The economy dropped at a pace of less than 1 percent in the second quarter of the year, as shown by a new government report. It was better than anticipated and provides the strongest signal yet that the longest recession since World War II is finally losing steam.

The dip in GDP for the April-to-June period, reported by the Commerce Department , comes after the economy was in a free fall, declining at 6.4 percent in the opening three months of 2009. That was the steepest downhill slide in close on three decades. The economy has now contracted for a record four straight quarters, underscoring the grim realities of the recession on both consumers and companies alike.

Many economists predicted a slightly bigger 1.5 percent annualized contraction in second-quarter GDP. This being the total value of all goods and services – such as cars and clothes and makeup and machinery – produced within the United States and is seen as best barometer of the country’s economic health.

Less drastic spending cuts by businesses, a resumption of spending by federal and local governments and an improved trade picture were key elements behind the enhanced performance. Consumers, though, retracted a bit. Rising unemployment, shrunken nest eggs and lower home values have weighed down their spending.

An important area where businesses concentrated on cutting back more deeply in the spring was inventories. They slashed spending at a record pace of $141.1 billion. There was a silver lining to that, however: With inventories at rock-bottom, businesses may need to increase production to satisfy customer demand. That would give a boost to the economy in the current quarter.

Federal Reserve Chairman Ben Bernanke said that he thinks the recession will end this year. Many analysts think the economy will start to grow again – perhaps at around a 1.5 percent pace – in the July-to-September quarter. That would be anemic growth by historical measures, but it would at least signify the downturns end.

Obama’s stimulus package of tax cuts and enhanced government spending provided some support to second-quarter economic activity. But one will see a greater impact through the second half of this year and will carry an even bigger punch in 2010, economists said.

Even if the recession ends this year, the job market will stay weakened. Companies are expected to continue cutting payroll through the rest of this year, but analysts say monthly job losses likely will continue to narrow.

Still, unemployment – now at a 26-year high of 9.5 percent – will keep rising. The Fed says it will top 10 percent at the end of this year. Businesses will be unlikely to boost hiring until they’re certain the recovery has staying power.

In the second quarter, businesses continued to cut all kinds of spending, but not nearly as much as they had been, one of the reasons the economy didn’t contract as much.

For instance, they trimmed spending on equipment and software at a 9 percent pace in the second quarter, compared with an annualized drop of 36.4 percent in the first quarter. Similarly, they cut spending on plants, office buildings and other commercial construction at a rate of 8.9 percent, an improvement from the annualized drop of 43.6 percent in the first quarter.

Housing – which led the country into recession – continued to be a drag on the economy. Builders cut spending at a rate of 29.3 percent, also an improvement from the 38.2 percent annualized drop reported in the first quarter.

Consumers, meanwhile, did a slight retreat in the spring.

They sliced spending at a rate of 1.2 percent in the second quarter, after nudging up purchases at a 0.6 percent pace in the first quarter. It turns out that consumers didn’t nearly have the appetite to spend in the first quarter as the government previously thought, according to revisions released Friday.

With consumers spending less on everything from cars to clothes, Americans’ savings rate rose sharply – to 5.2 percent in the second quarter, the highest since 1998.

A return to spending by governments helped economic activity in the spring. The federal government boosted spending at pace of 10.9 percent, the most since the third quarter of 2008. And state and local governments increased spending at a pace of 2.4 percent, the most since the second quarter of 2007.

An improved trade picture also added to economic activity in the spring. Although exports fell, imports fell more, narrowing the trade gap. That added 1.38 percentage points to second-quarter GDP.

The convergence of a collapse in the housing market, a near shutdown of credit and a financial crisis created what Bernanke and others have called a perfect storm for the economy. Those negative forces – the scale of which hasn’t been seen since the 1930s – plunged the country into a recession in December 2007. It is the longest since World War II.

Bernanke and his Fed colleagues warned earlier this month that it could take up to  six years for the economy and the labor market to return to long-term health. Recoveries after financial crises tend to be particularly slow.

The economy’s still-fragile state exposes to further shocks, Fed officials state. Given that, Fed policymakers are expected to keep a key bank lending rate – which influences rates on consumer loans – at a record low close to zero at its meeting in August and perhaps throughout the rest of this year, analysts say.

Capital markets continue to struggle, with a slowdown in investment sales and purchasers remaining on the sidelines. It is expected that demand will remain weak as long as companies continue to reduce expenses and shed employees. To make matters worse for property owners, many companies—owing largely to heavy and sustained job losses—are carrying excess space, which will need to be absorbed before new space demand can take hold.

Capital markets

The key story in capital markets currently is the steady increase in troubled commercial assets. General Growth Properties filing for Chapter 11 reflects the challenge to secure new or renew existing financing. According to Real Capital Analytics (RCA), distressed assets continued to increase in February to US$49.2 billion, comprising 2,293 properties, with US$5.7 billion of troubled assets that fell into default, foreclosure or bankruptcy, signaling possibly more trouble on the horizon. The ratio of offerings to closings remains high at five to one, resulting in further downward pressure in prices. As a result, cap rates will likely continue to increase. Cap rates for office alone are up 25 to 50 basis points since December overall, according to RCA, and are up even more for certain asset classes and locations. The increases in cap rates have moved the fastest and highest in the sec- ondary and tertiary markets. The biggest challenge for purchasers and sellers is how to determine value in a falling market—whether based on cap rate, yields, bor- rowing costs or the expected disposition price in three to five years, depending on the purchaser’s objectives. The limited activity also stems from the continued pricing expectation gap between purchasers and owners. Although this gap has narrowed compared with the beginning of the year, the lack of available financing continues to inhibit sales.

Office

The national office vacancy rate increased by 80 basis points from 14.7% at year-end 2008 to 15.5% in the first quarter. The decline corresponds to a 25 million-sq.-ft. decline in net absorption. The biggest increases in vacancy were in San Antonio (up by 320 basis points) and San Jose (up by 270 basis points). Job losses continued to reduce the demand for office space nationwide. The amount of sublease space on the market now accounts for 11.5% of all vacant space—a rise of 55 basis points. The net increase in sublet space occurred in downtown markets, as suburban sublet space actually decreased. It should be noted that the decrease in suburban sub- lease space had more to do with sublet terms expiring than an increase in demand. The overall vacancy rate continued to climb, with the national suburban office vacancy rate increasing by 90 basis points to 17.1% overall, and the downtown vacancy rate increasing by 70 basis points to 12.3% in the first quarter.

Industrial

The national U.S. industrial availability rate increased by 100 basis points from year-end 2008 to 11.5% in first- quarter 2009, due to falling demand and a few new completions. As a result, net absorption fell to negative 36 million sq. ft. Among the top ten industrial markets, the biggest increases in availability were in Atlanta, rising 470 basis points to 16.5%, and Philadelphia, up 150 basis points to 13.7%. The highest availability rates remain in Austin, at 22.0%, and Stamford, at 21.4%. Rental rates continued to fall, but the range was different depending on the market. The Institute for Supply Management (ISM) non-manufacturing survey decreased to 40.8 in March from 41.6 in February. The March ISM manufacturing index, released earlier this week, showed a modest increase. This rein- forces the further weaknesses in the industrial sector.

Multi-family housing

Demand for U.S. rental apartments remained weak in the first quarter of 2009, amid sharp job losses and a glut of vacant single-family homes and condominiums for sale and for rent. The good news is that multi-housing completions are tapering off, falling to an annualized pace of 242,000 units, 50,000 below year-ago levels. Apartment rents and revenues will still be negatively affected by rising unemployment and vacancy rates in the near term, and it will take further major declines in new supply before the market can stabilize and fundamentals turn positive.

Retail

U.S. consumer confidence increased an astonishing 12.3 points to 39.2 in April, after hitting its lowest level in February, according to the Conference Board. Given the Federal government’s various stimulus measures, we may see confidence increase in the coming months. Retail sales will likely continue to waver over the next few months, especially if the predicted job losses continue. Consumers for the most part will continue to focus on necessity items and defer big-ticket purchases. Many retailers will continue to struggle for the remainder of 2009, leading to more anxious moments for retail property owners and lenders.

Hotel

The hotel sector, perhaps the hardest hit in commercial real estate, is struggling with significant decreases in demand and an onslaught of new supply, resulting in lower occupancies and a loss of pricing power. Revenues per available room have declined approximately 18% year to date, with some segments and geographies experiencing declines in excess of 25%. Sector cash flows have taken a significant hit, given highly leveraged operating structures. U.S. transactions activity was down in excess of 80% for 2008 relative to 2007. Year-to-date activity is down compared to 2008; however, early signs of value capitulation are evident based on transaction activity. Further, special servicer and lender activity is increasing daily with an estimated quadrupling of loan defaults for the sector. This will likely cause more pressure to push cap rates upwards.

Analyzing real estate opportunities can be a daunting task. In an industry renowned for its terminology and abbreviations it can be difficult to see the wood from the trees. ERV’s, LTV’s, NNN’s, jump off the page and often only serve to muddy the waters when scanning over a possible deal. However, there are a number of key indicators that can help you quickly decide between those that merit further investigation and those which are resigned to the ‘ghosts of real estate deals past’ pile!

So, what should I be looking for? To make it easy here are 5 key indicators that should help you weed out the “good” deals from the “not so good”.

1.  Developer Experience

Typically, one looks to invest equity with the developer or joint venture partner who has sourced and strategized the deal. In essence, you are really investing your equity in this person, as they are the ones who will drive the project and hopefully deliver the estimated returns at exit.

With that in mind the more information that you can uncover about this sponsor/developer the better. Ideally, you want to see a long list of previous projects in the same geographical and property type market.  At the very least, you should be looking for one previous venture of a similar fashion.

2.  Developer Interest

‘Skin in the game’, call it what you like but you want to see the sponsor having an equity involvement of their own in the project. If they talk a good game about the potential returns of this ‘unmissable’ opportunity but have no investment of their own on the line then alarm bells should be ringing.  Sponsors who suggest that they have put “sweat equity” into the deal should be discounted. Ten percent of the equity requirement is a much safer investment for a passive investor to rely on.

3.  Returns

You’re in this to make money right? So it follows than the project return is the key performance indicator that you will first assess. Returns are usually stated as percentage IRR (Internal Rate of Return). Another abbreviation, but if you’re going to rank them, this is the most important! Essentially IRR is a measure of how hard your money is working for you; this should be aligned with the risk profile of the deal, and the type of investment. Look at similar deals in the market and what they purport to be turning out, or ideally, source information on historic deals and what returns were achieved. Endless information should be available on the kind of return to expect from such a project so make sure the figures are attractive but more importantly that they make sense and are viable given current market conditions.

4.  Fees

Its one thing finding a respected, experienced developer to joint venture with, however if they are maligned by greed then it renders their abilities and experience void. Both parties should be in the project together so it should not be necessary for the sponsor to pile on high management and general partner fees to ensure that they are compensated regardless of how much profit is generated at the end of the deal.  They are due compensation for management and for sourcing the deal in the first place, but make sure that fees are in line with market standards. It is often prudent to base fees on results that motivate the developer to hit target returns to the investor before being compensated themselves.

5.  Support Team

A Real Estate investment by its nature is relatively complex and so requires a number of complimentary professional resources to come together at both its inception and in order to function throughout its term. From CPA’s to attorneys the set-up needs to be as professional as possible. The initial offering memorandum should state the various firms working at each level of the deal. Here we look for reputable names and businesses that are established in their field. This will not only give us solace in our support team, but will give us further indication of the seriousness and commitment of the sponsor to proceed with the deal. We don’t want to see the local one desk, one employee law ‘firm’ listed here, but rather the seasoned attorney who has seen it all before.

If you are satisfied on these five elements of the deal that you are reviewing it is definitely worth picking up the phone and having a conversation with the developer to dig a little deeper into the deal.  A site visit and a review of the partnership and operating agreements is next, followed by a more careful analysis of the market and the sponsor’s business plan.  If you are still interested in the deal at this point it is worth your while to start paying some professionals on your side to assess the merits of the investment.  Use the best advisors that you can and listen to their advice, but remember the decision ultimately comes down to you – your advisors are trying to reduce your risk exposure, but that means money in FDIC insured accounts at 2%, you can probably stomach some risk and do slightly better than that. Good investing.

Eureka! You’ve found a golden real estate deal. But what happens if your bank won’t finance the amount needed to secure the property, or won’t do it in the short time frame needed? Do you cry yourself to sleep or do you seek alternative options?

One such option is a hard money loan.  A hard money loan is an asset-backed loan where the borrower receives funds secured by the value of a parcel of real estate. In situations where money is needed quickly, going down the hard money route can be very successful. However, before you run out the door, blueprints in hand, to your local hard money lender there are a few key factors you need to keep in mind.

Cost
The rate charge by hard money lenders is typically far greater than banks, which is understandable given the short turn around time and looser lending criteria -the credit profile of the borrower is not as important as the loan is based on the value of the property that is put up as collateral. The rate is not dependent on the Bank Rate. It is instead more dependent on the real estate market and availability of hard money credit. Figures available for the last year give a range of hard money rates from the mid 12%–21% (points are often charged upfront.) In situations where the borrower is unable to meet payments, they can be charged a higher “Default Rate”. While it is to be expected that the rate you will be charged is relatively high, it is also wise to ensure that this rate is somewhere in the normal market standard range.

Amount
One needs to be aware that the amount of funds typically lent by a hard money lender are, on a loan to value basis, less than bank loan to value ratios. Usual ratios are around 60% LTV. This relatively low ratio provides additional security for the lender so that they can foreclose on the property in the event of non-payment by the borrower.

It’s also important to note that this LTV is calculated on the property’s current value rather than a future value. This is the amount that a lender could expect to earn from a quick sale of the property in the event of a loan default. Current market values can differ greatly to market value appraisals which assume a sale in which neither the buyer nor seller is in a rush to close.

Fees
Hard money lending often receives critical press for its fee structure, which commonly charges up front fees in order to work on the loan proposal. Concerns mainly stem from those lending companies in the industry who take upfront payments to investigate loans and refuse to lend on virtually all properties while keeping this fee. While it is typically a virtue of hard money lending which can’t be escaped, borrowers should be mindful of both the amount of fees charged and also the track record of the company to follow through on their initial loan estimates.

Timing
Hard money loans often can be closed within 30 to 45 business days if the loan is already in process with a bank. This rapid time frame can provide a lot of flexibility for sponsors. Using hard money loans can allow sponsors to tie up and close deals quickly typically providing an opportunity to negotiate favorable “all cash, quick closing” rates with pressured sellers or banks.

Conclusion
For many hard money borrowers the only alternative funding source is bringing in a new equity partner and giving away a percentage ownership in the property or company.  As a result, before agreeing to work with a hard-money lender sponsors typically ask themselves:
“Is it worth it for us to rent the capital for one, two or three years in order to achieve our business goals or should we bring in a new equity partner and permanently give away a part of our real estate or company.”

The answer is inevitably a very simple ROI analysis that shows that in the long run, if there is a large capital growth component to the project, the cost of the hard money loan is far less expensive than sharing the expected EBITDA growth over the next two to three years with partners.  On the other hand, having lived through a downturn in the market over the past few years, sponsors have to be very certain that their business plans will play out as expected so that the sale or refinance events take place to replace the expensive hard money loans.  Many developers had to turn over the keys to their hard money lenders because their market expectations did not play out as expected.  Caveat emptor – buyer beware.