Monday, March 10, 2008

Fundamentals for 2008

We always hear that the key mantra in real estate is: location, location, location. While this will always be true, I think what we will hear a lot of in 2008 is: fundamentals, fundamentals, fundamentals. Over the last couple of years we have experienced an extraordinary positive market in all sectors of commercial real estate. The majority of this has been fueled by the capital markets: we have had low rates and plenty of money to be invested. With the start of 2008 we've seen an enormous change in the capital markets: lenders are starting to look harder and more diligently at the fundamentals of commercial real estate investments.

What does this mean for apartments? It means that we are going back to the basics when it comes to analyzing these properties and investors are making decisions based on these basic fundamentals as opposed to the cost of capital being the overriding factor in whether deals make sense or not.

We forecast that we will see a lot of the trends that emerged in 2007 will continue into 2008. These include a continued increase in rental rates, but not at quite the same rates that we experienced in some submarkets in 2007. Appraiser Mark D. Barry reported that turnover rents were up 5-10% for 2007. I agree and believe we will see additional increases in 2008 in the range of 4-8% in most but not all submarkets. One submarket which will be interesting to watch play out is the downtown Portland market. Right now, there are a number of large condo projects that are now being completed as apartments. This change will create a lot of inventory downtown and will put some downward pressure on the increasing of rents there.

Although the economy is showing signs of slowing, we still have in-migration to this area and prospects for continued job growth, although not as healthy as in 2007. With the slowdown in the single family market I think we will see an increased number of renters which will contribute to higher rents and continued lower vacancies in the apartment market.

Here at HFO, we are seeing lenders becoming much more diligent in reviewing operations of a property. Although interest rates remain historically very low and money is available at 6% or lower, the loan to value levels are lower. While this won't necessarily affect a well-heeled buyer, the change in the capital markets will definitely make getting into the market more difficult in 2008 for the high leverage buyer. We are also seeing that financing for transactions is taking a little longer to secure due to the lender’s increased scrutiny of the property.

2008 is getting back to where things were before the flood of cash started going into commercial real estate; we’re heading back to basics and really analyzing the fundamentals of an apartment property rather than availability and cost of capital as the overriding factor.

While it will always be location, location, location in real estate -- for 2008 it also means getting back to the fundamentals.

Greg Frick is a partner at HFO Investment Real Estate. He can be reached at 503.241.5541.