Real Estate Investors - Continued...

Commercial real estate investors are faced with the same choices in the economy as everyone else (including Qualified Institutional Buyers, the "big boys on Wall Street" - also called "QIBs").  These choices are:

The first rule of thumb is to remember the concept of a "riskless reward".  A riskless reward (for savvy commercial real estate investors) is one that can be obtained by providing capital investment into a broad group of securities or fee-simple estate property interests.  In our industry this is captivated by SPDRs - Standard & Poor's Depository Receipts ( an exchange traded fund - pronounced "spiders").  SPDRs represent a broad measure of capital market activity and typically provide a return of 10% to 16% per annum.  They can go to zero but the likelihood is quite small.  They offer the feature of instant liquidity (zillions of shares in SPDRs are traded daily) so this makes the SPDR the ideal starting point for the investment yields analysis we have in front of us.

The annual return on the SPDR provides a ready means of using comparative yields as one of the key elements in the overall risk analysis because the prototypical commercial real estate project represents (in many investors' minds) a non-liquid investment because no ready market exists for the securities or fee-simple real property interests.  To liquidate the investment represents some real issues as to the time it takes to obtain the highest sales value the market will sustain for a given group of assets.  This is a key benefit (and risk) of owning SPDRs.  They can certainly lose value in any near-term business cycle, but represent a long-term holding opportunity (at least 10 years) to your advantage.  The underlying assessment is that one is exchanging (in theory) an investment in a liquid security for one that is not.  This means the one that is not as liquid as the SPDR must provide an investment premium.  Convention has dictated that this premium should be on the order of 200% to 300% higher for the same holding period in exchange for holding an investment that is illiquid in nature.

This means the first rule - the potential yield rule - is that the investment should provide no less than a 200% premium over the current trailing 12-month yield on SPDRs and one should not reasonably expect to see many investments that are expected to provide a return premium equal to 300% over the current 12-month trailing yield on SPDRs.  Click here and return to the topics page.