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6.14.2006
The State of the Market
Commentary by Chris Kostanecki
Founding Partner of San Francisco Office
Over the past few years, rising investor interest in real estate investments and the availability of broader capital, coupled with historically low interest rates have created the “perfect storm” for real estate. These combinations have resulted in unprecedented compression of Capitalization Rates. In 2005, commercial real estate sales saw record velocity.
Despite this momentum, 2006 is off to a slow start. National research firm Real Capital Analytics has highlighted the decrease in velocity and reports a 37% decrease in velocity to date, compared with 2005.
For the first time in several years, product appears to surpass investor demand. A “Peter Lynch” approach to measuring market demand is to check on the deal flow with lenders, escrow officers, and third party investors that are in the middle of transactions. The consensus is a slowing of velocity.
The biggest influence is the marginalized cash on cash returns. Investors have seen these returns marginalized even further in 2006 due primarily to rising interest rates and significant increases in construction costs. This means that many investors are sitting on the side lines.
Capital Markets plays a huge role in market velocity. It is our prediction that 2006 will show that prices have flattened out; property valuation techniques will make the right adjustments; and transactions will occur where investors can obtain a stabilized return in the 6%-8% cash-on-cash range.
Based on the state of the market, look carefully to determine that you can achieve substantial levels of returns on your investments. Investments should provide a way to achieve predictable returns and match that up with the current Capital Markets dynamics.
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