Friday, June 20, 2008

Institutional Investors Are Re-Entering Troubled Real Estate Markets

Miami CondosPredicting the bottom of the real estate market, or any market for that matter, is anything but an exact science. With the state of our real estate market today, especially in the most troubled areas, many people are scared to even think about investing. In the midst of this uncertainty lies opportunity--at least that is the thought of some institutional real estate investors.

One such institutional investor is Strategic Real Estate Advisors. They believe that now is the time to get back in the market. They have created a fund called the Florida Prime Residential Opportunity Fund, which plans to raise $1 billion to invest in oceanfront condominiums and undeveloped land approved for housing, according to an article from Bloomberg. It appears most of their investments will be located in the Miami area, but they are also willing to look at Orlando and Tampa, according to the article.

The Florida Prime Residential Opportunity Fund isn’t planning to just jump head first into the market, though. They have targeted a price point of around $400 per square foot which they are willing to pay for these properties, and they will wait it out until the right deals to come their way. Properties are now selling for around $500 per square foot; at the height of the housing boom, prices were around $1000, according to Bloomberg. The fund says they expect to see annual returns of 20 percent and have set a holding time frame for the properties of 7 to 10 years.

Are these institutional investors smart, or are they setting themselves up for a miserable failure? That is the question many people are asking themselves. Personally, I think they should do quite well, but I think their 20 percent per annum projected returns might be a little unrealistic. Here is why I think they will do well:

  • They set a clear goal for what they are willing to pay for property, and it represents a great value
  • They have a large sum of money to work with, which mean they can get preferred pricing
  • They have set a long term time frame which will allow time for the markets to recover
  • They selected a market that has eternal appeal

Again, while I do think that in the end they will turn a decent profit, 20 percent seems a little high, especially considering that they plan to buy the properties with all cash. When the market finally does recover I just don’t see it jumping as dramatically as it did during the bubble. Instead, I see a 4 to 6 percent yearly appreciation as a more likely scenario once the market turns the corner. I’m assuming they plan to use the condos as rental units while they hold them, but again, the income they can expect to generate might not be as high as they are hoping. One of the problems with renting high end property is that first off, you typically aren’t able to get a high rent in proportion to the properties’ value, and secondly, you have a much higher maintenance cost. The maintenance will be an ongoing experience during the entire holding period, and then when they look to resell the property in 7 to 10 years, they will also likely incur a large remodeling expense to bring the property back up to top condition after several years of being rented. Of the two strategies, I think the land one offers higher return potential, but I still just don’t see 20 percent per year.

For investors, after you take out the funds fees and so on, you can probably expect to be left with a return that isn’t all that exciting. So while I do think that their plan is solid, and that they should be able to make some money, it won’t be as much as they are expecting. Individual investors, though, should be able to do even better utilizing a little leverage and some market savvy. If you plan to go it on your own in a volatile market like this, though, just make sure to keep your cash flow positive. Don’t bank on appreciation--let it be the icing on the cake, not the cake itself.


Renald said...

$400 per square meter appears to be in error. Shouldn't it be $400 per square foot?

Eric Ames said...


Thanks for catching that typo, yes it should be per sq ft.