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Commercial Rebounding With Less-Than-$5 Million Sales: Mortgages

Commercial Rebounding With Less-Than-$5 Million Sales
The CityCenterDC development site in Washington. Photographer: Andrew Harrer/Bloomberg

Broker Connie de la Garza has been trying to sell an empty medical-office building in Harlingen, Texas, for six months. He’s finally getting offers after slashing the asking price by 26 percent to $1.4 million.

“That’s when the real activity happened,” said de la Garza, the owner of Bahnman Realty Inc., who is marketing the property along with Brandon Beeson of Edge Realty Capital Markets. After two bids that were “absolutely ridiculous,” the third “is something that we can work with,” he said.

Sales of small buildings across the U.S. have risen this year to the highest since 2008 as buyers take advantage of prices that have yet to rebound from the property crash and increased access to financing. Improved demand would help broaden a commercial real estate recovery that’s so far been confined to trophy office towers, apartments and malls to a broader swath of the market. Loans for properties valued at less than $1 million account for almost a third of commercial mortgages held by banks, according to Trepp LLC.

“It’s making the market more liquid, more transparent and if we get rid of this distress we’ll have a firmer footing,” said Randy Fuchs, principal and co-founder of Boxwood Means Inc., a Stamford, Connecticut-based provider of data about small commercial properties.

The sales volume for properties of less than $5 million jumped 41 percent in May from a year earlier to $4 billion, Boxwood Means reported this month. Of the 122 metropolitan areas that the company tracks, 88 posted year-over-year increases. Total volume for the first five months of 2012 was $20.3 billion, the highest for the period since 2008.

Slower Recovery

These types of buildings-- local offices, shopping centers and restaurants that dot towns such as Harlingen, population of about 65,000 -- were slow to recover from the recession because of their dependency on local economies and the housing market. Prices for buildings of less than $5 million fell in May to a new low, bringing the plunge from an October 2007 peak to 22 percent, Boxwood Means data show.

The properties have trailed a rebound in demand for larger buildings, which tend to attract more money from real estate investment trusts and institutional buyers. A Green Street Advisors Inc. index of commercial real estate values measuring REIT properties is up 53 percent from its 2009 low and is just 6 percent from its August 2007 peak, according to the Newport Beach, California-based research firm.

“There’s definitely not a lot of institutional money chasing those kinds of deals.” Ryan Severino, senior economist at Reis Inc., a New York-based property-data company, said of small-capitalization properties.

Better Financing

Buyers tend to be high-net-worth individuals and private investment groups, according to Jennifer Pierson, national managing director of the private-capital division of brokerage CBRE Group Inc. in Dallas. Business owners also purchase the properties for their operations, Fuchs said.

Financing is becoming more available for small-cap deals, and credit terms is increasingly attractive to buyers, Pierson said. U.S. commercial and multifamily loan originations jumped 25 percent in the second quarter from a year earlier, according to the Mortgage Bankers Association.

U.S. banks have about $308 billion in commercial mortgages with balances under $1 million, equating to about 29 percent of all commercial-property loans, according to Trepp, a New York-based bank and real estate data company. Community banks, which tend to focus on small-business clients, are often the lenders for such deals. Loans for less than $1 million account for about 40 percent of commercial mortgages for banks with less than $1 billion of assets, Trepp data show.

Lending Increase

“We’re starting to see finally some pickup, nothing robust, but a pickup in commercial lending,” said Paul Merski, chief economist at the Washington-based Independent Community Bankers of America, a trade group for banks with assets of $3 million to $17 billion with almost 5,000 members. “We see a slight turning of the corner.”

Lenders are working through troubled commercial property loans stemming from the real estate crash, and smaller banks are now reversing their loan loss reserves, Merski said. Banks with less than $1 billion of assets have shed $6.5 billion, or 20 percent, of their bad loans since the first quarter of 2010, according to Matt Anderson, managing director at Trepp.

Buyers are attracted to small-capitalization real estate because it offers higher returns than other investments, such as in the bond market, said Jeffrey Ackerman, a managing director in CBRE Group Inc.’s private capital group in Pittsburgh. The Federal Reserve has kept interest rates near zero since 2008, reducing yields on most debt investments.

More Stability

“They see the opportunity to achieve good leveraged returns in real estate,” Ackerman said. “As the property markets are stabilizing and occupancy rates are going up and the tenants are doing better, that gives more stability to these investments and that makes them more attractive.”

Capitalization rates, a measure of yield for the real estate industry, averaged 7.7 percent this year for office buildings and retail properties priced under $5 million, according to Real Capital Analytics Inc., a New York-based research firm. They were 6.8 percent for apartments.

Improvement in the residential market may also boost commercial property landlords as a strong housing market helps increase consumer spending, Fuchs said. U.S. home prices climbed 2.5 percent in June from a year earlier, the fourth consecutive increase, CoreLogic Inc. reported on Aug. 7.

Lasting Change

A recovery is dependent on sustained improvements to the economy, and landlords for small-cap properties face declining leasing rates, according to Boxwood Means. Office rents fell 3.3 percent in May to $16.06 per square foot and retail rents declined 2.7 percent to $16.26, the firm’s data show.

“In order for there to be real positive and lasting change we really need to see some changes in the economic environment which would flow through to the commercial real estate market,” Fuchs said.

Community banks also are still facing losses from bad real estate bets that spurred the closure of more than 450 lenders since 2007. Delinquency rates for commercial mortgages at banks with less than $1 billion in assets was 4.3 percent in the first quarter, down from 4.87 percent a year earlier, Trepp data show.

Small-cap demand is partly dependent on location. Prices in the biggest cities have improved more than in the country as a whole, according to Boxwood data. The company’s index measuring prices for small buildings in some of the nation’s 20 biggest U.S. metro areas rose 1.3 percent from December through May.

“Investors are more likely to be investing in the larger markets at this point in the recovery,” Fuchs said. “Even the smaller properties are going to attract that kind of interest as well.”

‘Small Markets’

Beeson, the broker with Edge Realty, said it is more difficult attracting buyers for the building in Harlingen, located 331 miles (533 kilometers) southwest of Houston, because it’s in a small town.

“A lot of people just won’t go to those small markets,” said Beeson, who is based in Dallas. “If this were in Dallas or Chicago, it would obviously be a much more different animal.”

The 42,000-square-foot (3,900-square-meter), two-story building was transferred to debt holders in 2010 after the partnership of doctors that leased the building dissolved, according to data compiled by Bloomberg.

Interest in the property has been “good” since the price was cut to $1.4 million, Beeson said. He expects it to sell for close to that amount.

“The general perception is, we’re out of the worst so you better buy now in a down market,” said Pierson of CBRE. “There’s sort of the idea that the window is closing.”

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