Value: a fair or proper equivalent in money, commodities, etc.
-- Webster's Dictionary
But in the commercial real estate market the "value" that any building has at any specific time--in terms of what it will sell for, or what it will rent for--has more facets than a Fun House mirror.
There are the obvious ones: the building's location, amenities, general desirability and the local vacancy-occupancy ratio.
But also impacting value are less visible forces: pure and simple human nature; the subtle influence-bordering-on-distortion of foreign investment money; the tremendously active, but literally uncharted, subleasing market; gluts triggered by unforeseeable economic trends not directly related to the real estate market; rent controls and competitive pressures brought to bear from some highly unlikely sources.
And always present under the surface: tax considerations.
"Although," according to William A. Millichap, president and managing director of Palo Alto-based Marcus & Millichap, in an interview, "the impact of the new tax law isn't going to be as great on the commercial real estate market as a lot of people expected.
"While it's causing investors to ask more fundamental questions, prices haven't eroded as much as we thought they would because of a lack of product availability and a reasonable number of buyers coming into the market.
"But if interest rates hadn't come down and if we hadn't had this continuing buyer interest," he continued, "all of the predictions would have been absolutely true."
But don't underestimate human nature, Millichap added. "Especially in Southern California urban areas, it's difficult, if not impossible, to get sellers to sell at a loss. They're just simply not willing to do it--it's almost unheard of unless it's really a distress situation."
With a sales force of 300 and 14 offices extending west from Chicago, Marcus & Millichap bills itself as the largest investment real estate brokerage in the country, handling properties ranging from $1 million to $30 million in size.
And, Millichap continued, while market conditions in Southern California--most notably the high office vacancy ratio--might suggest a logical weakening in prices, the invasion of foreign investment money, primarily from Japan, has been a major factor in preventing this from happening.
"Domestic investors are looking at a cap rate--a free and clear cash flow--of 8% to 9%, or a bit more than that if there's risk involved," he said.
"But look at the Arco Towers sale (to Shuwa Investment Co. for a reported $620 million)--it went down at about 7% and the Japanese have bought four or five other buildings in Orange County with about the same cap. This puts investors like Metropolitan Life, Prudential and others in a real bind. They have to make a decision: Are we going to jump out of the market or do we settle for lower yields, too?"
Drop in Bond Rates
What makes a 7% yield more than acceptable to the Japanese is the plunge in interest rates in Japan on convertible bonds on which so much corporate borrowing hinges.
According to Jiji Press Ltd. in its early March market report, convertible bond coupon rates in Japan were cut five times in 1986--from 3.8% in January to 2.5% in December--"which has made it possible for corporations with high credit standings to raise large amounts of funds at less than 2%," according to the financial news service.
"And there's every indication," Millichap added, "that the extent of foreign investment is even higher than it appears to be on the surface because so much of it is done through trusts.
"They're buying domestic development firms which supply the expertise and the management for an eventual cut of the pie, but Asian investors are putting up the money. They make a real effort not to appear on the title."
While the correlation isn't crystal-clear, broker Millichap added, the foreign investors' willingness to settle for a lower cash return is "probably" impacting rents, too.
Don't Want Risks
"They've gone down, at least in virtually every metropolitan area in California," he said. In San Francisco, for instance, as much as 25% to 30%. And most of our investors simply aren't risk-oriented. They don't want to get into a situation where they're going to lose money.
"If we can say to an investor, 'you're going to get rents in the 8% to 8 1/2% range,' then we can sell those Grade A properties in Grade A locations. But, if they look at the risk factors involved--what's coming on-stream, what the office-absorption rate is, what the job-growth rate is--and if the figures don't work, then they're entitled to ask, 'what's all of this going to do to my rents?' "
Impacting rents even further is another influence--the subleasing market--that never shows up in conventional real estate statistics, Millichap said.