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Let’s Play Musical Chairs (Again)!

Back in the glory days of 2007 and 2008, prices for commercial real estate were hitting all-time highs. The yields on those properties were at all-time lows. At that time, I remember hearing investors from all over the country talking about how they were getting ridiculously high offers on properties they owned. I also remember them asking this question: “But if I sell my properties, where would I re-invest the money?”

Then in February 2007, Equity Office Properties (EOP), managed by the legendary Sam Zell, sold its portfolio of office buildings to Blackstone for $39 billion. This to me was a sign of the top of the commercial real estate market at the time. When the wise men sell, it’s probably a sign of the peak.

Blackstone immediately started selling off properties out of the portfolio to other investors. A large investor purchased eight buildings for around $7 billion on the same day they closed with EOP. The large investor clearly hoped to turn around and sell these same buildings to somebody else at an even higher price.

About this same time, I started hearing huge investors refer to the market as “a game of musical chairs.” That is, as long as the music keeps playing, everyone wins. But when the music stops, there won’t be chairs for everybody.

Fortunately, in the 560 speeches I have given since April 2008, I haven’t heard any reference to musical chairs. UNTIL LAST MONTH. The market for commercial real estate in many parts of America is absolutely on fire again.

Here are some facts and quotes I have collected from the Wall Street Journal in the past four months:

  • Urban office building prices in the first quarter of 2014 were 11.3 percent above their 2007 peak levels.
  • Blackstone is selling five high-rise office towers in Boston. They sold $9 billion in office properties in 2013, up from $1.8 billion in 2012. Blackstone has $80 billion in real estate assets under management.
  • According to their CEO Leon Black, Apollo Global Management is “selling everything that is not nailed down.” Their real estate group had $9.1 billion in commercial real estate under management at the end of June.
  • Carlyle Group sold $3.1 billion in assets in the first quarter of 2014 and purchased $1.1 billion in new deals. CEO William Conway was quoted as saying, “The world continues to be awash in liquidity, and investors are chasing yield seemingly regardless of credit quality and risk.” Carlyle has $43 billion in real estate assets under management.
  • Winthrop Realty Trust is liquidating the company. The company specialized in buying and selling distressed commercial properties. CEO Michael Ashner said, “I don’t see real relative value in the real estate space. Margins have compressed.”
  • Commercial mortgage lending standards are easing as well. The Journal reported that more than 25 percent of new commercial mortgage backed securities (CMBS) had a loan-to-value ratio above 75 percent. This is up from just 5 percent in 2010. Twenty-two percent of CMBS loans in the fourth quarter of 2013 were made on properties with additional subordinated debt, up from just 10 percent a year earlier.

Over the past five years, I’ve told a lot of people that I would mention it if I ever heard a reference to musical chairs . . . that this would be a sign of moving closer toward the top of the market for this new cycle. Clearly the music is playing again. Listen carefully.

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