A real estate investor recently asked the following: “I’ve noticed that most if not all properties in my area offer a cap rate of 3.5%-5.5%, and when I ask the brokers why the cap rates are so low they say it’s ‘perfectly normal’ for this area. Am I missing something here?”

It was “perfectly normal” to buy mortgage backed securities without collateral before they collapsed. It was “perfectly normal” to invest with Madoff before his empire collapsed. It was “perfectly normal” to buy dot.com companies before they became worthless. History is replete with giving comfort to poor investments by considering them “perfectly normal”.
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We are witnessing more and more vacant commercial real estate space. How many office buildings or retail buildings with vacant space really have to be vacant? Too many asset managers expect to re-lease expired leases at the same or higher rent. This type of thinking is either the product of a masochistic, naive or foolish (or all three) person. The supply/demand relationship of commercial space has changed. We are in a recession. Increased unemployment has reduced the demand for office space, and unemployed people shop and buy less. Accordingly, rents have changed. They have gone down.

The presumed logic behind attempting to charge a lessee whose lease expired the same or more rent is that if the space is leased for less income, then the real estate will be worth less. Herein lies the illusion. Today’s buyers or lenders base their valuations of commercial property on collected rent, not scheduled rent. Scheduled rent is a wish for rent that doesn’t exist.
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If only we would fix the present mark-to-market fair value accounting (FVA) standard, than everything would fall into place, and our economic problems would disappear. That’s the position many executives, associations, and companies are taking concerning FVA. What is mark-to-market FVA? It takes the current market value of an asset and adjusts it accordingly on the balance sheet.

The purpose of FVA is to respond to the definition of a balance sheet, which is as follows: A summary of an organization’s assets, liabilities, and ownership equity as of a specific date (where the market stands). The argument against the above is that the prevailing realizable values of many assets are ‘artificial’ given the current market’s distress, and FVA works when markets are functioning, not when there is extreme volatility.
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Reflecting on “Investors See a Glimmer and Shares Soar Worldwide” in the March 13 New York Times, the recent one-week stock market run-up has some of the experts (the same ones that missed the whole downturn) tripping over each other telling us the worst is over. They say we’re on the way to a 4th quarter recovery. That type of thinking is analogous to a person who is being tortured by 30 drops of water dripping onto their head being reduced to 25 drops. Conclusion: The torture is on the way to being over, and it should end in three minutes. On what basis?

The overarching problem is increasing unemployment for the economy and for income property value. We are still a consumer driven economy. The employment issue has been further exacerbated by the increased federal debt. Remember, when the amount of debt being borrowed increases, your interest expense increases. NetGain has calculated that currently we have to create 10 million new (civilian) jobs to support the increased debt. Are there any recent events that support a significant number of job creations? The answer is no, but hope springs eternal. On the positive side, there have been 32 recessions since 1845, and we’ve recovered (eventually) from every one of them.
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