Narrowing the Bid-Ask Gap with Conventional and Data-Backed Strategies
Coming off a long streak of rising valuations, cap rate compression, and historically low interest rates, commercial real estate stakeholders face a potentially deal-breaking disparity between the prices sellers are willing to accept and what buyers are willing to pay.
In this article, we’ll look at what the bid-ask gap means, how current market conditions are widening it, and conventional and data-backed strategies to narrow the spread.
1. Bid-ask gap defined and market conditions
Before we get further into the discussion, let’s define the concept. The Bid-Ask Gap is the difference between what sellers and buyers will agree to as the sales price of the asset. In other words, the ‘ask’ is the lowest price the seller is willing to accept, and the ‘bid’ is the highest the buyer is willing to pay.
In economic terms, the ask is an indicator of supply, and the bid indicates demand. The average bid-ask spread in the market is also considered a measure of market liquidity. When there’s strong liquidity in the market, demand will increase as buyers have plenty of debt and equity to leverage for acquisitions. Asset classes with solid demand and low cap rates will typically have tighter spreads.
Inversely, the gap increases when demand is low and the capital markets are bearish. This is particularly true going into 2023, as the market cools from its unprecedented run-up and sellers continue to reach for high prices. Meanwhile, buyers are wary of falling valuations and increasing financing costs.
While the FOMC cut rates during the pandemic to keep the economy going, investors were scooping up supply at exaggerated values to secure deals amid soaring competition. Those buyers were armed with ample liquidity and confidence in rising values and lease rates.
Many of those buyers and investors, including those who refinanced to higher LTVs, are now over-leveraged (negative leverage) and aren’t in a position to sell at the prevailing bid prices, thus widening the gap as demand subsides alongside buyer liquidity and confidence.
2. Closing the gap — conventional strategies
What can parties on both sides of the transaction do to close the gap?
The ideal approaches are those implemented in advance of marketing and negotiations.
For sellers, proactive strategies include making improvements, adding sought-after amenities, optimizing expenses, and maximizing occupancy. The intent of these measures is to reach peak NOI, reduce perceived risk, and stoke demand.
These initiatives may require additional capital, which could be too costly and/or unavailable under current conditions. Still, these repositioning strategies are worthwhile for owners with liquidity and will draw the highest possible bids.
Once at the listing stage (on- or off-market), it’s vital to market the property effectively. Polished and aggressive marketing stimulates latent demand by putting the property in front of the largest possible buyer audience and conveying the asset’s value and risk profile.
During the negotiation phase, it’s advisable to offer favorable terms and concessions where feasible. Enlisting the most capable brokerage, legal, escrow, advisory, and valuations professionals with proven negotiation, transactional, and regional valuation expertise is wise.
Sale-leasebacks are a popular approach for sellers when the gap widens. For sellers that occupy the property and don’t need to relocate, a sale-leaseback provides the opportunity to free up liquidity and maintain operations. The newly available capital can then be devoted to expanding and optimizing operations or held in reserve. This transaction structure also represents less risk for the buyer, who will have a guaranteed tenant with terms that offset economic risk.
Seller financing is another strategy for sellers to consider. Taking back a note on the asset allows sellers to command a premium price, particularly with rising interest rates and financing costs on the buy side. Seller financing also offers the seller tax deferral benefits on gains and passive income (principal and interest), with the potential to sell the note. The buyer benefits from this arrangement through reduced funding costs, bypassed LTV requirements, easier qualifying, and faster and less costly closings.
General strategies to get the best price as a buyer include bringing the most cash possible and focusing on raising equity to reduce financing costs and reliance on conventional lenders. Cash-heavy, quick-close offers have the best chance of acceptance with less-than-ask bids.
3. Narrowing the spread with data
In most cases, market and asset performance data that support your valuation and the assumptions it’s founded upon can sway the counterparty’s willingness to accept or move closer to your ask or bid.
Even where a qualified appraiser is involved, there’s still room for interpretation. Furthermore, the actual value is a moving target and is intrinsically tied to both parties’ value perceptions and risk/return expectations.
For sellers, performance, operational, and financial data regarding the property provides concrete evidence of expenses, occupancy, NOI, and other data points that will alleviate exposure concerns, validate the asking price, and demonstrate solvency and the upside. If the data doesn’t support the proposed ask, it can be leveraged to determine fair market value.
When internal data is paired with market data showing strong demand fundamentals, buyers develop more confidence and willingness to move closer to the asking price. Even when demand is on the decline, the data can clarify the trajectory and likely extent, allowing buyers to make informed decisions and fostering follow-through.
Buyers can also leverage market data to support their bid and assumptions, as well as see if the data justifies a higher offer based on potential rent growth and values in a future period after the market corrects.
Tools are available to facilitate the data collection, interpretation, and presentation processes. An automated data management platform is an essential resource that equips commercial real estate operators and investors with the insight to know where their assets, portfolios, and financials stand. With the data on hand, stakeholders can more quickly react to acquisition opportunities and bids and pivot rapidly to keep deals alive.
In addition to tech solutions, leverage your internal team and third-party advisors to assess the market, opportunity, and asset performance to ensure you’re not leaving anything on the table.
Validation and confidence
While some transactions aren’t meant to be, there are plenty that can avoid the rocks and shoals by positioning assets, financing, and bids proactively with concrete data that supports value assertions and assumptions. Market and asset performance data provide evidence to validate valuations and instill the required confidence for both parties to move toward a successful close.