If you’ve ever bought a new home, you probably began by looking at houses with asking prices that were within your budget. Then you assessed a potential house for desirability: Is it located in the right neighborhood? Does it have an adequate number of bedrooms or a big enough kitchen? In the end, you may have offered less than the asking price, if you thought the house had issues, or more if you found it highly desirable and knew there were others bidding on it as well. But what if the owner had set no asking price? Then what would you have based your bid on?
As odd as it sounds, when it comes to commercial real estate, owners routinely put buildings on the market without indicating the asking price, says Peng Liu, School of Hotel Administration, College of Business. “Only 30 percent of commercial properties have an asking price. That means the majority are on the market without a listing price, which is really surprising!”
Why Commercial Properties Have No Asking Price When Listed
Liu joined together with Dean Gatzlaff of Florida State University to investigate the reasons behind this behavior. They looked at institutionally owned commercial real estate, such as apartment buildings, office complexes, retail shopping centers, and industry warehouses. For these types of properties, buyers consider square footage, floor plans, and location just as homebuyers do. “But it’s hard to quantify location for commercial properties,” Liu says. “We know it’s important, but for different types of buildings, a good location can mean different things.” For a retail center, a good location can mean one that is easily accessible to more shoppers. For an apartment complex, a good location can mean one situated on a well-traveled route or with public transportation nearby. Then there’s the bottom line when it comes to the profitability of commercial real estate: cash flow. “In contrast to single-family homes, commercial real estate has information on tenants who pay rent,” says Liu. “That’s the real value. The problem is how to price that cash flow. How much a buyer is willing to pay for it can vary quite a bit.”
Sellers know this, Liu explains, and don’t want to cut off those bidders who might be willing to bid higher by setting an asking price. Instead, they invite potential buyers to visit the property and begin negotiations. “They leave the price to the bidder,” Liu says.
Liu and Gatzlaff also found that commercial properties that do have an asking price end up on average with lower transactions prices than those that don’t. “It’s not that having an asking price causes a lower transaction price,” Liu says, “but there’s a correlation between the two.” The use of a list price might signal to buyers that the seller is willing to negotiate a rapid sale or that the property has certain limiting conditions such as poorer tenant quality or lease terms.
Waiting Years to See the Results of a Transaction
Part of the problem with pricing a commercial property comes from the scarcity of these types of transactions. Typically owners of commercial properties hold on to them for a long time before selling again. “You have to wait years to get a transaction,” Liu says. “Then you can finally see the original purchase price versus the sale price and know the return on the building. And every building is different. They are in different locations, they are different property types and they have different tenants, so it is very difficult to come up with a value for any particular property.”
Commercial real estate asset value is roughly $3 trillion in the United States, so understanding how the market operates is very important, Liu says, but until recently there was a lack of big data sets to give a good overview of the market over time. Now there are companies compiling data across the country and globally. This is especially helpful because the fragmented nature of the market makes it difficult to look at commercial real estate from a holistic viewpoint.
The Local Nature of Commercial Real Estate
“Brokers in New York City might know the players and the market there extremely well,” says Liu. “They may also have offices in multiple cities and can carry over some knowledge between the markets, but each city differs enough that they must acquire local knowledge as well if they are to be successful. Commercial real estate investment is a local business—unlike the stock market, for example—and it is highly dependent upon the ability of the managers who oversee day-to-day operations of the buildings, and that makes it unique. The brokerage expertise is difficult to scale or develop across many markets.”
“You have to wait years to get a transaction,” Liu says. “Then you can finally see the original purchase price versus the sale price and know the return on the building. And every building is different.”
Despite the local nature of commercial real estate, more and more international investors have begun investing in other countries, especially the United States market, and Liu has been studying their behavior as well. Recently there has been a great interest in United States commercial property from Chinese insurance companies in particular. “These companies have a low cost of capital from their insurance businesses,” Liu says. “They benefit by diversifying and need to invest in high-quality property in gateway cities, especially overseas. These types of investments can generate the cash flow they need.”
Typically foreign investors are willing and able to pay more for a property than domestic ones. There are several reasons for this, including lack of knowledge about the market, but foreign investors also often have strategic plans that revolve around the property they acquire, Liu says. He points to the recent purchase of the luxury hotel Waldorf Astoria New York by the Chinese company Anbang Insurance Group (AB). Anbang paid a high price for the property, which came with a 100-year contract with Hilton to manage the hotel. But what AB had that other potential buyers didn’t was a strategic plan to bring in even more money by converting the top floors of the building into luxury condos for rich Chinese families. “With that revenue, AB is making more money than other buyers might have,” says Liu. “The conversion to condos had been approved before the sale of the building so they knew it would happen. These potential Chinese condo buyers are not available to the local investors.”
Liu finds studying the risk profile of individual real estate transactions similar in some ways to studying the stock market. “Many people have studied the stock market and individual stock performance in an effort to predict stock returns,” he says. “With commercial real estate, everyone wants to know how to predict the performance of an individual property, but because transactions are infrequent and the market is fragmented, there’s a barrier to understanding. I borrow techniques from big data statistics and from stock and commodities investments to try to shed light on this.”