Sales of office, retail, multifamily and industrial properties could exceed $100 billion in 2010. That would more than double the $45 billion projected for all of 2009, according to Real Capital Analytics.
"We have hit bottom and are starting the new decade on the upswing," the New York research firm said.
The projected increase would be the first year-over-year gain in investment-sales volume since 2007 when it rose 32% to $439 billion. In 2008, volumes had plunged to $133 billion.
Real Capital noted that credit markets have shown signs of thawing, which could help facilitate sales in 2010. It added that capital raising by investors has been strong this year, led by REITs, which raised $28.3 billion this year, including $17.2 billion of equity from 59 stock offerings.
While REITs have used much of the money raised to pay off maturing debt, Real Capital said they still figure to "dominate in acquisitions in 2010." Some REITs have already accumulated substantial war chests and are deploying them.
For instance, Simon Property Group this month agreed to buy the Prime Outlets affiliate of Lightstone Group in a deal that values the company at $2.33 billion.
In addition to REITs, a number of investment managers have raised capital to take advantage of potential opportunities. And much of that has yet to be deployed.
Exactly when the sales rebound begins is tough to predict. Property owners are not yet pressured to sell. And, by most accounts, the gaps between what they are asking and what investors are offering remain wide.
"For now, it's still a dilemma with buyers saying they don't want to go first," for fear they might overpay in what is a falling market, said David J. Lynn, head of U.S. research and strategy for investment manager ING Clarion Partners. "And before they go first they're saying they want an optimal payout."
Ross Moore, executive vice president and director of market and economic research for Colliers International, said, "It's more a matter of buyers still waiting for sellers to capitulate" and drop their asking prices.
Property values as of the third quarter were down 42.9% from their peaks in October 2007, according to the Moody's/Real Commercial Property Price Indices, and Moody's Investors Service warned they could fall up to a total of 65% from their peaks before bottoming.
Despite predicting a sales increase, Real Capital Analytics has also reported that there have been "very few" closed sales of distressed assets, which include properties whose loans are in default or are being foreclosed on. It also warned that distressed assets are unlikely to be offered at the deeply discounted prices that opportunistic investors may be expecting. So far, that has been the case, as growing volumes of maturity defaults are extended and other distressed loans are restructured, keeping those assets out of the market.
Nonetheless, assets that can be classified as distressed are expected to account for the lion's share of sales activity in the years ahead. For example, the FDIC had taken over 148 banks with $515.6 billion of assets from late 2008 through mid-November, and about $65 billion of CMBS loans were in special servicing as of early December, according to Realpoint.
Overseas investors are shaping up as a force that could drive up pricing, according to Janice Stanton, senior managing director of Cushman & Wakefield's capital markets group.
She said that German investment funds in particular are focused on buying in the United States after some had waited too long to buy in the United Kingdom before commercial property pricing there rebounded. She estimated that capitalization rates in the U.K. have dropped 50 to 100 basis points since topping at averages of about 6% in the middle of the year.
Because the U.K. market timing was miscalculated, Stanton said European investors will be willing to bid aggressively to avoid repeating that mistake in the United States. "U.S. investors are pricing differently," she added. "They are saying fundamentals will continue to deteriorate."
Examples of Europeans buying here include the German investment fund manager, Deka Immobilien GmbH, which in September bought 1999 K St. NW in Washington, D.C., for $207.8 million. The price reflected a 6.3% first-year capitalization rate versus the 7% rate that U.S. investors are said to have bid for the office property.
Victor Calanog, research director for Reis Inc, seconded the sense that foreign entities could stir the investment pot here. "The story for the past few months has been about a widening of the bid/ask spread, with both parties not willing to concede. If economic conditions appear to have stabilized, and foreign competitors are sneaking into the mix, perhaps the twain may yet meet and transactions begin to move," he said.
The sense that debt financing will become more available is based on three single-borrower CMBS deals that allowed.
Developers Diversified Realty Corp., Inland Western Retail Real Estate Trust Inc. and Flagler Development Group were able to raise capital at relatively attractive coupons. In addition, a number of conduit lenders are said to be priming their lending operations, with Bridger Commercial Funding saying it was re-starting its lending operation and would bring up to $200 million of loans to market through a CMBS deal by the middle of next year.
Wednesday, February 24, 2010
Wednesday, February 17, 2010
Investment Sales Volume Seen More Than Doubling to $100B in 2010
CRE News
Sales of office, retail, multifamily and industrial properties could exceed $100 billion in 2010. That would more than double the $45 billion projected for all of 2009, according to Real Capital Analytics.
"We have hit bottom and are starting the new decade on the upswing," the New York research firm said.
The projected increase would be the first year-over-year gain in investment-sales volume since 2007 when it rose 32% to $439 billion. In 2008, volumes had plunged to $133 billion.
Real Capital noted that credit markets have shown signs of thawing, which could help facilitate sales in 2010. It added that capital raising by investors has been strong this year, led by REITs, which raised $28.3 billion this year, including $17.2 billion of equity from 59 stock offerings.
While REITs have used much of the money raised to pay off maturing debt, Real Capital said they still figure to "dominate in acquisitions in 2010." Some REITs have already accumulated substantial war chests and are deploying them.
For instance, Simon Property Group this month agreed to buy the Prime Outlets affiliate of Lightstone Group in a deal that values the company at $2.33 billion.
In addition to REITs, a number of investment managers have raised capital to take advantage of potential opportunities. And much of that has yet to be deployed.
Exactly when the sales rebound begins is tough to predict. Property owners are not yet pressured to sell. And, by most accounts, the gaps between what they are asking and what investors are offering remain wide.
"For now, it's still a dilemma with buyers saying they don't want to go first," for fear they might overpay in what is a falling market, said David J. Lynn, head of U.S. research and strategy for investment manager ING Clarion Partners. "And before they go first they're saying they want an optimal payout."
Ross Moore, executive vice president and director of market and economic research for Colliers International, said, "It's more a matter of buyers still waiting for sellers to capitulate" and drop their asking prices.
Property values as of the third quarter were down 42.9% from their peaks in October 2007, according to the Moody's/Real Commercial Property Price Indices, and Moody's Investors Service warned they could fall up to a total of 65% from their peaks before bottoming.
Despite predicting a sales increase, Real Capital Analytics has also reported that there have been "very few" closed sales of distressed assets, which include properties whose loans are in default or are being foreclosed on. It also warned that distressed assets are unlikely to be offered at the deeply discounted prices that opportunistic investors may be expecting. So far, that has been the case, as growing volumes of maturity defaults are extended and other distressed loans are restructured, keeping those assets out of the market.
Nonetheless, assets that can be classified as distressed are expected to account for the lion's share of sales activity in the years ahead. For example, the FDIC had taken over 148 banks with $515.6 billion of assets from late 2008 through mid-November, and about $65 billion of CMBS loans were in special servicing as of early December, according to Realpoint.
Overseas investors are shaping up as a force that could drive up pricing, according to Janice Stanton, senior managing director of Cushman & Wakefield's capital markets group.
She said that German investment funds in particular are focused on buying in the United States after some had waited too long to buy in the United Kingdom before commercial property pricing there rebounded. She estimated that capitalization rates in the U.K. have dropped 50 to 100 basis points since topping at averages of about 6% in the middle of the year.
Because the U.K. market timing was miscalculated, Stanton said European investors will be willing to bid aggressively to avoid repeating that mistake in the United States. "U.S. investors are pricing differently," she added. "They are saying fundamentals will continue to deteriorate."
Examples of Europeans buying here include the German investment fund manager, Deka Immobilien GmbH, which in September bought 1999 K St. NW in Washington, D.C., for $207.8 million. The price reflected a 6.3% first-year capitalization rate versus the 7% rate that U.S. investors are said to have bid for the office property.
Victor Calanog, research director for Reis Inc, seconded the sense that foreign entities could stir the investment pot here. "The story for the past few months has been about a widening of the bid/ask spread, with both parties not willing to concede. If economic conditions appear to have stabilized, and foreign competitors are sneaking into the mix, perhaps the twain may yet meet and transactions begin to move," he said.
The sense that debt financing will become more available is based on three single-borrower CMBS deals that allowed.
Developers Diversified Realty Corp., Inland Western Retail Real Estate Trust Inc. and Flagler Development Group were able to raise capital at relatively attractive coupons. In addition, a number of conduit lenders are said to be priming their lending operations, with Bridger Commercial Funding saying it was re-starting its lending operation and would bring up to $200 million of loans to market through a CMBS deal by the middle of next year.
Sales of office, retail, multifamily and industrial properties could exceed $100 billion in 2010. That would more than double the $45 billion projected for all of 2009, according to Real Capital Analytics.
"We have hit bottom and are starting the new decade on the upswing," the New York research firm said.
The projected increase would be the first year-over-year gain in investment-sales volume since 2007 when it rose 32% to $439 billion. In 2008, volumes had plunged to $133 billion.
Real Capital noted that credit markets have shown signs of thawing, which could help facilitate sales in 2010. It added that capital raising by investors has been strong this year, led by REITs, which raised $28.3 billion this year, including $17.2 billion of equity from 59 stock offerings.
While REITs have used much of the money raised to pay off maturing debt, Real Capital said they still figure to "dominate in acquisitions in 2010." Some REITs have already accumulated substantial war chests and are deploying them.
For instance, Simon Property Group this month agreed to buy the Prime Outlets affiliate of Lightstone Group in a deal that values the company at $2.33 billion.
In addition to REITs, a number of investment managers have raised capital to take advantage of potential opportunities. And much of that has yet to be deployed.
Exactly when the sales rebound begins is tough to predict. Property owners are not yet pressured to sell. And, by most accounts, the gaps between what they are asking and what investors are offering remain wide.
"For now, it's still a dilemma with buyers saying they don't want to go first," for fear they might overpay in what is a falling market, said David J. Lynn, head of U.S. research and strategy for investment manager ING Clarion Partners. "And before they go first they're saying they want an optimal payout."
Ross Moore, executive vice president and director of market and economic research for Colliers International, said, "It's more a matter of buyers still waiting for sellers to capitulate" and drop their asking prices.
Property values as of the third quarter were down 42.9% from their peaks in October 2007, according to the Moody's/Real Commercial Property Price Indices, and Moody's Investors Service warned they could fall up to a total of 65% from their peaks before bottoming.
Despite predicting a sales increase, Real Capital Analytics has also reported that there have been "very few" closed sales of distressed assets, which include properties whose loans are in default or are being foreclosed on. It also warned that distressed assets are unlikely to be offered at the deeply discounted prices that opportunistic investors may be expecting. So far, that has been the case, as growing volumes of maturity defaults are extended and other distressed loans are restructured, keeping those assets out of the market.
Nonetheless, assets that can be classified as distressed are expected to account for the lion's share of sales activity in the years ahead. For example, the FDIC had taken over 148 banks with $515.6 billion of assets from late 2008 through mid-November, and about $65 billion of CMBS loans were in special servicing as of early December, according to Realpoint.
Overseas investors are shaping up as a force that could drive up pricing, according to Janice Stanton, senior managing director of Cushman & Wakefield's capital markets group.
She said that German investment funds in particular are focused on buying in the United States after some had waited too long to buy in the United Kingdom before commercial property pricing there rebounded. She estimated that capitalization rates in the U.K. have dropped 50 to 100 basis points since topping at averages of about 6% in the middle of the year.
Because the U.K. market timing was miscalculated, Stanton said European investors will be willing to bid aggressively to avoid repeating that mistake in the United States. "U.S. investors are pricing differently," she added. "They are saying fundamentals will continue to deteriorate."
Examples of Europeans buying here include the German investment fund manager, Deka Immobilien GmbH, which in September bought 1999 K St. NW in Washington, D.C., for $207.8 million. The price reflected a 6.3% first-year capitalization rate versus the 7% rate that U.S. investors are said to have bid for the office property.
Victor Calanog, research director for Reis Inc, seconded the sense that foreign entities could stir the investment pot here. "The story for the past few months has been about a widening of the bid/ask spread, with both parties not willing to concede. If economic conditions appear to have stabilized, and foreign competitors are sneaking into the mix, perhaps the twain may yet meet and transactions begin to move," he said.
The sense that debt financing will become more available is based on three single-borrower CMBS deals that allowed.
Developers Diversified Realty Corp., Inland Western Retail Real Estate Trust Inc. and Flagler Development Group were able to raise capital at relatively attractive coupons. In addition, a number of conduit lenders are said to be priming their lending operations, with Bridger Commercial Funding saying it was re-starting its lending operation and would bring up to $200 million of loans to market through a CMBS deal by the middle of next year.
Monday, February 8, 2010
Big landlords hope? O.C. recovery in 2013
February 7th, 2010, 2:49 pm · 16 Comments · posted by Jon Lansner
The latest Allen Matkins/UCLA Anderson Forecast Commercial Real Estate Survey of big landlords ad property owners shows a burgeoning optimism that a revival is somewhat near for much of Southern California. Well, the caveat being — eh, Orange County. Jerry Nickelsburg, UCLA senior economist, says of the region in a press release: “As the recovery from this deep recession takes hold, investors in commercial real estate are increasingly of the view that 2012 is going to represent an improvement over today.”
Yet the report says of Orange County:
“For some time we have been saying that the Orange County office market is a 2013 or 2014 recovery. The loss of finance and real estate jobs created a huge hole in demand which is not easily filled. Our panel is also more optimistic about Orange County than they were six months ago, but the optimism seems to be based more on the transfer of buildings to new owners at lower capital costs and on the decline of rents to levels which are sustainable in today’s market. In other words, the panel expects markets to equilibrate and market conditions to improve, but not to the extent of Los Angeles or San Diego. So, opportunities are going to exist in this very tough market, but not in the creation of new floor space for lease.”
The latest Allen Matkins/UCLA Anderson Forecast Commercial Real Estate Survey of big landlords ad property owners shows a burgeoning optimism that a revival is somewhat near for much of Southern California. Well, the caveat being — eh, Orange County. Jerry Nickelsburg, UCLA senior economist, says of the region in a press release: “As the recovery from this deep recession takes hold, investors in commercial real estate are increasingly of the view that 2012 is going to represent an improvement over today.”
Yet the report says of Orange County:
“For some time we have been saying that the Orange County office market is a 2013 or 2014 recovery. The loss of finance and real estate jobs created a huge hole in demand which is not easily filled. Our panel is also more optimistic about Orange County than they were six months ago, but the optimism seems to be based more on the transfer of buildings to new owners at lower capital costs and on the decline of rents to levels which are sustainable in today’s market. In other words, the panel expects markets to equilibrate and market conditions to improve, but not to the extent of Los Angeles or San Diego. So, opportunities are going to exist in this very tough market, but not in the creation of new floor space for lease.”
Hope seen for commercial real estate Survey: Small rebound is projected for 2012
BY MIKE FREEMAN, UNION-TRIBUNE STAFF WRITER
FRIDAY, FEBRUARY 5, 2010 AT 12:04 A.M.
It’s no secret that office landlords in San Diego and across the country are hurting as vacancies rise and lease rates plummet. But a survey released yesterday of commercial real estate builders and investors sees light at the end of the tunnel.
It won’t occur until 2012, according to the Allen Matkins/UCLA Anderson School Forecast survey. And it likely won’t be that strong in San Diego, as thousands of square feet of new offices built in the past two years may well stall a rapid recovery.
But it has been several months since the Allen Matkins/UCLA survey found anything optimistic in its forecast. So that alone is a change. Developers and investors often make decisions about projects two years or more ahead of when they actually complete them.
“They’re starting to look out and say there may be some favorable opportunities, when in June, the last time we took the survey, (the results) were pessimistic,” said Jerry Nickelsburg, senior economist with the UCLA Anderson School. “Now this survey indicates that at least people are out sniffing.”
The survey, which includes all of Southern California, predicts Los Angeles will recover first, in part because it didn’t have as much new construction added to the market as San Diego or Orange County, and in part because it didn’t see as many buildings empty from defunct finance companies.
For San Diego, the survey predicts an improvement in vacancy rates by 2012 as job growth in business and professional services, health care and education rebound. But lease rates aren’t expected to improve until later.
Mark Read, senior managing director of CB Richard Ellis, said his company’s research predicts lease rates will fall further this year, eventually dipping about 20 percent from their peak in mid-2008.
But CB Richard Ellis expects better vacancy and net absorption — a real estate term that calculates the amount of space leased versus the amount vacated — in 2011.
“It all depends on job growth,” Read said. “We just haven’t seen that yet.”
FRIDAY, FEBRUARY 5, 2010 AT 12:04 A.M.
It’s no secret that office landlords in San Diego and across the country are hurting as vacancies rise and lease rates plummet. But a survey released yesterday of commercial real estate builders and investors sees light at the end of the tunnel.
It won’t occur until 2012, according to the Allen Matkins/UCLA Anderson School Forecast survey. And it likely won’t be that strong in San Diego, as thousands of square feet of new offices built in the past two years may well stall a rapid recovery.
But it has been several months since the Allen Matkins/UCLA survey found anything optimistic in its forecast. So that alone is a change. Developers and investors often make decisions about projects two years or more ahead of when they actually complete them.
“They’re starting to look out and say there may be some favorable opportunities, when in June, the last time we took the survey, (the results) were pessimistic,” said Jerry Nickelsburg, senior economist with the UCLA Anderson School. “Now this survey indicates that at least people are out sniffing.”
The survey, which includes all of Southern California, predicts Los Angeles will recover first, in part because it didn’t have as much new construction added to the market as San Diego or Orange County, and in part because it didn’t see as many buildings empty from defunct finance companies.
For San Diego, the survey predicts an improvement in vacancy rates by 2012 as job growth in business and professional services, health care and education rebound. But lease rates aren’t expected to improve until later.
Mark Read, senior managing director of CB Richard Ellis, said his company’s research predicts lease rates will fall further this year, eventually dipping about 20 percent from their peak in mid-2008.
But CB Richard Ellis expects better vacancy and net absorption — a real estate term that calculates the amount of space leased versus the amount vacated — in 2011.
“It all depends on job growth,” Read said. “We just haven’t seen that yet.”
Monday, February 1, 2010
A California RE Downturn Won't Crash the Markets
Might banks’ growing problems with their commercial real estate loans spark a rerun of the subprime mortgage debacle? A lot of pessimists seem to think so, but I doubt it.
Yes, banks are running into severe credit problems with their CRE portfolios, and, yes, those problems are costing shareholders plenty. But there’s a difference between a normal, cyclical credit downcycle and Armageddon II. As it is, banks are enduring a lot of CRE pain, and will keep on enduring pain for several more quarters. That does not mean the whole financial system is at risk.
To begin with, the term “commercial real estate lending” covers all kinds of different kinds of activities, from financing the development of strip malls to so-called “owner occupied” loans to small businesses. Some of those categories will have issues—but by no means all. So generalizations about CRE lending should be viewed with suspicion. On one end of the credit spectrum, yes, financing strip malls can be a risky proposition. But at the other, owner-occupied credits tend to be among the most solid in the lending industry. A bank’s mix of CRE exposure is often as important as its absolute level of exposure.
In the near-term, the biggest CRE problems at many banks so far have to do with souring loans to homebuilders, many of whom have run into problems as a result of the housing bust. Those credit issues have more to do with the mortgage mess, and aren’t necessarily an omen of new problems in other parts of CRE lending. At many banks, homebuilder-related credit problems appear to be peaking, or will shortly. The problems at homebuilders will not likely start a domino effect of problems at other types of CRE lending, however.
In any event, here are six reasons to believe that the CRE downturn, while painful, doesn’t figure to turn into a system-threatening calamity:
1. Underwriting has been much better this cycle than it was in past cycles—and certainly better than the excesses that occurred during the subprime mortgage riot. There simply is no CRE equivalent of a ninja loan, or an option ARM, or a two-year teaser. (Nor, for that matter, is there any federal policy in place to promote subprime CRE ownership.)
Rather, lenders, urged on by regulators, have been careful this cycle to lend on cash flow, not asset values (as many mortgage lenders did, whether they knew it or not). LTVs tend to be lower than they are in residential lending. (At Zions Bancorp., to pick a fairly typical CRE-oriented lender, fully 55% of the bank’s portfolio has a loan-to-value of 70% or less.) So even if property prices drop by a lot (and in many markets, they have), loss severity will likely be relatively mild.
2. The bears are likely overstating the size of the potential problem. There’s just $3.5 trillion in CRE debt outstanding, against something like $10.5 trillion of residential mortgage debt. So any problems with CRE figure to be smaller than residential, from the get-go. And while critics imply that all $3.5 trillion in CRE debt is at risk to some degree, that’s not right. Remember, commercial real estate loans represent all sorts of different categories of lending, of varying inherent credit quality. The MBA reports, for instance, that among the top ten commercial real estate bank lenders, 48% of their aggregate balance of commercial (nonmultifamily) real estate loans were related to owner-occupied properties. The vast majority of those loans will stay current.
3. The commercial real estate market isn’t overbuilt to anywhere near the extent residential real estate was at the top of the housing bubble. In fact, certain segments aren’t overbuilt at all. Take a look at the chart below. It shows annual completions of office space, as a portion of existing stock, going back to 1956. Compare that to the residential building boom that went on in places like Las Vegas, Southern California, and South Florida as the housing bubble inflated in the 2000s. Once the bubble burst, the overhang of redundant supply has helped keep prices down. There simply isn’t a similarly sized overhang in CRE now. In most major markets, vacancy rates are still relatively low, and are nowhere near their 20-year highs.
4. Lenders have a lot more options in mitigating CRE losses than they do residential mortgage losses. Here’s an important difference between residential and commercial real estate lending: mortgaged commercial properties usually throw off cash flow; mortgaged residential properties don’t. That can make a big difference to lenders when the commercial mortgage goes delinquent. The commercial lender can temporarily rework the loan to accommodate the property’s reduced cash flows. Recent accounting and regulatory changes even encourage this. The residential lender, by contrast, has few alternatives to foreclosure. Skeptics dismiss CRE workouts as “extend and pretend,” but in fact workouts tend to be a low-cost alternative to foreclosure. They happen in every CRE downcycle.
5. Interest rates are low. That makes it easier for squeezed borrowers to hang on for longer than they could during the last CRE blowup in the early 1990s. Then once the recovery gathers steam, demand for space will increase and rents will rise, and much of the CRE problem will solve itself.
6. In many markets, property prices have fallen below replacement cost. In midtown Manhattan, for example, prices are off by 42% from their peak, and are now just half of replacement cost. In Dallas, prices have fallen by 29%, and are 33% below replacement cost. And in Los Angeles, prices 19% below their peak, and 20% below replacement cost. Given where prices are now, and how far they’ve fallen, further material declines in property prices seem unlikely.
Put all this together, and it’s hard to see how CRE loans are shaping up to be a rerun of the subprime mortgage disaster. Is the sector in for a further rocky period? Of course. We don’t expect to see any real signs of recovery until later this year. Meanwhile, the indications we’re seeing so far in banks’ fourth-quarter earnings reports is that lenders seem to have their arms around the problem.
That’s encouraging. As the market realizes that banks’ CRE problems are merely cyclical, and not the sign of another financial meltdown—regardless of what the doomsters have to say.
Yes, banks are running into severe credit problems with their CRE portfolios, and, yes, those problems are costing shareholders plenty. But there’s a difference between a normal, cyclical credit downcycle and Armageddon II. As it is, banks are enduring a lot of CRE pain, and will keep on enduring pain for several more quarters. That does not mean the whole financial system is at risk.
To begin with, the term “commercial real estate lending” covers all kinds of different kinds of activities, from financing the development of strip malls to so-called “owner occupied” loans to small businesses. Some of those categories will have issues—but by no means all. So generalizations about CRE lending should be viewed with suspicion. On one end of the credit spectrum, yes, financing strip malls can be a risky proposition. But at the other, owner-occupied credits tend to be among the most solid in the lending industry. A bank’s mix of CRE exposure is often as important as its absolute level of exposure.
In the near-term, the biggest CRE problems at many banks so far have to do with souring loans to homebuilders, many of whom have run into problems as a result of the housing bust. Those credit issues have more to do with the mortgage mess, and aren’t necessarily an omen of new problems in other parts of CRE lending. At many banks, homebuilder-related credit problems appear to be peaking, or will shortly. The problems at homebuilders will not likely start a domino effect of problems at other types of CRE lending, however.
In any event, here are six reasons to believe that the CRE downturn, while painful, doesn’t figure to turn into a system-threatening calamity:
1. Underwriting has been much better this cycle than it was in past cycles—and certainly better than the excesses that occurred during the subprime mortgage riot. There simply is no CRE equivalent of a ninja loan, or an option ARM, or a two-year teaser. (Nor, for that matter, is there any federal policy in place to promote subprime CRE ownership.)
Rather, lenders, urged on by regulators, have been careful this cycle to lend on cash flow, not asset values (as many mortgage lenders did, whether they knew it or not). LTVs tend to be lower than they are in residential lending. (At Zions Bancorp., to pick a fairly typical CRE-oriented lender, fully 55% of the bank’s portfolio has a loan-to-value of 70% or less.) So even if property prices drop by a lot (and in many markets, they have), loss severity will likely be relatively mild.
2. The bears are likely overstating the size of the potential problem. There’s just $3.5 trillion in CRE debt outstanding, against something like $10.5 trillion of residential mortgage debt. So any problems with CRE figure to be smaller than residential, from the get-go. And while critics imply that all $3.5 trillion in CRE debt is at risk to some degree, that’s not right. Remember, commercial real estate loans represent all sorts of different categories of lending, of varying inherent credit quality. The MBA reports, for instance, that among the top ten commercial real estate bank lenders, 48% of their aggregate balance of commercial (nonmultifamily) real estate loans were related to owner-occupied properties. The vast majority of those loans will stay current.
3. The commercial real estate market isn’t overbuilt to anywhere near the extent residential real estate was at the top of the housing bubble. In fact, certain segments aren’t overbuilt at all. Take a look at the chart below. It shows annual completions of office space, as a portion of existing stock, going back to 1956. Compare that to the residential building boom that went on in places like Las Vegas, Southern California, and South Florida as the housing bubble inflated in the 2000s. Once the bubble burst, the overhang of redundant supply has helped keep prices down. There simply isn’t a similarly sized overhang in CRE now. In most major markets, vacancy rates are still relatively low, and are nowhere near their 20-year highs.
4. Lenders have a lot more options in mitigating CRE losses than they do residential mortgage losses. Here’s an important difference between residential and commercial real estate lending: mortgaged commercial properties usually throw off cash flow; mortgaged residential properties don’t. That can make a big difference to lenders when the commercial mortgage goes delinquent. The commercial lender can temporarily rework the loan to accommodate the property’s reduced cash flows. Recent accounting and regulatory changes even encourage this. The residential lender, by contrast, has few alternatives to foreclosure. Skeptics dismiss CRE workouts as “extend and pretend,” but in fact workouts tend to be a low-cost alternative to foreclosure. They happen in every CRE downcycle.
5. Interest rates are low. That makes it easier for squeezed borrowers to hang on for longer than they could during the last CRE blowup in the early 1990s. Then once the recovery gathers steam, demand for space will increase and rents will rise, and much of the CRE problem will solve itself.
6. In many markets, property prices have fallen below replacement cost. In midtown Manhattan, for example, prices are off by 42% from their peak, and are now just half of replacement cost. In Dallas, prices have fallen by 29%, and are 33% below replacement cost. And in Los Angeles, prices 19% below their peak, and 20% below replacement cost. Given where prices are now, and how far they’ve fallen, further material declines in property prices seem unlikely.
Put all this together, and it’s hard to see how CRE loans are shaping up to be a rerun of the subprime mortgage disaster. Is the sector in for a further rocky period? Of course. We don’t expect to see any real signs of recovery until later this year. Meanwhile, the indications we’re seeing so far in banks’ fourth-quarter earnings reports is that lenders seem to have their arms around the problem.
That’s encouraging. As the market realizes that banks’ CRE problems are merely cyclical, and not the sign of another financial meltdown—regardless of what the doomsters have to say.
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