Changing real estate cycle offers investment opportunities

Has the real estate market hit bottom? Commercial real estate brokers are asked this question daily. But the better question might be this: Where are we in terms of the business cycle?

Glenn Mueller of Dividend Capital in Denver, a professor at the University of Denver, breaks the typical 20-year business cycle into four phases: Phase I-recovery, Phase II-expansion, Phase III-hypersupply (which follows the market peak) and Phase IV-recession. The Western Colorado commercial real estate market could soon be leaving Mueller’s Phase IV-recession and entering Phase I-recovery.

Growth in energy development, primarily in the Piceance Basin, prevented the West Slope from feeling the recessionary effects that plagued Denver and much of the nation in 2007 and 2008. As a result, Western Colorado remains one to two years behind Denver and the rest of the nation in the business cycle. Mueller and others in the know say Denver has experienced Phase I-recovery in the office, multi-family and retail sectors since the third quarter of 2010. Western Colorado markets soon could follow.

Mueller explains that in Phase I-recovery, the market remains in a state of oversupply from previous new construction or negative demand growth. While we see little demand in many commercial sectors, the office sector seems to be strengthening locally. While we’re losing some notable tenants in the retail sector, some new tenants are replacing the old ones at a fairly quick pace.

Another barometer in the local real estate market is local banks, their foreclosure inventory and new lending activity. While the latter is still subdued, a recent bank survey in Grand Junction indicated that most local banks are not heavily inundated with previously foreclosed-upon properties.

In light of the national recession and our local market weakness, the banks remain in surprisingly strong fiscal shape and are pragmatically working through their small real estate portfolios. Many bankers say they slowed or discouraged new lending in time to prevent much of the construction oversupply typical in most recessions. As a result, we might enter the recovery phase of the cycle without a large oversupply of properties to work through.

If we’re approaching recovery in the commercial real estate market, when should we invest?

The answer, of course, is to first ascertain the experience, knowledge and abilities of the investor.

Second, for what purpose or purposes will the investment be made? Is the investor nearing retirement and looking for a stable income? Perhaps a single-tenant triple-net lease with few or no investor expenses might be appropriate. Is the investor a skilled commercial developer? That corner parcel of land with the incredible location could be best-suited for an investment. Are rising commercial property taxes in Colorado increasing your reluctance to hold a commercial investment? Perhaps a multi-family property with residential tax rates offers the best solution. Whatever your reasons for investing, don’t lose sight of the purpose of the investment.

Third, determine the amount of cash available for a purchase, the loan that’s required for the difference and your comfort level in the resulting cash flow.

Are there desperate sellers in the market willing to sell for pennies on the dollar?

There are always sellers in every market that, for one reason or another, need to get rid of a property. Whether or not they will sell for pennies on the dollar depends on the level of their motivation and also on the market knowledge and savvy of the buyer and buyer’s real estate agent.

As a buyer, what return on investment do you require? Is an 8 percent return on your investment capital a reasonable return for the type of investment made? Is the investment riskier and therefore demands a 10 percent return? Is your management experience and expertise so keen you’ll settle for no less than a 12 percent return? What about the return of your capital?

Regardless, every experienced investor knows if you don’t buy a property at an advantageous price, it’s more difficult to achieve a normal or better than normal return on investment.

We now could be approaching the time to invest in Western Colorado real estate. Interest rates remain low and this is a great time to get some practice searching the market for deals. Remember, there’s no perfect time to buy, only the right property at the right price for your investment needs.

Once we’ve realized the market has hit bottom, it’s already too late to find that bottom. The rush of buyers will push prices higher very quickly. Take your time and good luck!