The investment sales market has been steadily improving over thelast few quarters, as fundamentals begin to improve and economicrecovery, while sluggish, is upon us. With regard to fundamentals,we have seen rent concessions evaporating and occupancy ratesimproving. The economy is moving in a generally positive directionbut is having difficulty finding momentum as employment growth iswell below expectation and last week it was reported that consumerspending experienced a decline of 1.2% in May, the first drop sinceSeptember of 2009. While the investment sales sector appearshealthy, the future of the market, however, is uncertain as marketindicators are presently difficult to interpret. These conditionsbeg the question: Are we in another bubble at the bottom of acycle?

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Today, nothing is impacting the investment sales market morethan the supply / demand relationship. Real estate markets arealways dependant upon the supply / demand dynamic, however;it appears to be impacting the market more acutely now than we haveseen in the past. Presently, there is excessive demand met by arelatively weak supply of available properties for sale.

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Demand drivers are active from every segment of the purchasingarena. When we first started to tangibly feel the impact of thecredit crisis in the summer of 2007, the institutional capital,which drove up value in the bubble inflating years of 2005 -2007,all but evaporated from the marketplace. The overwhelming majorityof investment properties that Massey Knakal closed from mid-2007until recently have been purchased by with high-net-worthindividuals and families that have been investing in the market fordecades. Recently, we have seen a reemergence of institutionalcapital as these investors have formed distressed asset buyingfunds and opportunity funds to take advantage of perceivedopportunities in today’s market. Add to this the significantnumbers of foreign investors and we have a demand side of theequation that is overwhelming.

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On the supply side, we have seen historically low levels ofproperties for sale. Typically, the supply of available propertiesis fed by discretionary sellers who decide it’s time to sell.Typically, when values decrease, as happened beginning in 2008,discretionary sellers withdraw from the market. As this occurs,normally distressed sellers will emerge to fill the void left bythe withdraw of discretionary sellers. In this cycle however, thishas not occurred. Everything that has happened from a regulatoryperspective has provided distressed sellers the ability to avoiddealing with their problems if they choose to.

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The result is a very low supply of available properties tosatisfy the excessive demand that exist in the marketplace. Due tothese conditions, properties are selling for more than fundamentaleconomics would dictate they should be selling for. Consequently,the “great opportunities” and “great deals” that were expected atthe onset of this credit crisis have simply not emerged.

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The supply of available properties is, however, increasing. Wehave seen a tangible increase in distressed assets coming to marketand these distressed sellers are being joined by discretionarysellers who are, once again, coming back into the market. They havebeen waiting for a while to implement sell decisions and theysimply are not willing to wait any longer to pull the trigger. Someof our clients are selling today because of the looming increasesin capital gains taxes next year. Others are selling because of thelikelihood that “carried interest taxes” will increase next yearfrom the capital gains rate to the ordinary income rate.

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The opinion that discretionary sellers are returning to themarket is supported by the fact that we have seen a palpableresurgence of 1031 exchange transactions. We know that these arethe result of discretionary sales as distressed transactions rarelyhave any residual equity which could be reinvested utilizing the1031 mechanism.

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Given this increase supply and the excessive demand that exists,we expect investment sales volume in 2010 to increase by at least40 percent over 2009 levels. Granted, we are coming off anemiclevels last year, but a significant increase in activity will bewell received by market participants. In a couple of weeks we willbe releasing our first-half 2010 statistics which will be a goodindicator of how the year is progressing and should tell ussomething about what we can expect for the balance of 2010 in termsof volume.

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With regard to value, as stated earlier, prices are increasingto levels above what economic fundamentals would dictate. It isalmost as if the market is experiencing a mini-bubble at the lowpoint in the cycle. Cap rates have remained at low levels afterexpanding significantly in 2009 and, remarkably, note salerecoveries have been extraordinarily high relative to collateralvalue. These conditions seem extremely positive today but, “Wherewe are headed?” is the bigger question.

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Last month’s disappointing employment data has showed thatemployers are still leery about making commitments to new employeesgiven the uncertainly surrounding the economic recovery and thevast array of tax obligations that are likely to increasesubstantially in the near term. Consumer spending and consumerconfidence remains weak and GDP growth is challenged. Economistsare, in increasing numbers, predicting a higher likelihood of adouble dip recession.

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We anticipate that the investment sales market, for the balanceof 2010, will be very healthy as current dynamics continue.However, moving forward there are things to be concerned about. Thedeleveraging process, which is already in full swing, has a longway to go before all of the properties in negative equity positionsare recycled or resuscitated. The 2006 and 2007 vintage loans,which are in the most distressed positions, don’t mature until 2011and 2012 and are often being kept alive by advantageous loan termssuch as interest only periods, interest reserves or are floatingover LIBOR which remains at miniscule levels.

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The anticipation that interest rates will rise, and risedramatically, is still looming over the marketplace as well.Interest rate increases will have significant negative implicationsfor the investment sales market and it is only a question of when,not if, these increases will occur.

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With regard to supply, a regulatory change impacting the abilityof lenders to hold loans on their balance sheets at par, even whenthey know the collateral is worth significantly less, could lead tosignificant increases in supply, exerting significant downwardpressure on value.

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Lastly, the expectations of increases in taxes of all kindscreates significant trepidation on behalf of participants in themarketplace. Capital gains taxes will increase from 15 percent to20 percent when the Bush tax cuts sunset as they are expected to atthe end of the year. Obamacare will add to this capital gainsincrease and personal taxes on federal state and local levels aresure to rise as politicians across the country demonstrate aninability to effectively cut spending. This is the case in all thatbut a couple of states which have seen shifts in policyrecently.

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Therefore, it is easy to understand how bearish participants areusing this opportunity to sell and take advantage of theextraordinary supply / demand imbalances, very low interest ratesand a, currently, friendly tax environment.

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Mr. Knakal is the Chairman and Founding Partner of MasseyKnakal Realty Services in New York City and has brokered the saleof over 1,075 properties in his career having a market value inexcess of $6.4 billion.

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