Timing and Pricing the Disposition of Commercial Real Estate

Q3-10 Situation Analysis

How should one decide on pricing a CRE asset in today’s market? Let’s assume that the property in question is a condominium project that failed during the past two years. Should the units be sold quickly at a relatively low price-list, or are there extra profits to be had by selling more deliberately at a higher price?

The answer to that question may depend on whether you are a bank or not, and it involves some of the most basic factors in Business 101: describing the market, defining the business model, and recognizing the cost of funds.

Regarding the market, one might

ask , “How did I obtain this condo project?” Probably it was obtained at a sort of fire sale, priced as a liquidation event. Or if the owner is a bank or other financial institution, it has been taken in foreclosure and/or marked down on the balance sheet at its liquidation value. That being the case, liquidation value is the basis upon which this property and others like it will come to market, and that is the basis upon which resale pricing should be based. This condo will be going head-to-head with similar product that has recently been foreclosed or liquidated or soon will be.

But maybe there is some value to be added, so let’s consider

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the business plan. If you hold or acquire property for resale, the more you attempt to add value (i.e., the higher margin you try to achieve), the more you are acting as a developer. So ask yourself if this is a good year to be a real estate developer. Or is this a year to be a jobber, a dealer in surplus, someone who knows

how to prepare property for rapid, efficient disposition. In LANDCO’s view, this economy remains awash in over-capacity, unemployment, and excess real estate. It would not seem to be an opportune moment for real estate development.

Finally, however, there is a unique and critical factor in real estate ownership today: cost of funds. LANDCO has looked at a number of bank-owned asset portfolios, and many of those institutions have expressed interest in holding their CRE assets for a more favorable selling environment. Their cost of funds is very low right now, and they argue that the assets in question have nowhere to go but up. Right or wrong, they place an appreciated future

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value on the asset and discount it at a very low rate, so they are explicitly overvaluing the assets in today’s market. At these prices, they aren’t sellers.

Many banks, of course, are interested in selling at liquidation prices, but those that choose to wait know that they are taking themselves out of the resale market for the time being. They feel that they can afford to do so, and it is one reason why LANDCO has been looking at potential bank-acquisitions for some time.

In many ways, we agree with these bankers. Owners who do not have a bank’s cost of funds cannot out-wait them. If values rise, the


cost of funds will allow them to undersell competitors at any point in the future. If values fall, these banks are hedged against deflation, whereas other owners will be wiped out. The only strategic advantage that the typical real estate seller has today is the fact that a lot of banks are temporarily holding certain assets off the resale market, waiting for the seller’s product to clear.

That is the seller’s opportunity. If he doesn’t price his product for rapid disposition, he cannot win. That is the one card that the market has dealt him. That is the one card that the banks would encourage him to play. Seeking a higher price in a more deliberate timeframe is a strategy reserved for those with the lowest cost of funds — the banks themselves, when they chose to employ it.