From crib to cemetery lot, we spend our whole lives taking up real estate. We work in it, play in it, sleep and eat in it. Real estate is the single largest investment for most Americans.
The real estate industry, especially the commercial business, has undergone enormous change over the last thirty years. Today, the market is an information business: information about owners, users, interest rates and construction costs. Which REIT just purchased another building and now controls the price of office space in a particular sub-market? What is the Fed going to do at its next meeting? How does the world price of crude oil affect the cost of industrial space in Houston? Is job creation going to be up or down next quarter? More and more, information – and the quick response to it – affects the performance of commercial real estate.
William E. Stonaker, CCIM, SEC has spent the last twenty years in commercial and investment real estate. Operating as Wilson & Stonaker, L.L.C. (formerly Wilson & Stonaker, Inc.), we know that real estate projects must compete for capital with alternative investments such as stocks, bonds, precious metals, minerals exploration and collectibles, etc. We know that you want two things from your investments: preservation of invested capital and return on investment.
As a whole, real estate investment is not tricky or elusive. However, hard work, focus, and persistence are needed to make any real estate venture a success. Additionally, one must be in the right market doing the right things at the right time. During the early 1970’s, the Metroplex was going through rapid job growth. Almost any property you acquired went up in price because of inflation and demand. Then came the oil shocks, gasoline lines, and President Carter in his sweater telling the American people to conserve. There was no oil shortage, just a shortage at the prevailing price structure. The country went into recession and so did the real estate market.
Then we were “blessed” with deregulation of the savings and loan business. Anyone with a hammer and a pickup was automatically a developer and could borrow more than the cost of building a project, even if he had no tenants for his project. The Metroplex was awash in empty office buildings – see through – outstanding projects of marble, granite, glass. The excesses of the S&Ls caused the major banks, construction lenders which still used good business practices in most instances, to fail along with the more traditional real estate developers.
Along came the FDIC, RTC, FSLIC, etc. In the mid-1980’s, over 40% of the Class A suburban office space in Dallas was controlled by the federal government. No one was buying. Office and industrial space was leasing at 50% of its proforma. The government’s inventory of real estate, both improved and unimproved, kept on growing. Finally, the economy began to come back. Interest rates were coming down and investors began to see that the “blood on the streets” was not going to last forever. Investors, many from out of the area, began acquiring commercial real estate at below replacement costs, many times at 50% or less of the original costs to build them.
That brings us up to today. Interest rates are low and real estate investors are enjoying natural increases in the returns of their improved property. The real estate investment trusts are in a feeding frenzy, buying up all kinds of improved property types: office, retail, industrial, hospitality, multi-family and others. The REITS have recently gotten into senior care and even gaming properties. No property type is immune from the appetite of the REITS as they finance their acquisitions with costs of funds far below traditional borrowers.
Since early 2001, the small investor has taken a very active role in the investment market. Two events have spurred this on more than any others: low interest rates and losses in the stock market. Low interest rates have given the small user of real estate the opportunity to be an owner instead of a tenant. For instance, the number of small medical office buildings owned in physician’s IRA accounts has exploded. And the losses in the stock market over the same period of time have caused investors to flee to the safety of an asset class they can control, at least to some extent.
Obviously, we have to take “new” issues into consideration like terrorism, government of all types changing the rules and a much faster obsolescence. There is not much we can do about the world terrorism except be careful where we invest and how much we diversity. The fact that our governmental bodies create issues such as environmental requirements, roadway expansions and improvements and mass transit require us to be involved at all levels of government. Obsolescence and other issues of ownership can be controlled by good management and planning. Do you take a hard look at each piece of real estate you own at least once per year? If not, maybe you should. We review our business plan on each piece of real estate we own every quarter.
Question: Where do we go today?
Answer: Back to the basics. Real estate investing can be broken into three types of investment philosophy. First is the “bond” investor – that investor who purchases the NNN deal with the office, industrial or retail lease. He will enjoy a bond type of yield backed by a credit company with a prime asset as his collateral. Over time he will experience rising property values of at least the rate of inflation.
Then there is the more traditional investment, that piece of property which can be upgraded, either through new or better tenants or by a make-over of the property. Acquisition of an improved, leased property is less risky but has less upside. Just allowing the current leases to expire and the rent rates to reach market levels will improve the cash flow and thus the value. Also, one of the best ways to increase the value of a property today is to refinance at a lower rate. Many more mature investors are prone to this method of ownership.
And last, but not least, there is the opportunity to create value, the value added approach to real estate investing. One can create value by buying and developing land, performing a complete use change on a prime piece of real estate, or by turning an otherwise unusable property into something that can be utilized as in the case of environmentally challenged properties. In today’s market, we must be willing to take a little more risk to achieve double digit returns. We must acquire land or improved property ahead of the wave of development or to use market knowledge to get to an area or particular event in a sub-market ahead of our competitors.
Any way that an investor decides to play this game, it must be done with skill, the utmost in integrity, and up to date market knowledge. More than at any other time in the history of commercial real estate, market knowledge is power. And what other asset class gives you so many options to control your account?