In the last post, we talked about the crap shoot in the investment market. As it pertains to overall sentiment, many investors, Whitebox Real Estate and our clients included, are somewhat hesitant to play keeping up with the Asian and European investors.
There’s no question that there are groups out there that have revised their strategy and decided that we are in a new era, this is a new way of thinking, and that we need to embrace it. Does that sound familiar? It sounds like 2007 and 2008 right before the recession. I don’t know if it is, or that I am predicting it. I’m just saying.
I keep mentioning that I don’t want to be the last one holding the hot potato. I am a true victim of the “Snake Bite Effect.” I have overarching fears of going into another recession and buying at the peak of the market.
I remember when the Galleria Office Towers at LBJ Freeway and the Dallas North Tollway seemed to keep trading for record prices. It seemed like it kept selling for a while, and every investor would buy it and flip it for a profit as the market continued to increase. In 2008, Cannon Commercial was the last one to buy it from Fortis at a $300 million price.
Fortis bought it in late 2006 for $285 million from Blackstone who acquired Trizec (with Brookfield) in 2006. Everyone seemed to keep making money until Cannon bought it. Cannon finally sold it for $300 million (that’s right) in late 2015 to CB Richard Ellis Investors. The paid the same price they bought it for seven years earlier.
Another example is the Chase Tower, which you may remember from the last crap shoot piece. It is located across from KPMG Plaza and is currently for sale. It is rumored to trade for around $240/RSF or $300 Million +/-. In 2006, Stream Realty bought the building for $250 million. In 2007, they sold it to Hines for $289.6 million. Not much of an upside.
So what does this mean? It means that there are two types of U.S. and Canadian investors. There are those that are willing to readjust their models to play in this new frontier of compressed cap rates, and there are those that are willing to hold out. At Whitebox Real Estate, we are opportunistic, so we won’t pass on a good deal if it is out there, but we feel there will be excellent deals that come to light in the future.
Let’s be real, it can’t go up forever. Markets have gone up and down since the Holland Tulip Bulb bust in 1637. What we have found is that there is a considerable amount of “rainy day investors” out there that are waiting for a market correction to pounce. This is truly a unique North American sentiment. After all, we are the land of the “Big Short,” where people actually bet and wait on markets to go down – only to swoop in and buy at a much lower price than it’s used to be trading at.
However, there is a new factor with this strategy. The fact is, most investors and advisors, myself included, continue to remember the market crashing. We remember the ridiculously good deals that were out there. We fancy ourselves as being patient. There is only one problem. With the current market and continuous influx of outside investment, it has almost pushed all of us to the sidelines.
Foreign investment continues to push the cap rates lower.
What we start to see is an unbelievable amount of money building up on the sideline, chomping at the bit to get into the market. My hypothesis is that the late 2000s recession was one of the best opportunities to get in because the macro-economic climate failed to push foreign investment to the U.S. There had also been no real slam to real estate prices since the 1980s.
When things started to go south, it was market free-fall, and there were much fewer patient investors. There were even fewer with any sort of money to invest, who were able to buy assets for ridiculously low prices and sell them a few years later for very high profits. Today the competition has accumulated, and that was one thing that was not around back then. In the late 2000’s there was not real “bidding” for distressed assets. That is not the case now.
I will use the oil market as an example of this effect. I heard Dr. Mark Dotzour speak at the SIOR conference in April. He spoke about the Saudi Arabian government deciding to try to run the U.S. oil companies out of business by reducing oil prices with the intent to increase the price after they level the competition.
What they did not understand was the rich capital market that existed in the U.S. to buy distressed oil companies. Dotzour told a story about making this point to a group of investment bankers specializing in distressed oil and gas assets, and he made the point that the Saudis did not understand that there was $10-$15 billion waiting to get into the market as it falls.
A woman came up to him after the presentation and said that she enjoyed it very much, but she thought there was actually about $100 billion out there, that is just for oil and gas.
Real estate in the U.S. is in a very similar position, and especially with the foreign investment, more buyers are headed to the sideline and are waiting to get back in. I think you will see competition for distressed assets, and I also believe this will help to mitigate the fall if and when it comes.
Don’t forget that Dallas-Fort Worth was recently listed as the third best metro area to invest in CRE behind Los Angeles and New York City. DFW is one of the fastest growing metroplex in the U.S. It is in the center of the country, which makes it easy to get from North America’s five largest business centers: New York, Chicago, Los Angeles, Mexico City, and Toronto.
Furthermore, it lies in the Central Standard Time (CST) zone, which is only one hour behind the East Coast and two hours ahead of the West Coast, which allows companies doing business on both coasts to extend the work day. It has great infrastructure. There are more airports in Texas than in any other state in the country and the state’s busiest airport is the DFW International Airport.
DFW is also one of seven metro areas in the country that have two major passenger airports (DFW International Airport and Dallas Love Field). It is also home to one strictly industrial airport (Fort Worth Alliance Airport), as well as several other private facilities.
DFW has two International Rail Intermodals: BNSF in Alliance, north of Fort Worth and Union Pacific, south of Dallas in Wilmer and Hutchins. Both intermodals are “Emerging Inland Ports” to distribute containerized product coming from China. The containers arrive in Long Beach, CA, and travel via rail, to DFW to be distributed within a 500-mile radius on trucks (the distance a truck can drive in one day).
The DFW metroplex serves as one of the five main distribution hubs in the U.S., joined by LA (Long Beach), Atlanta, New Jersey, and Chicago. Adding to the ease of transportation is the most obvious one – automobiles. Additionally, Dallas-Fort Worth almost looks like a giant bull’s eye on a map. It has four interstates right through the middle of the Metroplex: IH-20, IH-30, IH-35, and IH-45. It provides an easy way to get North, South, East, West and everywhere in between.
This is why Toyota, Liberty Mutual, and State farm – just to name a few major companies, have moved to DFW. It is anticipated that DFW will grow by nearly 3 million residents.
So where does this leave us in regards to cap rates? It is a crap shoot! Only time will tell. No one seems to know where cap rates are going and what the market will bear. All we can do is evaluate deals, one at a time.
In the grand scheme of things, most investments in DFW should be safe regardless of your basis, due to the unprecedented growth and influx of money.