After adopting a “wait and see” approach with the economy last year, many of my investors have changed course for the New Year.  Rather than waiting for things to recover, they have accepted that things may be slow for a while.  So – they are getting on with their lives and looking for a “bright spot.”  I am getting a lot of phone calls asking “Where are the deals?”  I chose that topic for my article this month.

Stabilized Occupancy
This real estate term is mentioned several times in this article, so I wanted to briefly define it.  When a real estate buyer completes a business plan (as he should) for a property he is evaluating, he needs to choose a “stabilized occupancy” number.  This number represents the average long-term occupancy that the owner hopes to achieve.  This number will differ between properties depending on product type and geographic location, but is generally in the 89% to 95% range.
Where The Good Deals Are NOT
Before discussing where these good deals are, let’s discuss situations that are best avoided.  I get a lot of phone calls from investors looking for commercial foreclosures.  For my investors who are seeking income, I recommend avoiding foreclosure sales.
Wait, I should stay away from commercial foreclosures?  I thought that those are the best deal?
All commercial foreclosure properties have one thing in common – a HUGE problem.  If the property had stabilized tenancy and positive cash flow, then the owner would not have let the bank take it back from him.  These buildings can have huge vacancies, large capital improvement requirements, or even environmental problems.  I always remind investors that commercial properties are valued based on the income that they produce.  A problem building has some defect that is affecting its’ cash flow.  This problem usually needs to be fixed before the property can be sold at a profit.  Usually it is a bad problem that is hard to fix – otherwise the previous owner would have solved it prior to foreclosure.
So, that office complex foreclosure that you’re eyeing is cheap – but it may be only 20% occupied.  The surrounding submarket could have huge vacancies as well.  Sure; if you could lease it up (an industry term for “bring the property to stabilized occupancy”), then you could sell it for a profit.  This could take a LOT of work.  (And risk).  In my opinion, it is better to buy good properties now.  Good, stabilized properties are available at lower prices today in part due to the problems these bad deals have brought to the market.  By buying properties with good tenants that are cash flowing, we can take advantage of lower prices while avoiding many of the problems.

Opportunity – Retail Centers for Lower Prices
Back in the late 1990’s, the prices of retail centers were low.  Vacancies were rising, and one story going around was that “nobody will shop at retail stores anymore – they will buy everything over the internet.”  The prices on retail centers – strip malls and larger enclosed malls – were low.  Those who bought retail in this time period were able to sell at a profit between 2002 and 2004 after things recovered.
Such an opportunity could be before us today.  Spurred by lower sales, higher vacancies, and some high-profile bankruptcies (Circuit City and Mervyn’s), retail prices are low today.  Opportunities exist to buy retail centers that are anchored by strong tenants with long-term leases – and benefit when prices rise again after the eventual recovery.  Both Circuit City and Mervyn’s had been weak performers for over a decade – their closure was not a large surprise to most.
A 20-year lease is only as good as the company behind it, so tenant evaluation is very important.
Many larger shopping center companies have been in the news recently – they are having financial problems caused by loans coming due.  These companies are being forced to sell their good properties in order to pay down debt on their underperforming ones.  Distressed sellers can mean better prices for investors.
Opportunity – Energy to Beat Inflation
According to the US Department of Energy, the United States is the 3rd largest oil producer in the world.  (This statistic always surprises people.)  However, as the planet’s #1 consumer of oil, the US is also the #1 buyer of foreign oil.   The 12.25 million barrels of oil that we import every day is more than twice that of Japan – the world’s second largest importer.  The oil that we import every day is greater than the combined oil exports from Norway, Iran, the U.A.E., Venezuela, and Kuwait.  (Worldwide exporters #3-7, respectively.)
Since we consume much more oil than the rest of the world, it makes sense that the price of oil is denominated in dollars.  Even if that changes, we still must pay for it with dollars.  If you believe that inflation is in our near future, than you can expect oil prices to rise.  Since the dollar we are buying oil with is worth less, we must spend more of them when we buy.
Therefore, if we own domestic oil production, inflation can push our income – and the value of our investment – higher.
Use Lemons to Make Lemonade
To use another cliché, “Every cloud has a silver lining.”  Finding the silver lining is tough – investors need to learn where to find it.  Those that are motivated to learn could gain a sizeable advantage.  In this economy, there is room for good deals.  Cash is king today, and now could be a great time to take advantage of these lower prices.

Christopher Miller is a Managing Director with Specialized Wealth Management in Tustin, California and specializes in tax-advantaged investments including 1031 replacement properties.  Chris’ real estate experience includes work in commercial appraisal, in institutional acquisitions for a national real estate syndicator, and as an advisor helping clients through over two hundred 1031 exchanges. Chris has been featured as an expert in several industry publications, and on television, and earned an MBA emphasizing Real Estate Finance from the University of Southern California. Call him toll-free at (877) 313 – 1868.

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This entry was posted on Thursday, January 7th, 2010 at 11:48 pm and is filed under Blog. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.