How to make a fortune in a down market

<i>Real estate insiders handicap today's investments for tomorrow's profits</i>

While activity remains sluggish in the New York real estate market, there may be pockets of opportunities for profits over the next few years for those who invest wisely.

Experts point to three areas for investors looking to lay the groundwork for a future fortune: office towers, land and multifamily buildings.

First, a warning or two. Many of the properties sold will go to insiders rather than victors in a public auction process. With few assets available for cheap prices through public listings, “smart money will use alternative paths to get to core real estate,” said Dan Fasulo, managing director at Real Capital Analytics.

While there will be “opportunities to pick up quality assets at attractive prices over the next year,” he warned that “investors who feel like we’re going to fall off a cliff … will be greatly disappointed.”

Of course, with so many projects carrying troubled loans, most of the investment opportunities will be in debt rather than equity. But Hugh Kelly, a professor at New York University’s Schack Institute of Real Estate, said the key is which troubled players will be willing to strike a deal.

“Debt on distressed assets seems so obvious, but the question is, who’s going to be the seller?” he said. Transaction volume has been light so far because of the large spread between the prices at which buyers and sellers are willing to do deals. “That will be a hard gap to close,” Kelly said. Still, smart investors can overcome these obstacles just as Sam Zell and Barry Sternlicht have done before them.

Strategy: Buy office buildings

Many institutional investors are looking at office buildings. And experts say that prices don’t need to be at their lowest for fortunes to be made.

Someone who picks up a well-located office building should benefit when rates bounce back. “That’s where a lot of people will make money,” said Peter Hauspurg, CEO of Eastern Consolidated. “You don’t need to be at the absolute bottom: 60 percent off [2007 levels] will make people a lot of money.”

High-quality buildings make the most sense, as occupancy rates should recover most quickly at these properties, experts said. “If you’re able to look at a Class B-plus or better office building and purchase it at a discount-to-replacement price — around $650 to $800 per square foot — by the time we get to 2013-14, you’re going to have significant capital appreciation,” Kelly said.

While many companies have dumped space during the downturn, the need for it “can turn quickly,” Kelly said. “If we get a jobs recovery by 2013, we’re not going to have enough space.”

Andrew Singer, CEO of the Singer & Bassuk Organization, maintained that more opportunities will arise for investing in unfinished speculative office projects as interest rates rise. At this point, he said, well-capitalized owners can afford to keep the buildings without tenants because their financing costs are so low, so the owners have little incentive to sell. “When interest rates rise,” he noted, “the refinancing world won’t support loans on some of these buildings.”

For now, investors are interested in properties that are already producing income through renters, said Jon Epstein, executive vice president of capital markets for Grubb & Ellis. “Investors we speak to are being selective on offices because of the occupancy and availability rates,” he noted.

Strategy: Look for land

Many experts say land now represents a strong investment option.

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“Non-cash-flow assets like land should provide some of the best opportunities,” said Ryan Nelson, senior vice president in charge of acquisitions for Sherwood Equities, which is based in Manhattan.

Loans for land are less likely to be extended by lenders than loans for income-producing projects, the thinking goes, so land will be available for purchase. But it won’t be easy, Nelson said. “The foreclosure process is a bear. It can take up to two years. There won’t be quick profits.”

Still, success awaits patient investors. Land can now be purchased at discount prices in Manhattan and Brooklyn in a range of sizes, Singer said. “If I were a long-term investor with enormous liquidity, I would be out there seeking vacant land not ready for development. That could show huge returns in five to 10 years.”

When it comes to Manhattan, though, real estate attorney Edward Mermelstein disagrees. “Land absolutely doesn’t make sense in Manhattan,” he said. That’s because vacant property below 96th Street costs $200 to $300 per square foot. Add construction costs of $250 to $500 per square foot, and investors would be paying more than current sales prices for built property.

Strategy: Find good rental buildings

On the residential side, investors should think about rental buildings instead of condos.

Kelly believes rental properties make more sense because the city faces a chronic shortage of rental units. “I think rental demand will come back before condos,” he said.

Troubled condo projects can be enticing, but so far there have been few opportunities for large-scale investors. Experts say more will become available as banks increasingly become reluctant to extend loans. “I think banks will move much more aggressively to take over projects, and there will be significant opportunities to step into projects from ones just begun to ones just about finished,” Singer said.

But Nelson doesn’t expect investments in condo buildings to be as profitable as other sectors. Ironically, that’s due to the fact that condos are healthier than many office buildings.

“Multifamily pricing has held up rather well,” Nelson said. “It didn’t fall as far as other sectors, so it doesn’t have as far to come up. Government financing [for condos] is still available through Fannie Mae and Freddie Mac.”

For individuals, condo units constitute an attractive investment opportunity, some experts say. With Wall Street firms handing out billions in bonuses, at least partly in cash, recipients will have plenty of money to spend on condos, possibly even pushing prices higher.

“If the bonuses that eventually get paid out even approach levels of more normal times, we’ll find that distress in the upper end of the residential market will begin to ease,” Kelly said. Now would be a good time for an individual to buy a condo on the Upper East Side that has dropped in price from its peak, he noted.

Bottom line: Be prepared

Experts said New York is currently experiencing the dark before the dawn and noted that there is only going to be a short window of time for smart investors to jump in and make their future fortunes.

“At some point, investors will realize there won’t be vast amounts of opportunities out there, and stabilized assets will start trading again, just as they did in London six months ago,” said Real Capital Analytics’ Fasulo.

“Everyone will be surprised how much values run up in the next one to two years.”