As CRE prices have risen to very high levels, and cap rates have declined too much, the debt markets are making it difficult to see how prices can continue to rise much if at all. Spreads have widened considerably and the CMBS market is in a real quandary on how to price risk, and how to properly determine the right spread under the new rules on retention. This situation is not going to get better anytime soon as bond buyers have become more risk averse and as the confusion on pricing retention is far from being settled. The hotel industry is now seeing spreads widen fairly wide of where they were, and that is on top of many capital markets players being dubious about what 2016 is going to generate in terms of NOI for hotels. If hotel REIT and bond prices are a good indicator, hotel investors are very dubious of the likelihood that the industry pundits will be anywhere near correct in their glowing forecasts even as occupancy is showing a continued decline.

There are markets where multi is now potentially reaching excess units as more and more buildings come on line, and as investors are starting to question the cap rates. All while construction costs ratchet upwards. Retail is going through major restructuring as online sales and Amazon and others take a bigger market share. Many consumers are shifting to online shopping instead of battling the parking lots at the malls. This trend is accelerating as more young people become consumers and do most things online. The future of retail as we knew it is now very murky. Whole there will always be stores, the question is how big and how many. Will they become more like showrooms and warehouses, or will they continue to be a place where the vast majority of people actually buy items. Very unclear where all this settles out over the next five years. Add to this the high US dollar deterring foreign consumers, and many cities already well covered by major chains and malls, and it is harder to see where opportunities really lie in retail.

Office may be doing OK in major markets, but suburban office in many markets will continue to have slow rent growth as the economy continues to muddle along. While there are some markets where demand for certain types of flex space is still good, it is very unclear how much more demand there will be for traditional office in suburban markets as millennials move back to the cities with tech jobs. Industrial is in recession, so there will not be much demand for much new factory space for quite awhile unless the dollar declines, which is not likely for several years.

So when we looked at the risk reward and decided to shun bid contests for overpriced deals, we looked to use our high level of expertise and experience for new opportunities that had little competition and very little bidding for assets.. That asset class is brown field land development. We have within our group some of the best experience of any development group in the country. Over 20 years we have handled the largest and most complex contamination projects, and we have never had a liability claim nor loss. It is all about understanding how to underwrite the real risk, how to quantify it, how to structure around the risk to shift it, and how to insure it. We have what we believe is the best legal talent for this as our counsel and we partner with vertical developers where we choose to go up instead of flipping the cleaned land. We now believe this may be ready for raising a substantial fund with our Asian investors who also believe the US is overpriced.

The point of all this is to say, you need to consider looking at alternative areas of investment now that all of the distressed deals are done, and most assets are priced to an excess level. While many developers think things with brownfield development are routine, and all you need to do is hire a remediation firm, we have watched as smart developers have found the risks and the ability to work through regulatory mine fields is far more complex and costly than they imagined. You need to know how to plan the land uses in light of the type of contamination, and the right type of development, and how to talk to the regulators to overcome what we understand are going to be their hot buttons. In working with otherwise very successful and smart developers, we are constantly surprised at how little they really know about brown field development. It is very complex and takes years to really learn and understand how to maximize the development opportunity, and how to price the dirty land such that it takes account of what the real development costs and risk mitigation are. Once you do understand all of this, the returns are worth the difficulties. We are doing a deal now on an old oil depot where we acquired the parcel with no bid issues, which will have an IRR in excess of 45%. We are buying the land at 50% of all in land plus remediation costs. Other opportunities are in conjunction with certain city administrations who want real expertise in doing major land clean up to redevelop large sections of older cities. When compared to typical bid transactions, and other overpriced acquisitions, the brown field sector is way ahead if you know what you are doing.

Instant Insights /

Brownfield Development -An Opportunity For High Risk Reward

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