More than anything else, real estate is a knowledge business.You make a profit or endure a loss based on what you know--or don’tknow--about local market conditions, along with the national andglobal economic influences affecting it. To that end, Lee &Associates’ vice chairman Ed Indvik recently spoke to GlobeSt.comabout changing market conditions and what to expect for 2011. WhileIndvik is based in the firm’s Los Angeles office (Lee &Associates boasts a large California presence), the company alsoretains an office in Little Falls, NJ, which is headed up byco-founder, president and principal Rick Marchisio.

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GlobeSt.com: How does commercial real estate compareto one year ago?

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Indvik: There is certainly more stability onthe capital markets side. If you had to say on a relatively basisfrom the highs or lows, we’re closer to the lows than the highs interms of the availability of capital. But there is a lot of money.I break it down into several divisions. The first is theinstitutional money--these investors are looking for dependablecash flow/yields on high-caliber multifamily, retail, office andindustrial assets. If you have a well-located asset with gooddesign characteristics and you can point to a dependable revenuesource, then that will get scores of bidders. Not unlike 2005 to2007, you will be in a position of what we call last and final.You’ll go back to a small select group and say give us your bestoffer and then you inform the successful party.

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Then you have the other end, which are the pure opportunisticfunds that by and large are looking to get something at a discountto replacement cost. They understand that the revenue source/cashflow is highly volatile right now and is probably hard tounderwrite because rents haven’t stabilized in most markets. Infact, it’s anybody’s guess whether rents will be higher or lowerone year from now. If you take the past two years, they’vecontinued to drop, with some exceptions. These investors aregenerally entrepreneurial and they need to have cash because it’sdifficult to get financing for these assets. And if they can getthe right price, which is less than replacement cost, there iscapital available.

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Then you have properties that fall in the middle (somewhatstabilized with 50% vacancies). In those cases, again, investorswill look at some sort of discounted cash flow analysis where theywill be very conservative on rental assumptions and renewals. Theywill also want to mark every transactions that’s already been doneto the current market rents. They tend to be more entrepreneurialand they have good resources and bank relationships.

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The financial markets are coming back if you look at the smalluser. So with that, it’s spurred a lot of absorption of smallerproduct. On the other end, with the institutional buyers, they arebeing very conservative on their underwriting. They are looking fordependable cash flows and their LTVs are going to be veryconservative--in the 50% to 60% range--with debt coverage of 1.2%and above.

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GlobeSt.com: In which of the three categories youmentioned do most investors fall?

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Indvik: It depends; mainly because thedistressed asset market is so prevalent right now in terms of boththe banks and the CMBS and to a lesser extent the life insurancecompanies. If you just take the banks and the CMBS markets, thereis a tremendous amount of product available. So certainly thevelocity is probably more oriented toward that just because thesupply is so much greater. And those lending institutions havebecome much more realistic about the values they have so thetransaction volume has picked up significantly.

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On the institutional side, there are a few things to consider.One, what are the portfolio objectives of those owners? They tendto be large, money-management companies for real estate or coreassets for the pensions/insurance companies and they tend to have astrategic objective to turn part of a portfolio at certain times;so that’s part of it. And, then, there are investors who just needto liquify their balance sheets to help stabilize other assets theymay have. But it wouldn’t shock me if it weren’t 80% bank/CMBS and20% institutional. There is a strong market right now in the triplenet, especially in the $1-million to $8-million market, and thoseare everything from drug stores to restaurants.

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GlobeSt.com: Is there more stress in certain assetclasses or is it starting to flatten out?

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Indvik: If I had to rank them from worse tobest, I would start with retail and then office, followed byindustrial and multifamily, the latter of which is strong thanks tohigh demand and cap rates. Obviously, multifamily rents are down sovalues are also depressed, but with the yield as low as 4% and 5.5%to 6.5% cap rates, you’re getting good leverage. And thefundamentals of the market on the housing side are such that moreand more people are looking at multifamily simply because theydon’t have the capital with which to buy a home.

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GlobeSt.com: What do you see in terms of rents foroffice going forward?

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Indvik: It will all come down to employment.There are some unknowable factors out there. How is business goingto respond to the demand? On the one hand, it appears the economyis stabilized and we are entering a period of moderate growth. Buteverybody’s talking about how many of these jobs will never comeback, in part because businesses have become much more efficient.Productivity will skyrocket. Everybody is going to be much morecautious about taking on the burden of additional costs until theygain confidence as to what their business prospects are.

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At the same time, we are becoming much more competitive. If youlook at the cost of running a business--from what you pay anemployee to the cost of your building plus your prospectsinternationally with the depreciated dollar--all speak well to usbeing more competitive on a worldwide basis and that should augermore demand both from domestic and international companies. Thoseelements all help in terms of the recovery.

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But the time frames are up in the air. I’m not pessimistic aboutrents but any prudent person is probably still cautious about whenthey will stabilize and when we can expect to see some growth afterthat. Certainly, the better the market, the better the outlook forgrowth.

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GlobeSt.com: Do you think we will see moredistressed trades in the coming years?

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Indvik: I do. Part of it started out with alearning process; meaning, truly understanding what the process offoreclosing means for your balance sheet. And I speak mostly to thefinancial institutions and their ability to then understandultimately what values are. The gap between the ask and the bid hasnarrowed substantially. We’re not running into resistance on thenumbers that we once were. There are still some issues associatedwith the ability of banks to make sure their recognition of theloss, the impact on their balance sheets, is properly managed. ButI do think we’ve seen velocity and going forward we will see evenmore. Obviously, that will continue until we do get stabilizationof rents and then some valuation issue associated with the assetitself.

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The caveat is that we have very low interest rates, which ishelping to an extent with the yield requirements. But what happensa year or two from now if the economy picks up--we have so muchdebt out there crowding out the markets. As much as we want tothink everything is going to stay the same as it relates to theability to underwrite, if we start to see inflationary pressure orsee interest rates go up, then it will mute the upside on valuegoing forward, which means we will need to look again at what thestrike prices are between the bid and the ask. So I see challengesfor a few years.

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It really gets down to the fact that for the most part we areoverleveraged both on the governmental as well as the personalside. The good thing is that most businesses have done a good jobof getting their balance sheets in order but you still have twofairly significant segments--the consumer being 65% and thegovernment accounting for another 10% to 11% of the USeconomy--that have serious issues related to their balance sheets.Until they can get that back in order, it will hinder the economicrecovery. Overall, I’m hopeful, but still cautious.

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