As recent as two years ago, commercial foreclosures were affecting the markets and underlying property values. Then talk surfaced that the “blue blood” money was back and looking to make deals.
Fast forward to 2013: Is this still the case?
“In regards to office and industrial, the ‘blue blood’ is very active in the marketplace,” says Todd Jarman, senior vice president Commercial Real Estate for BBVA Compass. “The recent announcement of joint ventures with Clarion Partners (and Wentworth Property) and Walton Street Capital (and Everest Holdings) continue a string of similar headlines we have seen more for many months now.
Values are holding very well, Jarman says, and in many cases appreciating nicely. He adds the market has not seen the wave of commercial foreclosures that were expected a number of years ago. Given the strong demand for good product, he adds, lenders holding distressed properties have instead opted to either entertain short-sales, note sales or direct borrower negotiations.
“In regards to the current lending environment, our local banks are very hungry for stabilized product (both office and industrial), and we are beginning to see lenders take market/leasing risk on industrial buildings (big box /West side) — as several speculative developments are underway,” Jarman says. “Lenders continue to be hesitant on market/leasing risk on office, unless a very ‘special story’ exists. I would suspect that any new office development would require substantial pre-leasing — at least 50% or a number that could provide break even DSCR.”
According to Scott Holland, managing partner, Keystone Commercial Capital, foreclosures have tailed off to a point that they are not having the downward pressure on values that they did over the past few years.
“I believe the market has found a floor and while there are still good values to be found in the market, the increasing transaction activity is bringing buyers back into the market as they can begin to feel comfortable with where the floor is and can focus on creating value as the market begin to resurge.
“As for money, I believe there is a significant amount of various equity capital (institutional, wealthy private and true entrepreneurial investors) in the market looking for value creation opportunities,” he says, “These markets appear to be in the early stages of recovery and everyone is trying to get an investment stake in the ground in order to enjoy the market lift that traditionally follows a significant down market — and what a down market it was.
But just as with the abundance of equity capital, there is an abundance of debt capital.  While the sheer volume of both equity and debt capital can’t be disputed, their adherence to fundamentals at this stage of the recovery is also clear.
“The not-so-distant memory of bad buys and bad loans will continue to keep both of these capital sources disciplined in their approach to the business for the reasonable foreseeable future, Holland says.
Commercial foreclosures are waning and CMBS special servicers have the bulk of what is available, says Jaclyn Noel, senior VP and private banker at Wells Fargo.
“The process with these groups takes longer because of the layers of legality,” she says. “Bank inventories are down and the economy is improving. Capitalization rates for these property types are normalizing.
Capital is flowing from different sources both locally and internationally, especially from Canadian investors.
“All the usual suspects are active again: banks, CMBS, life companies, pension funds, finance companies, private placements. Our Private Bank is actively providing commercial real estate investor financing.”
The Metro Phoenix office market remains very soft due to over-supply and weak absorption, says Vicki Williams, senior VP Commercial Real Estate at Alliance Bank of Arizona. Leasing activity, she says, consists primarily of tenants moving from one submarket to another and/or moving up from Class B properties to Class A properties.
“Institutional capital is available to acquire trophy, stabilized Class A properties only, which trade at low cap rates,” Williams says.
The market for Class B properties is the most active, according to Williams. Buyers for stabilized — or relatively stabilized —  Class B properties include investment funds and private REITs who partner with pension funds. These assets are selling at higher cap rates, which is reflective of those investors looking for risk adjusted returns.
“They do not anticipate rents to trend upwards in the short term and therefore plan on a longer hold strategy of 7 years or more,” she says. “Truly value-ad, distressed, multi-tenant office properties are being acquired by buyers willing to take more risk for a higher potential return. These investors are Canadian investors, individual investors and opportunity funds.
“Financing for these properties continues to be difficult to find due to the higher risk and lack of cash flow, as these value-ad properties have significant vacancy and may also need some rehab work. They are being acquired at very favorable prices, often from a lender.”
These investors’ strategy, Williams adds, is to lease up the properties at the current, low rental rates and then sell them at lower cap rate within a 3-year time frame. Multi-tenant medical office is the favored property type, though well located multi-tenant office properties in the Southeast Valley, the Camelback corridor and North Scottsdale are also trading.
“While the office market is expected to remain soft for the next several years, the industrial market has been strengthening,” Williams says. “Institutional investors continue to prefer big box, single-tenant properties.  Life insurance companies are starting to invest in new, speculative construction of big box space based on the strong absorption in this segment seen in the past couple of years.
“Multi-tenant, small bay industrial properties are being acquired by private investment companies consisting of ‘friends and family investors.’ This Class B market is the most active.”