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Rx for recovery: Real estate investment 101 

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When future pundits look back and debate the lessons of the recent “Great Recession,” the champions of the recovery are not likely to be those few intuitive individuals who bought up bargain real estate assets at an instant when market uncertainty suddenly yielded to investor opportunity. Recent economic data regarding real estate sales and investments indicate that a slow recovery is already underway, and that the process of recovery will require individual investors to embrace longer term investment strategies.

Although real estate values may never return to pre-recession levels during the lifetime of current investors, it now seems fairly clear that those pre-recession market conditions were artificial and unsustainable for reasons that are unlikely to be repeated. Thanks to the experience of the past decade, the individual investor of 2011 is better informed about market risk and property valuation than his or her counterpart in 2001. The question therefore is not if, but when, individual investors (including homeowners) will return to real estate as part of their overall investment strategy.

We believe that the answer to that question can be distilled to a single determining factor: restoration of investor confidence in real estate. This factor is exceedingly complex and varies by geographic region, asset class and investor sophistication. One thing is clear, however: Restoration of investor confidence requires the ability to overcome the effect of the universal loss of investor confidence as property values nationwide declined an average of 40 percent from 2007 to 2009.

There are still an estimated $1.4 trillion in commercial real estate loans set to mature over the next several years (many of which are not performing or are secured by properties whose value is insufficient to support a refinance). The majority of those loans were made by lenders using funds earmarked by investors for what was perceived as a safe investment in a real-estate secured loan.

Likewise, the majority of the assets financed through those loans are held in what were supposed to be safe real estate investment portfolios. Unfortunately, the properties were over-valued, the loans were too high and the equity is gone. Not many of those investors can be expected to repeat that investment decision anytime soon. And yet, institutional investors are generally optimistic.

Commercial property sales volume is up from the abysmal 2009 low, and continues to increase in 2011.

In 2007, sales nationwide were $557.8 billion, according to Real Property Analytics. In 2009, sales totaled an anemic $54.6 billion, and sales for 2011 are projected to hit $230 billion.

These numbers and other economic data over the past two years point to a simple fact – commercial real estate investment at the institutional level operates independently of general market perceptions of individual investors. By returning to reliable real estate investment strategies (investing for sustainable long-term returns instead of a short-term flip), institutional investors will help restore individual investors’ confidence.

Further examples of institutional investment at work are seen in the improving market for CMBS loans, which may reach $50 billion in 2011 (compared to $90 billion in 2004), and in the record amounts of capital being raised by REITs for investment. With the 2012 election cycle underway, interest rates are likely to remain at their current levels, and unemployment, currently 9.8 percent in San Diego County, is expected to decline at about 1 percent per year, which means corporate and retail expansion and increased leasing activity.

While the overhang of maturing non-performing loans will continue to be an offsetting influence, sophisticated investors should keep in mind that even as prior positive results are no assurance of future success, past poor performance is no guarantee of future failure.

Dawn Saunders is of counsel in the real estate section in the San Diego office of Mintz Levin. Scott Biel is a member in the firm's San Diego office, where he practices in the real estate section.

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