Monday, February 9, 2009

Feature: Bid-Ask Differential Still Substantial

Our first two posts this week will feature commentary from Jason Friedland, Partner and Director of Operations and Investments for Iron Stone Real Estate Group, a Philadelphia-based, multi-disciplined, value-added real estate investment group of companies. Jason will discuss the bid-ask gap between buyers and sellers on today's post, and give his take on how deals are getting done in today's environment on Wednesday. We would love to hear your feedback via the comments section below the post, and hope you enjoy.

(If you are interested in being featured as a guest blogger for Llenrock Blog, please contact us and provide your business, contact information, and relevant topics on which you would like to blog.)

The majority of the real estate opportunities the next 6-18 months will be in the form of performing and non-performing bank notes. With the credit markets still in turmoil, only cash buyers will be able to take advantage of these opportunities. Purchasing in cash results in lower rates of return compared to an equivalent deal that uses leverage unless, of course, the asset acquired with cash is acquired at a substantial discount. Sellers tend to adjust slowly and grudgingly to a weakening market, and through 2008 sellers were reluctant to dispose of assets at discounts commensurate with the changed market conditions. But in recent weeks we have seen greater downward flexibility in pricing from banks that need to dispose of mortgage notes in order to clean up their books.

The uncertainty of asset valuation is driving down the prices of real estate, leaving lenders in control of assets. Banks and other financial institutions are selling performing and non-performing notes to mitigate their portfolio exposure, limit potential losses, generate cash flow and improve their balance sheets. For sale portfolios normally include distressed mortgages on multifamily urban residential, commercial, retail and mixed-use properties that are already in default as banks prepare to reclassify them as real estate-owned (REO). But many lenders are willing to sell performing notes at well below par value due to the deleveraging pressures they face. This situation presents an opportunity to make money simply by purchasing a cash-flowing instrument at a discount.

With that said, the bid-ask differential between buyers and sellers remains substantial overall. While we continue to see tremendous deal flow and opportunities, we will remain patient and cautious as the market continues to correct. The good news is that there are ever more sellers and relatively few viable buyers. On the seller side, a variety of pressures are forcing their hands, and the seller's principal motivation is the need to liquidate the asset, not maximize dollar value. In the universe of buyers there are relatively few in the market who have the cash and the capacity to price, negotiate, and execute a deal in a timely manner. The bad news is that we expect underlying real estate asset values to continue to decline or move sideways in the near term.

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