Investment Analysis
Bid vs. Ask
Motivated investors are closing the pricing gap on institutional assets.
By Michael P. Hedden |
Activity within the
institutional commercial real estate market is picking up as a result of the
abundance of capital seeking real estate opportunities. Property sellers who
have been holding firm in their asking prices are being rewarded for their
patience by buyers who are motivated to procure quality assets at perceived
attractive prices. Rather than simply bid the price to unrealistic levels, buyers
are analyzing numerous alternatives to achieve ownership positions and obtain
attractive returns on their investments.
The Buyer Perspective
From the buyer’s
perspective, each acquisition is a case study in strategic methodology,
analyzing and pursuing numerous avenues to the transaction. Recently, a trend
has emerged in the form of joint venture partnerships where buyers assist in
the recapitalization of the assets that are facing loan maturity deadlines on
debt with high loan-to-value ratios. Alternatively, purchasers of a property’s
debt can foreclose upon its default and obtain title to the property through a
loan-to-own strategy.
Another approach is to wait
for the lender to foreclose or a bankruptcy procedure to play out when an owner
defaults and then purchase the property in court. Of course, for core assets
that are highly desirable and attract considerable buyer competition, direct
acquisition of the asset from the seller is the most reliable and traditional
method.
As evidenced by recent deals,
motivated investors have used all of these means to procure core real estate
investments in prime markets and this trend is expected to continue through
year-end. But as the supply of attractive purchase opportunities shrinks,
buyers are starting to take on riskier assets in less-than-prime markets.
Tolerating Risk
With this increase in
transaction activity comes the price discovery and transparency of an evolving
market. The convergence in the bid-ask conundrum is now coming more from the
buy side than from the sell side — more from the bid than the ask. The
abundance of available capital, both debt and equity, has been the primary
reason for this increased buyer activity.
With the pressure and
incentive to put real estate equity capital to work, the risk tolerance and
go-forward assumptions regarding cash flow expectations have become more
optimistic and are driven more by the need to invest than by market
fundamentals. The willingness to take on more risk in real estate transactions
combined with increased competition has shortened the due diligence periods for
aggressive purchasers of prime super-core assets.
Over the past several
years, many investors have raised significant pools of funds with the
expectation that distressed sellers facing foreclosures, bankruptcy, or
refinancing would be willing to sell prime assets at distressed prices. That
has not been the case. In some cases, the institutional buyers have been
motivated to invest and have paid premiums rather than allow the raised capital
to sit idle causing them not to meet the fund investors’ expectations.
The sellers of real estate
or mortgage note holders have seen this increase in volume and upward price
movement for certain assets and are content to hold out or kick the can down
the road. The strategy of delay and forbearance has enabled sellers to become
firmer in their pricing as the market slowly recovers. Since the credit crisis
began more than three years ago, sellers were anticipated to follow the same
pattern that unfolded during the late 1980s market collapse, with liquidation
at distressed prices. However, in many cases, asset owners and debt holders
have opted to hold out for a market recovery. As a result, a convergence of
market pricing is occurring, with more buyers raising their bids than sellers
lowering their asking prices.
The fact that the ample
supply of capital chasing too few available core assets has driven the recent
price increases is reflective of the basic economic principle of supply and
demand.
Buyers have developed a
more-strategic approach to making acquisitions that is reliant on a case study
approach to each situation. The current environment gives buyers several
options to acquire a desired asset. The analytical tools market participants
use are the same, but the process differs depending on the competition, market
fundamentals, and capital availability. Debt and equity availability in the
right proportion cannot be taken for granted. Due diligence and deal structure
are more important than ever and the expectations of the future are more
circumspect.
In those markets that have
become heated, such as New York and Washington, D.C., less time is spent on due
diligence. Instead, more-aggressive valuation assumptions are being
underwritten in order to beat out the competition, putting upward pressure on
bid pricing and limiting the need for sellers to concede on asking prices. In
those markets where time is not of the essence, a more-strategic case study
approach to the acquisition can be made.
Transactions today reflect
the combination of the deal-specific complexities faced by prospective sellers
with the bid-ask convergence. The result is the resurgence of risk taking by
prospective buyers with the increased availability of debt and equity. The real
estate market is showing signs of recovery and, as a result, the pace of
transaction activity continues to accelerate; however, the new framework under
which real estate transactions are being executed is carefully thought out and
very strategic.
Michael P. Hedden is a
managing director at FTI Schonbraun McCann Group, the real estate advisory
practice of FTI Consulting. Contact him at mhedden@smgllp.com. The views
expressed herein are those of the author and not FTI Consulting or its other
professionals.