Two camps have emerged. The first is what I will refer to as the “Disaster Camp” and the second is the “Recovery Camp.”

The Disaster Camp (DC) is the illusive analysts whose cryptic research clearly indicates we are entering an era of melt-down. The DC guys and gals come at us armed with their complex charts and narratives that prove conclusively that we are headed into doomsday.

The Recovery Camp (RC) is equally persuasive with their slick, bullet-pointed PowerPoint presentations. The RC camp trumpets phrases like “sidelined investor capital waiting to be spent” and “Bond money waiting to pounce on market opportunities.”

After all is said and done, more will have been said than done! I’m conflicted as a result of the plethora of combative voices that leave me feeling as if I have just stepped off a wild roller-coaster and cannot gain my bearings.

As we enter 2010, I’m a lot like many of my clients, nauseated and bewildered and I am vowing here and now to never ride that roller coaster again.

For at least the opening stages of 2010, I am going to go back to trusting the basic fundamentals of investment and my instincts. In the early part of 2010 I’m resolving to delete all of the emails that are in the DC and RC camp. Away with the charts and the PDFs that tell many tales.

Here is what I am going to do in 2010…return to trusting me, myself and I. Oh, I will be forced to gaze at many more PowerPoint prophets and read many more detailed documents designed to either scare me into sleeplessness or fill me with the phony messages of hope beyond reason.

My thought is that 2010 is going to be a year of disaster AND recovery. We will eat at both sides of that aweful table made up of vinegar and sugar. That is why I am going to return to trusting myself and to a healthy avoidance of investment extremism. I’m inviting you to do the same.

Posted by Donald Teel – Arizona Commercial

Everyone, everywhere, is talking about the real estate market. Even people who do not know anything about the real estate market are talking about the real estate market.

Understandably, much of the discussion remains negative. After all, some estimates tells us that the net value of all commercial real estate in the United States has plummeted by as much as 30% since 2006. I would like to address the shiny side of this very ugly coin.

As we come to the end of 2009, how can we successfully invest in commercial real estate?

Many small to intermediate investors have been discovering that buying was the easy side of commercial real estate investment coin…the shiny side! Managing and turning properties in the volatile environment of 2009 has proved to be the tarnished side of our coin.

With respect to the fundamentals of investment, nothing has really changed. Yet, we all know much has changed and continues to change, especially with respect to the acquisition and cost of capital and sustained values. For the purpose of this article, I would like to place a market spin on what I think are the 10 most important principles for small commercial real estate investors to follow in 2010 and beyond.

Property Type. Who could have predicted that the multi-family sector would be where it is today based upon our assumptions ten years ago. We must remind ourselves that our assumptions are merely momentary conclusion based upon ever-evolving data and that the moving data is almost always something over which we have most likely, no control.

Type-casting isn’t just a Hollywood phenomenon, it’s imperative with every real estate transaction these days and in the case of multiple tenant revenues each lease will need to be sifted and ground down in order to determine its viability and value going forward. There are “leases” and there are “Leases” and there are “LEASES.” Nothing works well if the tenants don’t!

Inventory, absorption rates and occupancy rates and CAP rates are imperative to the investment equation. There is no negotiating these issues and they are deal breakers.

Still, it’s Location. It appears that the newest and perhaps safest strategy for small to medium investors is to get big by investing small all over. Just as mix of property types is essential to a sound investment strategy, so also is the principle of multiple locations based upon regional economic dissimilarities. Atlanta’s medical office values and projected demands will be different than those of Seattle and it would be ridiculous to compare Phoenix multi-family to say Manhattan multi-family.

Within macro locations there are micro locations and micro product. For example, if one really must invest in multi-family in Arizona, it would be wise to see investments with 4-8 tenants, under $2 million and perhaps not in the dense market of metro Phoenix but perhaps in central or northern Arizona communities of Prescott, Sedona, Payson or Flagstaff, since these markets are more self-contained.

Sound commercial investment thinking must go beyond the local to the national and even, when qualified and warranted, an investor can think international.

Commercial investment is about the cash flow and it is the cash flow that will ultimately determine the investment property value.

The Pace of Personal Risk. Too much, too fast is what I saw occurring from 2000-2006. Investor appetites were often out of control, money was easy and many believed the returns were going to be sustainable. Not so, we all know now! Pace of investment, especially where the investor is relatively new to commercial real estate is sooooooo important. It’s advisable that a new investor look at one property every 18 months for three years, as a basic formula. There is just too much to watch, more to know and the risks are greater than at any other time in history.

A partnership buffer can help with personal risk. It’s not advisable to put all of your eggs into one basket and it is less than optimal to do so alone. It looks like partnership are becoming more attractive to a lot of previous Lone Rangers who are now mortgage heavy and cash light. On most properties I have owned, there has been a partner behind me, beside me and in front of me and it always helped with both risk balance, capital demands, mortgages and in the end divestiture.

Going slow and not going slow alone is the new formula for smaller investors.

Demand Analysis. I have watched many small investors purchase a property with limited or no demand analysis. Demand analysis looks at the next owner who will step in at year 5 and it looks at the numbers that can indicate current and future user demand.

Questions to ask might be: Who wants the property today and why? Who will want it tomorrow and why? Who are today’s buyers and why? Who are tomorrow’s users and why?

I have never been fond of Las Vegas and I am not a gambler. Dice and I don’t mix well and cards are even worse. Slot machines emanate noises that frighten me. Gamblers eventually fold and there is really no place in commercial investment for risky speculation. Demand analysis can minimize some of the crap shooting that became all too inherent in real estate investment during the first decade of the 21st century.

Earlier in this piece, I talked about inventory and absorption rates. In many cases, investors complete ignore these trend lines and make investments solely on attractive CAP rates at the time of purchase. Understanding the demand cycle past, present and future will tell you a lot about an investment and give you some comfort that tomorrow’s market will serve your interests.

Ask Vs. Bid Strategy. Spread is everything. Spread forms the initial basis and our capitalization model should strengthen it further. We are seeing an incredible amount of stress regarding what owners say they must sell or lease for and what smart buyers are willing to risk. The ask value is no longer valid when risk is high. What an owner paid is almost irrelevant to today’s informed investor and nothing is worse than extremism on both sides of that negotiating equation.

In the past year, more than ever, I have heard buyers talk about things like “we need to adjust our offer (bid) in a way that we are protected for 36 months in case the market continues its decline. Buyers are bidding with a calculator set, not to appreciation, but rather to depreciation. Buyers are actually betting on losses!

The ask vs. bid spread creates a huge set of psychological negatives in a transaction and traditional lenders are taking hard and long looks at projected appreciation based upon property actuary tables, the life cycle of performance.

Better than half of all small to medium sized commercial property owners have seen more than 25% decreases in their property values. This is disrupting lease values, tenant negotiations and ultimately the asking price.

Crafting (another work for Brokering) the transaction involves a lot more patience and skill with respect to coaching the competing interests of the Asker and Bidder so that there is a reasonable expectation of a meeting of the minds. Tilting the transaction to one side or the other can lead to serious financing problems, not to mention ROI issues. Owner who ask too much attract buyers who offer too little. In the end a good commercial transaction will be empirical, not emotional.

Creative Capitalization. Risk is always a function of the market conditions and the cost of capital or, I might say the “capital plan.” These days, I am becoming a big fan of creative capital sourcing, i.e., partnering the capital requirement through partnerships and other structures including, LLC and Sub S corporations (see your legal and tax advisors for input).

The lending streams are parched and institutional lenders are increasingly favor stronger partnerships that can personally and severally guarantee. However, there are other capital marriages that can include down payment partnerships that provide a down payment partner with 30% interest in a single asset commercial LLC in exchange for a 20-20% capital requirement. Today’s numbers need to look very good and provide 12-15% cash-on-cash return. In addition, the exit strategy must be rock solid at the end of a 3-7 year model and will most likely need at least one round of new financing.

Shifting or spreading risk is a good way to think. Formation of partnerships, joint ventures, LLC and corporations that involve multiple players is what I call creative capitalization. Do not over-leverage a property just so you can buy it. In fact, never over-leverage.

Management. Property management for small and medium sized investors is a much larger factor than is admitted. The value of maintenance, attention and presence can create substantive value increases to an investor. Yet, many smaller investors attempt to manage property without management services. This is almost always a mistake. Professional property management services have been known to hold value and in some cases protect owners from factors that can destroy return.

Property Management can be the eyes, ears and sense of touch and taste for a small investor and the cost of management should be rolled into the performance analysis.

A simple rule to follow is that if you do not have to manage your own investment, do not attempt to do so. The marginal savings will not be worth the effort. Typically, if a small investor has more than 4 units to manage or more than a $300,000 investment the management should be placed in the hands of trained Certified Property Manager.

Let me remind you that bad management can also contribute to the decline of property value and selecting, reviewing and correcting property management is a part of the investment model.

Reserve Resources. Capital reserves are as valid for the $200,000 investor as they are for the $15,000,000 investor. In fact, the stakes may sometimes be higher and the risk ratio more dangerous for small investors who do not create and maintain capital reserves as a part of the investment formula.

Capital reserves are something your Broker can assist you with and a factor in property management analysis that helps owners manage for the long term by having funds available for those pesky, yet often expensive “surprise” capital requirements.

One of the key reserve resources is adequate property, casualty and catastrophic insurance, including, when necessary, flood insurance. In addition, a percentage of cash flow should be allocated to a capital reserves account, monitored by your Property Management Company.

Air conditioning, heating, parking lot surfaces, roofing, glass, pools, common areas and other expenses can destroy property value and place capital demands on an owner that are unsustainable. When you invest always, always…let me say it again, always create a capital reserve analysis commensurate with the property and make the property performance fund these reserves.

Reserves can also be in the form of personal wealth or lender commitments. The principle is a simple one; if you are a commercial real estate investor you WILL need a source of capital funds and having access to capital can serve as a hedge against the market. Survival can sometimes be dependent upon having access to affordable funds.

Holding and Folding. There is that popular country western song with the lyrics, “you’ve got to know when to hold ‘em, know when to fold ‘em” that has as much wisdom as it does rhythm. Knowing when to hold and when to fold is a skill, not just an impulse. This skill is true not just in the game of poker but in a commercial real estate investment model as well.

Many investors who were advised to “fold ‘em” waited too long. They should have sold when advised to do so by their Broker but they refused to do so and now they hold properties that are highly devalued in the market.

There are many rules to follow when holding and folding and each property, its location, the objectives of the owner, market trends and the availability of financing all play a role in determining when it is time to sell and walk.

Pay attention to trends. Study the trends. Know the trends. Especially important to the hold-n-fold tension is your knowledge of capital and lending trends. These are often ignored in favor of market analysis. Capital markets are often ahead of broker analysis of market trends. Lenders are typically a cycle ahead of the market and therefore knowing when to hold and when to fold is largely a function of lending strength and the availability of affordable financing.

Let me say one more thing about this subject. If you have a property that is free and clear and the leasing trends are in a downward spiral for that property type, it may be best to fold and carry back the financing for as long as you can in order to offset value losses created by market declines. If you can be the bank, be the bank.

Rotation, Rotation, Rotation. Exchange rules are not such an easy game to play today; however, exchanging property is a key fundamental to building long-term wealth. Once you are in the game, it is not so much about location, location, location as it is about rotation, rotation, rotation.

Flipping property by means of tax deferred exchanges should be built into your investment plan and model at the time of your first purchase. The key to this is that sales are taxable events in the eyes of the Internal Revenue Service, while 1031 exchanges are not immediately taxable events.

The 1031 tax deferred exchange is an IRS approved model for selling one “qualifying” property and from the proceeds acquiring another property of like kind within an IRS approved length of time. The transaction of selling and re-investing is treated as an exchange and not as a typical sale where capital gains are taxed.

Property rotation under the IRS rules of exchange is the most lucrative long term method for building wealth through real estate investment. There are specific rules and processes that must be followed for rotating in and out of properties but a qualified Broker or what is known as an “Intermediary” can explain those rules to you.

With each investment, we must ask ourselves the questions, “When will I sell?” and “What will I do with the capital…pay taxes or, invest again to increase your wealth?”

Posted by Donald Teel, Arizona Commercial

Taking the guesswork out of commercial real estate investment requires more than a hope, a prayer and signature.

The genesis of commercial real estate investment is found in the analysis of the basic math surrounding the transaction. Costs, cash flow, depreciation, appreciation, money in and money out. Math is the science of the deal.

While the origin of commercial transactions is found in the science of basic mathematical functions, the art of performance is found in the crafting of the document; this is the model. Well crafted documents are extensions of the numbers and the intentions of the principals.

If there is to be any semblance of predictability of performance such must be memorialized and embedded in the language that constructs the investment, i.e., the purchase agreement or lease agreement.

Then too, the document’s credibility is only as good as the integrity of its signatories; their motivations. They who sign are those who are called upon to act in accordance with their written promises.

Summary: the deal is as good as the numbers (the Math), the performance is as good as the document (the Model) and the execution of the promises is only as good as the integrity of the principals (the Motives). Upon these three the investment hinges.

The numbers are the science, the document is the art and the performance is the warranty. Upon these three the deal hinges and the door of performance opens and closes.

I have seen and written a lot of documents. In my career I have seen short documents that were good and long documents that were bad. There have been times when the short word accomplished as much as the long word and vice-versa.

Good numbers, contrary to the opinions of some of my contemporaries, are seldom the guarantor of performance. My experience has shown me, countless times, that the integrity of the transaction is always found in the fulfillment of the promises of the principles and this only as a result of superior documentation, whether short or long.

In retrospect, I have seen great documents backed by great numbers end in disaster due only to the diminished capacity, whether intentional or not, of a Principal Party to perform as promised. Lawyers want us to believe that documents are everything. I have seen good deals with superior documents go south because of bad intentions.

Nothing can overcome a Principal with a misguided principle, no matter the document, no matter the math.

Then too, I have seen miserable documents when placed in the hands of principled Principals run their course without incident.

After more than two decades I have learned that the math, the model and the motives are the three inseparable ingredients of any commercial real estate transaction; the most powerful being the later.

To me, this is the holy trinity of real estate investment and one cannot function without the other two.

Upon these three the deal hinges.

Future of CAP Rates

Posted by Donald Teel, Arizona Commercial

Commercial investors and real estate brokers/agents toss around the term “cap rate” as if it were some sort of tell-all with respect to commercial property value or the measurement of the strength of a commercial property investment.

Hold your horses!

Can a CAP rate determine a property value? Are CAPS an accurate measure of an investment? Can CAP rates be trusted as a true litmus test for investment?

Answer: No, no and no. In fact, CAP rate determinations are now coming under assault.

Brokers often convey value and pricing by dividing net operating income by a purchase amount, such as 125,000 (noi) divided by $1,125,000 (price) equals a cap rate of 11.1%.

CAP rates are simply the measurement of a property value for a given 12-month period “IF” the property were purchased “cash.” CAP rates are impacted when investors utilize financing and the terms of financing, such as interest rate, points, call date, etc., impact “true cap rate.”

Real World CAP Problems. What happens in a market where the actual or contemplated lease rates fall below levels suitable for so-called “adequate” cap rate?

Savvy investors know how important cash flow is and more importantly, how important predictable and sustainable cash flow is in a down market. Real world cap rate problems occur when the strength of rent rates is compromised by a struggling economy or by tenants who vacate properties due to their business failing to perform.

Example: If the prevailing and sustainable (emphasis on “sustainable”) market rents are anticipated to trend downward for more than 12 consequtive months due to a faltering national economy, cap rates may be a less than optimal way to determine purchase price value.

Welcome to today’s real world problem with cap rate valuation! I have a theory that the accelleration of tenant default has now become the single most powerful force in declining commercial property values. There goes sustainable NOI.

The Assault on CAP Rates. Shopping cap rates is usually a faulty initial premise in today’s market since most investors are unwilling or unable to park cash into 100% of the purchase price of a leased property.

Today, long term tenant performance is becoming less stable and the market competition for “exceptional” tenants is heating up. Vacancies are driving down NOI, lenders know this and are now adjusting their cap calculations to include historical property performance perdictions.

Cap rates as a tell-all financial apparatus are under assault and weighted calculations for financing and property segment performance MUST be taken into account by investors more than it has in the past.

A trustworthy cap rate will always be adjusted by the cost of money and the cost of alternative investments measured against real estate investment returns.

The strength of lease agreements, tenant performance, type of business and the cost of money over time (typically 3-5 years) are now more significant than ever.

Want more information about cap rates and the central and northern Arizona commercial markets? Email me or, if you prefer, call me toll free at 877-777-9100.

25,000 SF Retail - Prescott, Arizona

This is an excellent opportunity for an investor to acquire a value added, well located commercial investment property in Prescott, Arizona.

The existing lease is a new 10-year absolute NNN lease with increases and percentage rent and two five-year options to renew.

In addition, the property includes a 4,500 sf pad for retail expansion.

Property Description:
ASSUMABLE FINANCING. 5.75%, 27 year note, 15 years with option to renew at market rates. 8% CASH ON CASH. Single Tenant new 10-year Absolute NNN Lease with Escalations and Percentage Rents. 25,000 sf. Investor opportunity to acquire a well located, value-added asset with no landlord responsibilities. Includes a 4,500 sf Pad for additional expansion. Goodwill of Central Arizona is one of the largest and oldest nonprofits operating in the state of Arizona for more than 60 years.

Location Description:
Located within the Prescott Towne Center, a 53,000 sf retail center comprised of 3 buildings directly across from Village at the Boulders with Super Wal-Mart, Big Lots, Tuesday Morning, JoAnn’ s and Dollar Tree.

Prescott is located 90 miles NW of Phoenix with a mild 4 season climate resulting in a healthy growth rate. The Prescott MSA has a population base of approximately 100,000 and a trade area of approximately 165,000.

For more information about this property or any other commercial real estate investment opportunity in Prescott Arizona, email Mary Jo Kirk, CCIM or call me at 928.710.4045.

CRE Investment Advantages

NEWS: CB Richard Ellis CRE Investment

CB Richard Ellis (CBRE) commercial investment firm has some things to say about how investors indulge in the current CRE soup. In a Special Report document published in April, 2009, entitled “Advantages of Investing in Commercial Real Estate,” CBRE addresses both CRE stock and invididual investment strategies and states,

A key difficulty in developing and implementing an exit strategy in the current CRE environment is the wide chasm between the bid-ask spread. A contributing factor to this is the relatively high appraisal values prevailing in the U.S., causing sellers to dig in their heels unless they are truly distressed. At the same time buyers are looking for bargain-basement opportunities. As a result, transaction volume has plummeted 74% in the U.S., according to Real Capital Analytics.

On main street America this analysis has real meaning as commercial property owners experience their own “bid-ask spread” in terms of lease and selling prices, i.e., what owners want and need measured against what tenants and buyers are willing to pay. The “bid-ask spread” truly impacts sellers with mortgages created in the 2005-2007 time period, especially if any cash-out factors came into play on these loans or, more significantly, if second position notes and deeds have been created.

The CBRE report is worth reading even by the most casual and low-keyed commercial investor because it helps bring clarity to the current market situation in which we all find ourselves.

Still, the CBRE document makes a good case for looking long term with respect to CRE investmets, whether securities or real property. CBRE’s “Special Report” is a must read document.

DOWNLOAD THE CBRE DOCUMENT: Advantages of Investing in Commercial Real Estate

Commercial capital and financial experts are predicting that the commercial market will begin to experience an accelleration of “Bank Owned” (REO) properties as more and more owners experience downturns in tenant performance and the inability to service existing mortgage debt, note calls and stringent refinance requirements.

It’s About the Money. Throughout 2009 and well into 2010, commercial owners are going to come under some pressure with respect to turning properties and even exchanging out due to the financial markets.

Sellers are already having problems finding buyers for conventional property investments. Why? It’s about the money AND it’s about the decline in values that buyers don’t want to face after they purchase.

New Market Realities. Savvy investors are thinking about the new market realities and where they need to park their money for the next 24-48 months. The key is minimizing risk.

This investment reluctance is leading investors to pursue real estate owned property (REOs) and that is why Arizona Commercial, my company, has established “REOS” or, Real Estate Owned Services” as am owner consulting and investment service.

REOS involves consulting services for existing owners, bank asset managers and of course, investors who are resisting declining property values found in traditional investments.

Want to know more about REOS? Register with us for confidential inclusion in REOS. Or, if you prefer, email me or, better yet, call me, toll free at 1-877-777-9100.

This aerial image of Prescott, Arizona’s downtown commercial area does not tell us much. It simply makes me wonder what is happening north, south east and west of the core area. There is a need to pan.

Market perspective plays a huge role in the analysis and decision making behind NOI, ROI and long term wealth accumulation for an investor. Putting distance between oneself and the market creates a better view.

Today, perhaps more than at any time in the last decade, market perspective counts and can easily impact a commercial transaction’s ability to perform and deliver the desired financial objective.

Lenders are looking at transactions with an eye toward long term performance based upon what I might call property actuaries. If a property segment (type) such as retail, medical, industrial, multi-family is on life support, the lenders are going to factor that illness into the capital risk formula.

New investors and current owners should insist that their commercial broker illuminate market trends because these north, south, east and west views of the total market will (notice, I didn’t say, “might”) impact performance.

Markets such as central and northern Arizona and their key communities of Prescott, Sedona, Flagstaff, Payson and Kingman are inseparably linked to metro market trends.

At Arizona Commercial, we study the markets. We are deliberately assertive with clients about where the market is going, not just where it is today.

The birds eye approach means looking at the market from above and understanding what the various segments and pocket are doing and where they are likely going.

CONTACT DONALD TEEL BY EMAIL OR TOLL FREE AT 1-877-777-9100.