Many people believe—with good reason—that the current recession and the 2008-2009 stock market crash were caused largely by the bust of the housing market and the consequent crunch in home mortgages. On the commercial real estate side, the news hasn't been much better.

For instance, the National Council of Real Estate Investment Fiduciaries (NCREIF) compiles an index of commercial property values based on appraisals; this index typically has been less volatile than market-based real estate indexes. Since the inception of the NCREIF Property Index (NPI) in 1978, values had never fallen more than 7% in any calendar quarter, and that negative number was reached only once, in 1991, when the savings-and-loan crisis and "see-through office buildings" (the term originated in Houston during the late 1980s to refer to commercial overbuilding) were in the headlines.

In the fourth quarter of 2008, though, NPI property values fell by 9.5%, followed by 8.7% and 6.7% drops in the first and second quarters of 2009, respectively. For the 12 months through June 2009, commercial property values fell an astonishing 24%, according to the NPI. (Total returns for those 12 months were better, thanks to a positive 5.5% in net operating income.) Thus, a commercial property that would have sold for $1 million in the spring of 2008 might bring only $760,000 in the fall of 2009.

As might be expected, some real estate professionals see profit potential after such a falloff. "In general, you paid a high price if you acquired property prior to mid-2007," says Jeff Shafer, president of CNL Securities, a real estate firm in Orlando. "Since then, prices have softened. If you're acquiring properties now, you may find opportunities."

Investors usually are receptive to this argument, but this time may be different. "Some clients, especially retirees, are very conservative now," says Dennis Stearns, a planner in Greensboro, N.C. Bonds and bank CDs may seem more appealing than buying commercial property in a sluggish economy.

On the other hand, Stearns' entrepreneurial clients are putting commercial real estate at the top of their list. "They view it as a once-in-a-lifetime buying opportunity," he says. Whether or not that's true, it does seem that with today's low valuations, there are real deals to be had.

THE NUMBERS GAME

Let's take a look at the financial factors contributing to today's opportunities. The first one is higher cap rates. Cap rates, which represent the projected return for one year if a property were bought with all cash, are used to price commercial real estate deals. A broker prices an unleveraged property by taking the net operating income (NOI) and dividing it by the sales price. The result is the cap rate. For example, if a property bought for $1 million has a $50,000 NOI, the cap rate is 5%. Higher cap rates are better for investors because they mean a property has a higher income.

During the boom, cap rates on attractive retail properties dropped to the 4% to 6% range, according to Greg Genovese, president of the securities division at Thompson National Properties, a real estate firm in Irvine, Calif. "Now you can buy the same types of properties at cap rates of 7% to 10%, perhaps from overextended owners," he says.

Cap rates are up, but financing options are down. "There are fewer lenders left," Genovese says. "However, good sponsors have relationships that can get loans, while some loans are assumable for property buyers." What's more, spreads are attractive now, according to Genovese. If you can borrow or assume a loan at 5.5% or 6%, then buy properties at cap rates of 9% or 10%, you can make money.

Today an investor's ultimate profits might be reduced because leverage is down. "You used to be able to finance commercial real estate at 100%," Genovese says. "Now, you'll generally get 50% to 60% leverage, although you can get more if you're assuming a loan. Even with 50% or 60% leverage, though, you might wind up with higher investment returns today because of the drop in values and selling prices."

DÉJÀ VU

Real estate may be a good buy now, but it's not really the first time on this merry-go-round for many financial planning clients. As the NPI numbers indicate, commercial property previously plunged in 1991. After a string of positive years, property values fell in the late 1980s and early 1990s, largely because of overbuilding during the preceding boom.

NPI total returns turned positive in 1993; property values started moving up a few years later. From the mid-1990s to the real estate bust of 2007 to 2008, most commercial real estate investors enjoyed robust returns—and those returns usually were magnified by extensive use of leverage.