The Driving Force Behind Commercial Real Estate Value - Past, Present, Future
It was at this time that the large developers and general partners of the 1980s discovered real estate investment trusts (REITS). Although REITs had been legislatively in existence since 1960, the concept hadn’t attracted much attention. Large developers and general partners found they could extract their net worth from the public by creating REITs – their exit strategy. In 1993, new legislation allowed REITs to manage their own property. Now the developers and general partners could sell their properties to the public (via a REIT) and keep the management fees, further increasing the number of REITs that were formed and that went public.
As the product of publicly traded vehicles, REIT yields were very competitive and offered a real estate investment with real liquidity and increased ROI. A positive attitude toward commercial real estate emerged. The expansion of REITs as an investment vehicle stabilized and attracted capital for the commercial real estate industry. REITs were the driving force behind commercial real estate values for the 1991-1994 era.
The driving force behind commercial real estate values: 1995 and beyond
From 1975 to 1980 the driving force was increasing rents.
From 1981 to 1985 it was tax benefits.
From 1986 to 1990 it was refinancing.
From 1991 to 1994 it was REITs.
It is unlikely any of these factors will be the driving force for 1995 and beyond. Currently, rental increases are not sufficient to be the driving force. Considering the federal deficit, tax benefits will not be a factor. Refinancing commercial real estate is now much more difficult with lenders using more prudent due diligence and wanting high debt-to-equity relationships. REITs have appreciated at a much faster rate than their yields and are not the dramatic buys they once were.
Professional management will be the new driving force affecting commercial real estate values. Professional management will involve the entire investment process, including goals, acquisition, capital expenditures, lessee profile, property management, financing and alternative income. With the growth of REITs came the institutionalization and public disclosure of the commercial real estate industry, causing a metamorphosis from being transactional with a short-term outlook to corporate with long-term outlook.
Goals are more clearly defined. Goals are translated into the acquisition process where adequate capital has been provided. Property management’s focus is not exclusively on the income side (that’s how they’re paid). Net operating income NOI is their focus. Additionally, with lessees spending up to five times their rent on other goods and services, property management is working to get some of that money. Profits generated from that money increases yield and value.
This is a good time for commercial real estate. Although cycles (ups and downs) will continue and some investors (the greedy and naive) will loose money, the emphasis is on professional management and commercial real estate’s core intrinsic values. (1) Current yield. (2) The quality of current yield. (3) The outlook for future yield.
