Golbert noted that property owners facing such tax liabilities could, at least in theory, defer them by structuring tax-deferred exchanges. The problem, he said, is that such deals are difficult to structure today. They require equity and debt. If a property owner was hit by a foreclosure, chances are slim that he has sufficient equity to structure such a transaction, and "it's tough to borrow" for such exchange transactions.
February 22, 2010 WASHINGTON – Today, Senate Banking Committee Chairman Chris Dodd
(D-CT) wrote Federal bank regulators and asked them to report on their
efforts to stabilize the very troubled commercial real estate market
Despite positive signs in the economy, Dodd noted evidence the
commercial real estate market continues to struggle.
- Last month, the Congressional Research Service reported
“delinquency rates for commercial mortgages climbed from 4% at the end
of the third quarter of 2009 to more than 6% in January 2010.”
- At a Congressional Oversight Panel hearing last month, a
Federal Reserve official testified that “Federal Reserve examiners are
reporting a sharp deterioration in the credit performance of [CRE] loans
in banks’ portfolios and loans in commercial mortgage-backed
securities,” and warned that more than $500 billion of CRE loans will
mature each year over the next few years.
- This month the Congressional Oversight Panel reported
“that nearly half of CRE loans at present are “underwater” and that the
largest “loan losses are projected for 2011 and beyond.”
Given growing concerns, agencies on the Federal Financial Institutions Examination Council released a policy statement in October on
prudent commercial real estate loan workouts to “assist examiners in
evaluating institutions’ efforts to renew or restructure loans to
creditworthy CRE borrowers.”
Today Chairman Dodd followed up, writing these agencies that “I
would like you to provide an update on how this guidance is helping to
stabilize the CRE market. In addition, I would like an explanation of
how [each agency] has addressed the CRE issue so far, and what
additional steps you plan to take.”
“I believe that the weakness in the CRE market requires prompt and
robust responses from the regulators to guard against harmful effects on
financial institutions and the economy,” Dodd said. “I urge you to
redouble your efforts to provide appropriate oversight of this vital
component of our economy, and look forward to working with you to bring
much needed stability to the CRE market.”
The letter went to Federal Reserve Chairman Ben Bernanke, Federal
Deposit Insurance Corporation Chairman Sheila C. Bair, Office of Thrift
Supervision Acting Director John E. Bowman, Comptroller of the Currency
John C. Dugan, and National Credit Union Administration Chairman Debbie
United States Senate Committee on Banking, Housing and Urban Affairs
Feb 22, 2010 - CRE News
In a sign that the period of large monthly price
declines may finally be over, commercial property pricing in December
increased for the second consecutive month, according to the
Moody's/Real Commercial Property Price Indices, or CPPI.
The 4.1% hike to 113.58 follows a 1% gain in November that was the first
monthly increase since December 2008 in the indices' all-property
component. CPPI is a collaboration of Moody's Investors Service and Real
Estate Analytics and tracks repeat sales of properties. December's
increase also is the largest monthly gain ever recorded by the index.
Still, pricing ended last year 40.8% below its peak in October 2007, and
was down 29.2% from the end of 2008. The largest monthly drops last
year occurred in the first half, while prices declined at a steadily
slowing pace in the second half before reversing course and heading
upward in November.
"Although we are unable to conclude the bottom is here, we do feel that
the period of large price declines is over," Moody's said.
It noted that higher sales volumes often indicate pricing bottoms may be
near. December's 716 total sales for a combined $9 billion was up 75%
by count and more than double in dollar value from November's sales
December's dollar volume also was up 5% from December 2008, and marked
the first year-over-year gain in volume since credit markets became
dislocated in late 2007.
The December 2009 transactions included 162 repeat sales with a combined
value of $2.2 billion.
Pricing in the fourth quarter of 2009 increased from the preceding
quarter for every property sector except retail, which dropped 1.5% to
an index of 139.61.
The office sector led the fourth-quarter pricing upticks with a 7.9%
gain to 122.15. It was followed by multifamily's 7% gain to 125.89 and
industrial's 5.6% rise to 127.3.
For the full year, however, pricing for each sector was down by levels that range from 19% for retail to a high of 23.2% for industrial.
Within the 10 largest metropolitan markets, office pricing in the fourth quarter increased a whopping 26.8% to 134.65, but was still down 14.6% for the entire year. New York registered the largest full-year decline in office pricing at 38.1% to 141.17.
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