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Eye on the Market, January 31, 2012
Opportunity knocks: the risks and rewards of opportunistic real estate investing

The ever-expanding ECB balance sheet (next repo operation of $1 trillion?), Chinese liquidity injections and commitments by the Fed to provide free money forever have given markets a reprieve of unknown duration. This allows us to focus for a moment on investments in commercial real estate. In the US, supply and demand factors are, on the margin, improving. However, the Fed's zero interest rate policy has created (another) cycle in which yield-hungry investors drive up prices of traditional commercial property investments ("reit-er madness"). Opportunisitc investing is a complement to traditional real estate investing, and may benefit from the widening gap between the price of core and distressed real estate. Opportunistic properties are typically available at substantial discounts, for a variety of reasons:

** Off market locations (e.g., 9th Avenue vs. 7th Avenue in NYC; Isle of Dogs vs. City Center in London; our south-of-Market Street building in San Francisco, particularly when we moved there in 2001; or suburban locations just about anywhere)
** Substantial amount of unleased space
** Owner capital problems (overstretched, unable to fund tenant improvements and leasing commissions; over-leveraged and funneling cash away from good properties to save struggling ones)
** Debt problems (debt service coverage close to breaching actual or technical default, and/or pending debt maturity with loan to value well above 100%)
** Banks with no interest in maintaining or improving foreclosed property. Basel rules require much higher capital charges for foreclosed real estate (compared to performing loans), and Tier 1 capital ratios are still rising; both explain why banks often opt to sell
** Unfinished spec properties that need a last round of fresh capital to be completed

To give you a sense for what opportunistic investing really entails (its risks and its rewards), we focus in the attached document on three illustrative examples: a national chain of neighborhood and community retail shopping centers; Hotel California; and a suburban office property in Cambridge, Massachusetts (the Bobo Newsom of suburban office buildings).

Michael Cembalest
Chief Investment Officer


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