Good properties will be hard to find in 2007

I attended a recent 2007 economic outlook breakfast yesterday morning at Derryfield Country Club. As one speaker, a banker, said, 2006 wasn’t great but it wasn’t bad either. In fact it was more of the same with the economy just bumping along.

In a show of hands, the audience agreed with him. His prognostication was that 2007 would be even more of the same — nothing spectacular, but nothing dire. He felt the inverted yield curve (short-term interest rates being higher than long-term rates) would last throughout the entire year. This is tough for lenders. I just put $5,000 in a five-month CD at 5 percent, which beats the money market and savings accounts.

I agree. In 2007 there will continue to be more money to invest than good places to invest it. Good investment properties are as rare as hen’s teeth. A client from Vermont and I drove through Concord, Manchester and Portsmouth looking for a solid investment property for him to do a 1031 tax-deferred exchange. Using the CIBOR Commercial Property Exchange database, I printed off a listing of over 60 properties for sale between $1.4 million and $3 million. Reviewing the list carefully, I culled out 13 properties that might be of interest. We cut seven off the list, and I gathered more information on the other six. The next day we visited the six properties and took a familiarization tour of the areas’ industrial and office parks.

As we drove back to the airport we agreed that there is a dearth of good properties and that he would likely need to reduce his expectations for yield/return in order to accept less risk.

The client is not a “flipper.” He wants to hold the property for at least 10 years, so location, location, location, along with solid construction and flexible space design are absolutely key ingredients in this equation.

Traditionally, buyers seek a 10 percent return on the new property. This is a rule of thumb, with many exceptions. In the past five years, buyers have had to settle for much lower returns in order to secure good investment properties. My client was seeking an 8 percent return, but after our tour, we both felt he might have to go down to 7 percent or 7.5 percent. Now keep in mind, by using the 1031 exchange he will avoid paying capital gains taxes on over $1 million of value. In New Hampshire, that would be at least 23.5 percent (15 percent for the feds and 8.5 percent for the state). But in Vermont, it could be more.

There are plenty of buyers, lots and lots of lenders, but way too few good properties that can be purchased at a price to yield an 8 percent to 10 percent return. One strategy we employ is using a tenant that we are charged with placing in the market, to commit to a property and then identifying a qualified buyer who will become a secure and reasonable landlord. Believe me, this is much easier said than done. But when we can create this synergy, both parties are extremely pleased.

My Vermont buyer and I have both worked in the commercial real estate arena for more than 30 years, are cynical about some of the prices being paid for properties. This is especially challenging for a “holder” versus a “flipper.”

Even Sam Zell of the huge Equity Group Investments REIT, swore he was a long-term holder of prominent office buildings in major markets, until a group came along and offered $36 BILLION. These kind of prices can make anyone a seller.

Will 2007 see more of these transactions? All indications are yes. Interest rates are projected to be level, and investors are plentiful.

The good news is that 2007 should not disappoint us, but someday market forces will reassert themselves, and there will be a correction. Many pundits say this is happening in the housing sector right now. I am not sure. The run-up in real estate values, both residential as well as commercial, since the crunch of the early ‘90s has been staggering.

I sold buildings in 1993, ‘94 and ‘95 for $10, $12 and $15 per square-foot. Today, many of those properties are commanding $10, $12, or $15 per square-foot in annual rent. A house I bought in 1980 for $30,000 and sold in 1986 for $92,000, recently sold for $252,000.

The point is that the hyper run-up in values of property over the last 10 years is far in excess of historical norms. There could well be some air to be let out of this over-inflated balloon. A downward pricing correction of 15 percent to 20 percent is not out of the question. The key question is, when? But if I knew the answer, I would be well-retired and no longer writing this column. nhbr

Bill Norton, president of Norton Asset Management, is a Counselor of Real Estate (CRE), a Fellow of the Royal Institution of Chartered Surveyors (FRICS) and a member of the board of The Initiative for a 2020 Vision for Concord. He can be reached at wbn@nortonnewengland.com.