CENTURY CITY, CA-As the economy continues its sluggish movement toward recovery, investors in Southern California markets have responded to cautionary tales of the last decade. As a result, two trends have emerged: intense competition for core, stabilized assets has driven large institutional investors into secondary and tertiary markets; and low interest rates have propelled an influx of developers and individual investors to enter the commercial real estate market.

Large, stabilized assets typically attract institutional investors or real estate firms with extensive reach. Investors beholden to institutions or firms may have hundreds of millions of dollars or more to invest and must meet a certain return. In order to achieve a certain yield, they solicit stabilized, proven assets which can return 7% or more versus a standard < 1% on a CD or bonds. Established assets generally attract investors who aren't looking for value-add; they are focused on stabilized core assets. Lessons learned from the recession and increased competition has prompted a flight to quality assets, driving larger institutional investors to non-prime markets. Compared to five years ago, stabilized assets are at a premium with highly compressed rates. Large institutional investors are therefore being pushed into secondary, even tertiary markets. In Southern California, everyone wants to put money into core stabilized assets, pushing prices up and forcing large real estate funds to become more aggressive. Even with extremely compressed CAP rates, prices continue to rise.

In recent years, two additional types of investors—developers and individuals—have flocked to commercial real estate in large numbers to take advantage of low interest rates. Again, with most CDs, bonds and savings accounts paying one percent or less, attraction to real estate and strong underlining values are more appealing to these types. 

Developers are attracted to value-add properties and are therefore more inclined to take on risk. They look for underutilized, underperforming assets and are willing to redevelop, shuffle tenants, and improve assets' physical appearance to increase rents.  Additionally, low interest rates, cheap money and lender willingness to provide loans have made investments more accessible, less time-consuming and more available than in the recent past.

Individual investors typically want to put capital into assets requiring little attention. These investors tend to go after stabilized assets in strong locations where they can park their money and collect income without much work or headache. Compared to developers and institutions, individual investors are far more willing to accept lower returns of five to six percent (or less) and are now gravitating toward stabilized core assets. This, in combination with low interest rates and lenient lending practices, is driving down CAP rates and increasing prices.

Most investors are now more concerned with underlying value of the real estate as opposed to its yield. They are looking beyond raw numbers and assessing the underlying value by asking about an asset's quality, locations and irreplaceability. How does the property look? What is the potential for improvement? What are projected appreciations in 10, 20, 50 years? The recession has taught investors to look beyond the now of real estate and focus on the future of the asset. They are willing to get a lower CAP rate today if they can retain that rate for 50 years or improve on the CAP rate in the future.  

The hard lessons of the recession are reflected in market movement; for investors who have always practiced a quality-over-quantity approach, these lessons aren't new. Though we cannot predict with absolute certainty what the market will look like in the future, it's clear that barriers to entry are leveling, and products typically attracting seasoned investors are becoming less available in this transitory period of economic recovery.

Justin Mendelson is a senior director at Charles Dunn Co. The views expressed in this column are the author's own.