Fear of the Deal

The fallout from the mortgage crisis two years ago supposedly attracted many buyers to the real estate sideline, waiting to jump in at the long-awaited end of a 20-year “seller’s market.” And in a few markets, namely the single-family, owner-occupied, market, lower asking prices have been met with eager bids. However, in the commercial and real estate investment world, fewer transactions are occurring these days than perhaps anticipated when the crisis spread. Much of this has to do with banks struggling to let go of underperforming assets and REO properties. Yet the paralysis affects the buyer side of the equation too and is not just limited to markets involving troubled assets. While inefficient markets might shoulder some of the blame, the stall pattern appears rooted in a more fundamental human reflex: fear.

How else do we account for the irrational market behavior at a time that is supposed to represent an historic opportunity? Unlike the savings and loan crisis of the 1980’s there is no RTC present to acquire and dispose of assets in a dedicated environment. While the previous and current administrations invoked a series of federal measures designed to prevent the widespread failure of banks and stimulate the economy it left the disposition of troubled assets to the free market. It is now clear to me that the law of supply and demand, the free market’s judicious overlord, is subordinate to the law of basic instinct. Widespread fear of the deal on both sides of the table leaves many transactions in a state of perpetual possibility, but not realized.

I suspect that the market fear we speak of originates in very different visions of the future held by buyers and sellers. To speak on behalf of one narrow class of buyers, in this case developers of for-sale product, the crystal ball reveals a future customer that is much different than the one from yesterday. In their minds, tomorrow’s end-users will bear the mark of today’s economic difficulties. Therefore, the thinking goes, their future buyers will be less liquid, pickier and fewer in number. This view of the future, and the fear of overpaying, drives the bid price south. Sellers, on the other hand (including many lending institutions), still aglow from the days of wine and roses, appear ready to wait out the current dystopia. Today’s crisis is merely a spot on a larger market cycle. Since the future is sure to be brighter they fear leaving money on the table. Patience is their partner. Such a sanguine view of the future holds the ask price at status quo.

Regardless of which version of the future will bear out, time is the critical coefficient here. Developers seeking new inventory can no longer think in mere two to three year increments. The new reality calls for a longer hold period with built-in flexibility to adjust for future unknowns. Their bid price will factor in a “feasible today” analysis over a longer span of time. Across the table, sellers can stall on the ask price, believing that a two to three year wait will allow the frenzy for distressed assets to clear the table and a return to demand-driven price scenarios.

It would not surprise me that free market fear and the resulting gap in expectations between seller and buyer will continue with respect to investment acquisitions for quite some time, perhaps through the two to three year period described above. In the interim, the buyers looking for a “pipeline” will chase markets where seller motivations close the ask/bid gap. The hidden troves of debt-encumbered assets and bank-owned portfolios will be picked-over and business models will be adjusted in the search for properties that can work within the new risk environment. As a result, many commendable projects will remain in manila folders to collect dust–waiting in fear for a future that may never come.

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