Improving fundamentals across all property types is drawing a greater amount of investors to value-added assets. While there are still investors focusing on acquiring stable, well-leased assets, others have shifted their attention to buying value-added properties that offer income and value appreciation and higher returns through retenanting, repositioning, and/or the releasing of available space. It seems that most investors now want something that can give them upside. A few years ago, properties with vacant space and near-term rollover were perceived to be undesirable and risky. Now, such properties are highly sought after in many office markets. In the case of multifamily properties, investors are looking for older properties to upgrade the interiors and raise rents in order to more compete with the new properties in its submarket. These investors are typically looking for a 15-20% return on its capital investment or remodeling costs. For example, an investor spending $3,000 per unit in remodeling costs would anticipate an increase in rents of $37.50 to $50 for a remodeled unit. In summary, the desire to capitalize on steady demand, declining vacancies, and growing rent levels indicates that property values and pricing are starting to be driven more by underlying fundamentals than by capital flows. There is less need to get capital into real estate because there are less alternative investments, but there is still a tremendous desire to invest capital into select assets because of favorable fundamentals.
Sales of significant commercial properties totaled $350 billion in 2006, which is a 14% increase over 2005. But it pales in comparison to the 50% increases sustained in 2004 & 2005. Throughout 2004 & 2005, capital from every sector grew rapidly. In 2006, acquisitions from several capital sectors slowed and a greater amount of investment shifted in favor of institutional buyers and private equity funds. This shift is expected to continue in 2007. Acquisitions from private equity funds and institutional investors totaled $130 billion last year, up from less than $25 billion on a combined basis since 2003. Over the past year, acquisitions by private equity funds surged 78%. Private equity funds have allowed more investor/operators to compete for the acquisition of assets that they once would not have been taken into consideration for purchase. These funds typically provide 80%-90% of the equity investment allowing the operator to highly leverage its investment and still maintain control through the management and/or leasing of the asset. By increasing its purchasing power, the operator may then diversify its investment in various assets through high leverage capital sources. With the fundamentals of real estate playing a larger part in the valuation of assets along with the continued activity of private equity funds, investor/operators should continue their recent transaction activity by applying their competitive advantage of superior market knowledge.