Monday, August 20, 2007

"Justifications" for buying property at a low cap rate

This is an interesting theory I came across today. The gist of it is that deals have been done at high prices (the so-called "Blackstone Effect" from its EOP acquisition) under the theory that you are buying the property for its future value based on the assumption of continuously rising rents.

I call that kind of thinking risky, except maybe in the scarcest markets (Manhattan, maybe downtown SF, central London, etc.) and perhaps even there to boot. In the 1990s everyone thought rents would never go down and that demand would always exceed supply. El-wrongo. Now this is a completely different market from fifteen years ago, but as Santayana wrote (a phrase that, alas, Jim Jones co-opted in his tragic camp in Jonestown), "Those who cannot remember the past are condemned to repeat it."


Jeff Brown said...

Usually, the justification is doing the deal - period.

Considering the level of investment sophistication the buyer would have to have at the price level under discussion, the thinking becomes even more mysterious.

One possible explanation is the amount of capital is so great, they're looking at these low cap purchases as a superior choice when compared to simply having the money 'parkied.' Kind of a stretch though, don't ya think?

David Stejkowski said...

I too think it is a stretch. Some of these returns are so low that treasuries or Libor contracts are almost more attractive in comparison on multiple levels. But these are real estate funds and people have to have deals to have jobs or to eat.

I would have my money parked right now personally, and I in fact even have a project or two in mind to buy if some highly-spec deals I know about go south.

If you are in a really "sexy" market then buying for the rise might make sense, even if it defies traditional CRE investment logic. But we've gone from only GSA-type deals being 7-caps a few years back to gosh knows what today!