We have sole ownership of a couple of office buildings that are performing very well at the moment. We were recently approached by a broker who was encouraging us to sell now while the market is still strong. We have heard all of the talk about rising interest rates and a looming downturn. Is it possible that the market may remain strong throughout the remainder of 2018? What evidence would support such a belief?
Answers
I wish I had all the answers. The panels I have attended recently tend to see the industry in a prolonged eighth or ninth inning. Valuations show buildings are losing value, but prices have not fallen yet. My recommendation is to look carefully at each asset. Look at current information. Values are most affected by the dynamics of the market. What is the quality of your tenant base? Does the building need renovations? Are they in primary markets or secondary markets? Depending on the asset class and location, you might test the market. But please don’t jump without carefully considering factors in the locality of your buildings. Is there a long-term mortgage that can be assumed by a buyer? Does it make sense to refinance now? Is your ownership structure optimal for maximizing your after tax return? These questions should be part of your analysis.
As a lawyer, I am not sure that my personal opinion on this type of question is reliable. That said, I read a great deal on the U.S. real estate market, speak about it at conferences and listen to true industry experts on their views. Generally speaking, the tremendous runup in real estate valuations over the last 10 years has been very much led by the lower capitalization rates and lower interest rates. Interest rates have seen increases, both short and long term, for the first time in 10 years and I think that there is no longer any room for compression of cap rates, as they have been at all-time highs. This would suggest that there is more room for downside pressure on pricing than upside in the market. But here are countervailing forces at work to mitigate that. There remains an abundance of equity wanting to purchase assets in the marketplace, though the very low cap rates and resulting high valuations are giving investors some pause, and there is still abundant debt. The one factor that can help predict upside or downside in this environment is general market fundamentals. Is the U.S. economy and creation of new jobs still expanding (it is) and is expansion likely to continue for some time? (Most say it will, short of some unforeseen bump in the road of our economy.) How will that likely affect rental rates in various market sectors, such as office, residential and the like? There is some greater risk in multifamily than has existed for a while due to cap rate compression, rising rates and, in some markets, great increases in supply, which makes it more difficult to achieve projected rents and cash flows. But in other areas, new construction has been muted generally for some time. So, this is a complicated and dynamic analysis that can be turned by unforeseen events, but the trend seems to be slow, upward trends in fundamentals that should mitigate any drop in prices in most areas due to higher interest and cap rates. That said, great increases in value of most assets in most markets would be hard to anticipate, short of some great development on a particular property in a value add situation
Hope this is helpful and good luck.
We view that there are still opportunities to benefit from in the US markets. If a broker is encouraging you to sell performing assets, usually they are keener on their own commissions and marketing a perfectly performing asset. When we divest from assets it is only for better opportunities and not just to sell a performing asset with stable rent, etc. for a simple reason of a broker encouraging to sell.