By: Justin Laub
I recently sat down with a friend in the oil and gas industry who asked me, “Is it a good time to invest in real estate?” Given how much real estate prices have accelerated, he wanted to hear my opinion on whether real estate investments make sense right now, specifically in Texas. For the uninitiated, one look at the graph above would be a major cause for concern. For seasoned real estate practitioners, the answer is more nuanced.
It is absolutely true that prices for properties in major markets across the country are either near all-time highs or higher. Similarly, Cap Rates are as low as they ever have been for many property types around the country. Why, then, would a sophisticated investor be inclined to invest his money in commercial real estate? Given the breadth and diversity of the commercial real estate market, the answers are many. Some of the more general conditions that apply to whole market include historically low interest rates, a robust capital markets environment, ready and willing sellers, and a drastically better macroeconomic environment today versus five years ago in the depths of the Great Recession.
One of my recent capital placement assignments encapsulates this debate well, as I was engaged to raise equity for the purchase of a garden-variety multifamily property in North Texas. Two items that immediately stood out were the low cap rate and the relatively high cost-per-unit being paid for the property. The low cap rate and high cost basis turned away a number of private equity capital providers who simply were not comfortable looking into the deal beyond these two basic reference points. Not that these two facts weren’t true, but they didn’t tell the whole story. The merits of the deal – looking beyond the headlines – were the following:
- the property was located in a solid submarket with high rent growth;
- it was under-managed and had below-market rents; and
- the property was being delivered free and clear, which allowed for a fresh 10-year fixed-rate GSA loan at today’s historically low interest rates.
In short, yes, the going-in cost basis was relatively high, but the cash-on-cash yield would be verifiably strong for the term of the loan. So, the downside was limited to holding the asset for a longer period of time than expected, in the event that you are not able to get the exit price you would like in three years.
The above is but one example of an investment that can make sense in the face of high prices and low cap rates that define much of today’s commercial real estate market. Making a sound real estate investment is a function of numerous variables, such as location, condition, and cap rate. The concepts of price-per-unit and cap rate, which serve as good barometers for any investment, are integral to the investment analysis process. They help give investors their bearings when looking at a new opportunity. However, in order to assess the merit of an investment, one must be willing to look beyond the headlines and drill down into the unique circumstances that make for a compelling investment.
For an assessment of whether your next investment makes sense and whether it would be possible to raise partner equity for you, feel free to reach out to me, Justin Laub at email@example.com, or visit our website at www.metcapital.com