Written by: Russ Wiles
The Republic | azcentral.com
Date: 6:07 p.m. MST September 14, 2014
Reach the Russ at email or 602-444-8616.
PHOENIX, AZ – Commercial properties in the Phoenix area, especially the East Valley, are among the most undervalued in the nation and thus relatively attractive to investors, especially if interest rates start pushing higher next year.
That’s the assessment from Mascia Development LLC, a New York company that evaluated 350 metro areas around the nation for investment appeal, assuming rising interest rates in the next year lead to property-price declines.
The report identifies the East Valley, specifically the Chandler-Mesa area, as among the best markets for apartments, office buildings, warehouses, stores and many other types of commercial properties.
Mascia Development considers these cities to have the best and worst prospects for commercial properties, especially in the event of rising interest rates.
Most undervalued real estate markets: Albuquerque, NM; Anchorage, AK; Columbus, OH; Joliet-Aurora, IL; Kansas City, MO; Chandler-Mesa, AZ; Lincoln, NE; Madison, WI; Nashville, TN; and Tulsa, OK.
Most overvalued commercial property markets: Austin; Boston; Dallas; Houston; Los Angeles; Miami; New York; San Diego; San Francisco; Washington DC.
Large “gateway” cities such as Boston, Los Angeles, Miami and New York — which have been favorite destinations of international investors — carry the most risk.
“Global gateway cities are oversaturated with international investors and yield-starved domestic investors, which have driven up property values to unsustainable levels, creating the most risk for steep declines in value as interest rates rise,” the report said.
In an interview, Mark Mascia, the company’s president and chief executive officer, said commercial properties in gateway U.S. cities that are well-known around the world are popular places for wealthy Asian and European institutions and high-net-worth individuals to invest.
“They buy real estate in cities that they know,” he said. “They love these sexy markets.”
By contrast, prices in less-glamorous second- and third-tier metro areas, such as the Valley in general and the East Valley in particular, aren’t as inflated. That implies commercial properties here are in better shape to weather possible price declines induced by any sustained rise in interest rates, which would appear likely if the economy continues to pick up steam, he said.
Mascia said he considers the Phoenix area to be a “phenomenal” market for commercial properties, though the area often is lumped together with much more distressed areas such as Detroit. After the housing downturn, the Valley’s reputation for all real estate was unfairly beaten up, he said. “We view Chandler and Mesa as especially strong,” he said.
Mascia added that the Phoenix area isn’t dependent on a single industry like many places in Texas and North Dakota. While these cities and towns are prospering now, some are “one-horse towns,” he said. Austin, Dallas and Houston all rank among Mascia’s five most overvalued markets.
Many attractive secondary markets also feature other favorable aspects including strong and diverse employer bases, long-term population growth, modest new supplies of property and attractive current yields on real estate. These areas offer the “best risk-adjusted returns,” according to the report.
The Mascia study is focused around “cap rates” in various cities. Cap rates are investment returns on properties purchased for cash, without including capital gains or losses or adjusting for taxes, Mascia said. “It’s like a bond’s yield,” he said.
Popular gateway cities tend to have lower cap rates, making them more vulnerable to interest-rate hikes. Secondary and third-level areas have higher cap rates, and property prices in these areas wouldn’t drop as much if interest rates increased.
Assuming a fairly steep rise in interest rates of 2 percentage points or 200 “basis points,” the popular gateway cities might suffer steep property-price declines of around 33 percent on average, according to Mascia’s forecast. Because cap rates are higher in less-popular cities, a similar 2-percentage-point rise in interest rates might result in more muted price drops of around 20 percent.
The analysis is similar to that on bond-market investments. Lower-rated junk corporate bonds, for example, are less vulnerable to interest-rate risk than top-quality U.S. Treasury bonds. The lower any bond’s yield, the more its price would fall assuming the general level of interest rates increased.
If higher interest rates led to price declines for commercial properties, owners in gateway cities also would feel more pressure to raise rents dramatically to recoup their losses, Mascia said.