Kimberly Cinnamond is an associate in Richards Barry Joyce & Partners’ investment sales group in Boston.
Greater Boston’s commercial real estate market has been witness to marked changes in the past twelve months. With the onset of turmoil in the capital markets stemming from the subprime residential mortgage fallout, commercial sales transaction volume has fallen precipitously, loan underwriting standards have been tightened, interest spreads on loan quotes have widened, and buyers have become much more cautious in their underwriting of acquisitions.
As a result the length of time between purchase and sale agreement and closing has increased sharply.
The Greater Boston market sales activity totaled $6.1 billion in the first six months of 2007 versus $428 million in the first half of 2008, a drop of more than 93 percent. As deal volume has decreased, due in large part to the tightening of loan underwriting standards and a lack of available debt in the market, buyers are having to be far more conservative in their underwriting of assets than they were just 12 months ago and are having to search the market much harder for the loan amount and terms they need to conclude the transaction.
In the past year, a noticeable lengthening of the time it takes to close a commercial real estate sales transaction has occurred. Over the course of 2007, the average due diligence period was under fifteen business days, as was the typical closing period for commercial property in Greater Boston — a total of thirty days, start to finish. A year ago it was not unheard of to have a buyer require less then a week for both the due diligence and closing periods, respectively. However, through the first half of 2008, buyers, on average, required over 35 days for the due diligence period and nearly 30 days to close a transaction, more than double the period of one year ago.
Buyers Rule
The return to a more traditional length of due diligence and closing periods is a result of a shift in negotiating leverage from sellers to buyers. A year ago, buyers were taking down deals as quickly as possible in a race against compressing capitalization rates driven by aggressively competitive buyers. With the onset of turmoil in the capital markets in mid to late summer of 2007 the downward movement in cap rates came to an end in the second half of 2007. As buyers regain the upper hand in purchase/sale negotiations, they are taking the time to more carefully perform many of the fundamental due diligence activities such as detailed physical inspections, thorough environmental review and interviews with existing tenants.
Buyers are also scrutinizing financial models more closely than ever as current in-place returns have replaced “projected” returns as the most important indices. As a result, sellers and their representatives have to be more involved in helping buyers understand how a property produces income returns and navigate the dynamic, often cumbersome, process of getting a transaction to close.
Seller Financing Issues
Sellers are having to be far more flexible throughout the due diligence process, providing additional time to complete inspections and ensuring that the buyer has access to all information necessary to complete a full review of the asset. Because it is far more difficult to arrange for acceptable financing, sellers’ representatives are having to get more involved in assisting mortgage brokers in assembling loan packages to secure financing and close the transaction.
Despite the decrease in deal volume in the first half of 2008, the second half of the year looks promising. Many of the Greater Boston sales transactions which were scheduled to close earlier in the year will likely close before year’s end (indeed, some already have) as the lengthy process of loan procurement is concluded.
While many prospective sales offerings have been pulled from the market after receiving lackluster reception from the investment community, others are simply taking far longer to finance and close.
