Just about anything with walls and tenants has unsolicited bids on it. In the first 11 months of 2006, apartment sales transaction volume reached $78 billion and was on track for the year to easily surpass the record $88 billion total notched in 2005, reports Real Capital Analytics (RCA). The heavy deal velocity continues to drive up prices and lower capitalization rates, a troubling situation for yield-hungry investors.
From the end of 2003 through November 2006, average cap rates for stabilized assets, as tracked by RCA, fell from 7.4% to 6%. In scorching markets like Manhattan and San Diego, average cap rates in November ranged between 4% and 4.5%.
Unwilling to outbid the competition for core assets that offer little upside potential, a growing percentage of well-capitalized private investors, institutions and even REITs are buying underperforming properties and embarking on a major capital improvement program.
“It all boils down to the amount of risk you're willing to take on the front end of a deal in order to create value in the future,” says Steinberg of The Prescott Group, referring to the importance of a healthy exit strategy. “So it's not really about current cash flow. It's more about the longer-term upside potential.”