As one year is about to conclude and another start, many of us turn our gaze forward and think… what will the next year bring?

Our thoughts (at least those of us who are optimists) trend toward the positive, and how we will make 2012 better than years past. If the commercial real estate sector impacts your business, however, your stamina for creating a positive outcome in 2012 will be tested.

In light of certain economic data, who among us wants to admit that we could be at the beginning of a decade long slow-growth recovery, given the challenges that we have only recently overcome?

Our gateway city of Boston has fared better than other parts of the country, and is poised to be strong again in 2012. Despite its unique strengths, however, Boston is not immune to global market forces. The same obstacles that perplex the national real estate market will no doubt have an impact locally. Our crystal ball for 2012 sees certain bright spots, but we are also cognizant of certain concerns that could otherwise challenge a positive 2012.

Bright Spots

Over the course of the past month, we have informally polled various industry sources, from economists to clients. Based on this information, we believe that sources of capital for U.S. investment remain strong. The so-called “wall of capital” stands ready to be deployed into the real estate sector through a variety of sources from private funds, public REITs, non-traded REITs, life insurance companies and banks. Each of these entities has their own investment criteria, but opportunities exist for each.

Core, city center investments will remain highly competitive on both the debt and equity side. REITs will compete with private equity for such investments; banks and non-bank lenders will bid for the debt.

We believe a majority of the activity in 2012 will focus on turn-around investing in troubled or distressed assets. These investments remain the best source for investors seeking yield, but often such opportunities will be in secondary and tertiary markets that exhibit strong fundamentals.

We predict that such “value-add” investing will increase in 2012, based on a willingness of sponsors and lenders to work together as the days of “extend and pretend” and “delay and pray” come to an end. This type of investment inherently often requires more brain strain, but for those willing to put in the effort, the reward will be theirs.

Market Challenges

While we have faith in our prediction, one cannot be a Pollyanna in light of certain realities. Certain challenges may have a major impact on the overall CRE market:

• Election Year/Political Landscape – Our nation’s political system is fractured and has become polarized to the point of extremes. As we head toward a national election, we predict further inaction by Congress, the result of which will create a handbrake on economic recovery, let alone growth, across the broader economy, as well as in the real estate sector. Specifically, and despite the opportunities noted above, we are concerned that private capital investment under the specter of further economic regulatory regimes could be stunted.
• Europe’s Debt Crisis – The global instability caused by the debt crisis in Europe impacts us all. Like a stone thrown into a lake, once that stone sinks, the ripple effect moves outward and impacts all in its path. So, too, will be the repercussions if the Euro fails, certain countries fall out of the Eurozone or an overall deal among the European Union cannot be reached.
• Impaired Capital – Real estate investing, on many levels, is about leverage. At the start of 2011, major sources of capital – banks, commercial mortgage-backed securities and life insurance companies – were poised to re-enter the CRE markets, albeit at lower leverage. It is our opinion that the initial enthusiasm of these capital providers diminished throughout the year. Each of these capital providers will need to overcome certain hurdles from maturing debt to troubled loans. And if these problems prove too great, then their ability to provide new capital to fuel growth will remain impaired, slowing the overall CRE recovery.

On balance, we do not portend a rapid recovery, but believe that in certain sectors the elements exist for an upward trend in real estate investment. The question remains: Are we capable of navigating the hurdles as they unfold?

John Balboni and Ashley Brooks are attorneys at Sullivan & Worcester, with a practice emphasis on debt and equity issues in real estate transactions.