Super Liquidity, Part 2

If you thought 2005 was a banner year for investment sales, brace yourself for the eleven-digit sequel. Atlanta-based real estate consulting firm Kingsley & Associates projects that U.S. pension funds will invest roughly $59 billion into commercial real estate this year to fulfill their elevated real estate allocations. Meanwhile, foreign investors — bent on parking their capital in U.S. real estate — will pour roughly half that amount into the market. As usual, the lure of high single digit returns and the lack of obvious alternatives are proving hard to resist.

“There are so many sources of investment capital, and all of them will continue to seek deals this year,” said Ray Torto, principal and chief strategist at Boston-based real estate consulting and analysis firm Torto-Wheaton Research, addressing this week’s Mortgage Bankers Association (MBA) conference in Orlando.

This cumulative demand spurred a flipper’s paradise in 2005. Torto Wheaton Research finds that 7% of all investment-grade real estate traded hands in 2005. While the $24 trillion bond market turns over 300% to 400% every year, this high single digit milestone represents record turnover for the $4.7 trillion institutional real estate market. What’s more, said Torto, there’s room for that 7% turnover to grow this year as the weight of capital lures more sellers into the market.

The catch, however, is capitalization rates, or the initial yield on a property. Unlike some analysts calling for further cap rate compression this year, Torto believes that the cap squeeze has run its course — after all, the Federal Reserve is determined to fight inflation by raising rates. Higher long-term rates should ultimately bring cap rates up as well. Torto is skeptical about the Fed retreating from this mission, and he believes that the Federal Funds rate, the overnight interest rate at which banks lend to each other, will hover near 6.16% at midyear 2007. He also noted that the 20-year average on the Federal Funds rate is 6.4%, or roughly 2.2% above its current level. “This wouldn’t destroy your business by any means,” he said.

Torto’s optimism was tempered by concerns that an apartment glut may be forming in many markets. Torto also worries that a flood of condo units could impact the multifamily market if condo converters pull back from their eye-popping acquisitions binge. Not only could multifamily liquidity take a hit, but many high-end apartment owners could find themselves competing with condo projects that have reverted back to rental units.

“This is all good news,” said Torto. “Other than events which we cannot predict, we really cannot see many things going wrong in the markets.”

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