It's hard to find anyone who's still bearish on the economy or the market these days. Listen to the average pundit on CNBC and this is what you'll hear:
-The credit crisis? It's over! Quit worrying.
-The real estate mess? Fixed! No problem.
-The economy? Rebounding. The worst is behind us.
-The markets? They're headed to infinity and beyond! Better get on board.
I've talked about the credit crisis a few times. And no less an authority than the International Monetary Fund (IMF) believes we've only acknowledged $1.29 trillion of the $4 trillion in total global credit losses to date. That means we're not even a THIRD of the way through the process.
In the real estate arena, we're seeing tentative signs of life in some hard-hit markets. But it's the distressed, "fire sale" stuff that's moving. Inventory levels remain high, and foreclosures show no sign of abating. In fact, foreclosure filings hit a new record high of 341,000 in March — a gain driven by rising unemployment, falling home prices, and the expiration of several, temporary state and industry moratoriums.
And that's just on the RESIDENTIAL front!
The COMMERCIAL real estate business is in full-scale meltdown mode. Prices are plunging, vacancies are soaring, and rents are dropping. Office tenants recently vacated a whopping 24.9 million square feet of space, the most since the 9/11 attacks. And General Growth Properties, the second-biggest mall operator in the U.S., just filed for Chapter 11 bankruptcy protection. The company is buried under $27 billion in debt, and its bankruptcy is the largest EVER seen in the commercial real estate industry.
It's (still) the Economy, Stupid!
But it's the economy that could be the weakest link here. Several companies have come out and said that business isn't getting any worse. Some of the earnings reports I've read talk about how conditions are now simply horrendous, rather than Armageddon-like.
But does that mean things are getting better? Is the economy really ramping up? Is the worst really behind us? I find that hard to believe. Just consider what we learned this week ...
The consumer is still on the ropes! Retail sales plunged 1.1 percent in March. That was a huge swing from the 0.3 percent gain in February, and much worse than forecast.
No matter how you slice and dice the numbers (exclude autos, exclude gas, etc.), you still come to the same conclusion: The consumer is on the ropes and not in the mood to blow his dwindling paycheck at the mall. That's unlikely to change anytime soon, not with the level of continuing jobless claims now running at more than 6 MILLION — the highest in U.S. history.
Factories are sitting idle! Industrial production dropped 1.5 percent in March. That was far worse than the 0.9 percent dip that was expected and the 14th decline in the past 15 months. Capacity utilization — the amount of available space that's actually being used — fell to 69.3 percent. That's the lowest level in the 42 years the government has been keeping track!
Deflation is far from dead! The Federal Reserve has been pumping money into the economy like mad to offset deflation. But so far, it doesn't seem to be working out that well. The Producer Price Index (PPI) dropped 1.2 percent last month, much worse than the forecast for a flat reading.
On a year-over-year basis, wholesale prices are now falling at a 3.5 percent rate. That's the deepest rate of deflation recorded in this country since January 1950! In addition, consumer-level deflation came in at 0.4 percent, the most since 1955.
Garden Variety Recession ... Or Something Else?
Many Wall Street investors are operating under the assumption that this is a garden variety recession. They're saying that the modicum of "less worse" news we've seen is a harbinger of "recovery." They expect consumer spending to resume its normal pace, factories to ramp production back up, and everything to be hunky dory by year end.
But if this is a much deeper economic decline ... one driven by the biggest bout of debt destruction and deleveraging this country has seen since the Great Depression ... that's a different story. In that case, the Fed's reflation efforts will fail. At best, the economy will muddle along. At worst, it will slip even further down the rabbit hole. And stocks will ultimately head lower.
I don't have a perfect crystal ball. But I believe the risk of a Japan-style economic stagnation is much higher than the traditional Wall Street pundit thinks it is. And I believe this recent rally smells more like the bear market variety — very sharp, relatively short-lived, and ultimately, doomed to fail. So I most certainly wouldn't be chasing it.
Until next time…
This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.
Showing posts with label Commercial real estate. Show all posts
Showing posts with label Commercial real estate. Show all posts
Friday, April 17, 2009
Tuesday, April 1, 2008
Real Estate and the Credit Crunch Update 2008
The Current Affairs of the Real Estate & Capital Markets
by Rob E. Lee
All trees aspire to grow to the sky; likewise during a boom market the human spirit cannot believe that there will be an ultimate bust. As last year drew to a close the investment environment transitioned from cautious optimism to a heightened level of realization that there was a global credit crisis brewing in the financial markets.
Today, the commercial real estate market has entered a period of declining values, or as any would say "correcting values" in an effort to adjust the risk basis. Many properties are overleveraged or encountering financial difficulty. The collapse of the housing market coupled with fuel and food price inflation are putting tremendous strain on the American consumer, the ultimate driver of our economy.
Hidden behind the creative genius and financially engineered products that drove much of the aggressive view that the economy could do no wrong during the last decade, Wall Street and Main Street have been oversold, especially with respect to securitized single-family residential debt products, or subprime loans. In fact, the housing market was overleveraged more than anyone realized, or even suspected, relative to the fundamental values of the underlying residential assets.
According to Jack Cohen, CEO of Cohen Financial, a leading commercial real estate investment bank, a massive real estate resetting and de-leveraging is occurring during this first quarter of 2008. Some say it is due directly to sub-prime and single family housing troubles. Mr. Cohen says this is not entirely true. The commercial and residential markets are not linked but for three items: 1) space demand is linked by the health of the economy; 2) lending is linked through the capital markets; and, 3) bond pricing is linked through the investor base (supporting the capital markets). Otherwise, no other links exist. Commercial and residential issues are not at all intertwined. "None of the flaws in the sub-prime business model are remotely present in the commercial real estate lending business. To the contrary, the strengths of the commercial real estate lending business model were not present in the sub-prime business model," stated Cohen.
As the residential market's weakness increased in 2007, the commercial real estate market reached its pinnacle to date, with mega multi-billion portfolio deals such as the Blackstone Group and Equity Office Properties (EOP) Trust transaction. When the cracks in the foundation of the credit markets appeared as a result of the subprime mortgage market meltdown, the commercial real estate market took notice and quickly inventoried its own aggressive dealings and pricing during the past five years. Risk aversion quaked throughout the world's credit markets, resulting in the Federal Reserve pumping liquidity into the financial markets and dropping the federal funds rate. The world and domestic commercial real estate investors prepared for new terrain.
The Federal Reserve created the perfect environment and many lenders detached risk from reward in a market where more money was made securitizing the loans rather than holding them. Demand for securitized loans forced lenders to sacrifice underwriting standards and reengineer loan products such as interest-only loans and low or no debt-service coverage requirements. Financing at all levels of the capital stack created more asset demand. Cap-rate compression happened quickly, falling from 11% in 1995 on average to 6.29% in June 2007. Without leverage, investors would demand a higher return.
In the wider marketplace, the subprime debacle has ensnared some of the biggest institutions on Wall Street. Write-downs at Merrill Lynch totaled $22 billion by mid-January, and Citigroup wrote off $20 billion. Citigroup Chairman Charles Prince and Merrill Lynch CEO Stan O'Neal resigned. Even mortgage financiers Freddie Mac and Fannie Mae, stalwarts of the secondary mortgage market, face potential write-downs of $16 billion for the fourth quarter of 2007 because of flawed subprime loans and other investments.
The threat of recession is also taking a toll on the market, further shaking the confidence of bond buyers and sellers. The Federal Reserve's startling, 75 basis point cut in interest rates on Jan. 22 - the largest reduction in more than two decades - quieted turbulent stock markets momentarily, but raised new questions.
"While it's meant to stabilize things, that to me are going to make people more nervous," says Kim Diamond, managing director at Standard & Poor's, since it signals the Fed's deep concern over the economy. "A 75 basis point cut off-cycle is pretty extreme."
Despite a slowdown in 2007's growth rate, the U.S. economy remains resilient beyond most expectations - but that is what keeps market nerves on edge while providing a much-needed stable market influence. Fortunately the global economy is on solid footing and is expected to grow at a faster pace, helping the U.S. weather this slow domestic economic picture.
For borrowers, the call to action is to proceed cautiously and creatively, rather than sit on the sidelines. Forget about an attempt to convince a lender to be "aggressive" or "creative" when financing your next real estate deal. Banks have gone back to basics - solid fundamentals, and nothing less will do.
Although inflation pressures probably will continue in 2008, the Federal Reserve has shown its willingness to accommodate the markets by lowering interest rates and injecting liquidity into the economy to help avoid a recession. Unemployment remains low, but with the continuing housing slump and high energy prices, consumer spending and job growth may slow. Strong employment will favor commercial real estate, keeping vacancies low and providing the necessary support for investment earnings. However, geographic differences in commercial investment markets will play a pivotal role, as some U.S. regions have seen variations in their local economies.
Unstable financial market realities favor commercial real estate. As the financial markets become riskier and less attractive, commercial real estate - as long as it holds its own - becomes more attractive on a relative basis. It does not mean that prices continue to climb, but commercial real estate does maintain a more attractive position relative to stocks and bonds . With average yield rates on commercial real estate investments still higher than those for many other investment alternatives, commercial real estate likely will continue to be a preferred investment vehicle from a risk-adjusted basis. For example, National apartment fundamentals were strong during 2007, thanks to a great deal of help from the subprime lending fallout in the residential market. However, supply may begin to outpace demand, as unsold houses are rented and units slated for condominium conversion re-enter the market as rental units.
With continuing strength in overall commercial real estate fundamentals, it is no surprise that capital still is flowing into the market. However, the amount of funds has slowed, especially highly leveraged debt, and likely will continue to decrease this year. This trend will continue to affect asset pricing, working to move prices below the record-setting levels of the past year. This slow but steady downward movement should help to calm fears of overpricing in some markets.
Although we view debt capital as tightening the hatch and clearly as more discriminating and volatile, there is still an ample amount of debt capital to support the right level of financial leverage for commercial real estate. Further, there is plenty of equity capital from both domestic and foreign sources that is inclined to invest in commercial real estate.
2008: Markets to Watch
The following list of top 10 markets by property type is based on RERC's price/value analysis, which utilizes RERC's valuation expertise, market knowledge, and financial modeling capabilities to identify these markets.
Office Industrial Retail Multifamily
Salt Lake City Kansas City, KS Los Angeles Portland, OR
Austin, TX Sacramento Baltimore Austin, TX
Sacramento Seattle Minneapolis San Antonio
New York Dallas Cleveland Chicago
Cleveland San Diego Charlotte, NC Washington, DC
San Francisco Houston Philadelphia Norfolk, VA
Los Angeles Cleveland San Antonio Seattle
Seattle St. Louis Las Vegas Charlotte, NC
Denver Minneapolis Miami Denver
Portland, OR Los Angeles Sacramento, CA New York
Despite the psychological drama of the credit crunch - from tightening underwriting standards to the global stock market plunge on Jan. 21 - plenty of capital is still available for deals in the $20 million to $30 million range, the core industry size, brokers say. However, overleveraged property investors undoubtedly will face loan defaults, workouts or foreclosures. This is the downside of overleveraging assets in a cyclical business, which forces property owners to go through a detoxification process so that the lending cycle can begin anew.
Industry confidence can be regained if fear doesn't overtake rational decision-making. "We can talk ourselves into recession. If we continue to terrify ourselves, and let this drag out, then it's going to become a self-fulfilling prophecy," said Randy Reef, senior managing director of Bear Stearns, at the CMSA conference in Miami. The CMBS market was overheated and poised for a reversal, but losses can be kept tolerable, he maintains.
Many echo the thoughts of Jack Cohen, of Cohen Financial in that the industry doesn't need new or more capital. Rather, in 2008 we need old capital confident enough to invest. This is only possible if everyone stops pining for the easy lending days of 2006 and the first half of 2007 and accepts the new world we live in for what it really is-good for business! The dislocation of capital happened for technical reasons; let's not make this worse by eroding commercial real estate fundamentals. Accepting the shift is the fastest path to a new foundation of wealth creation. Capital is still plentiful for deals that make sense and real estate investment banks like Cohen Financial are still able to finance deals and provide capital for those buyers and sellers who realize the market is still full of opportunities.
About the Author
Rob E. Lee, M.B.A., CCIM
Senior Associate of Investment Properties for Colliers International's Private Capital Advisors Group in Los Angeles and is currently serving as the President for the Greater Southern California CCIM Chapter. He can be reached at Robert.Lee@Colliers.com or (310) 787-1000. He is a 2006 alumnus from the Graziadio School of Business and Management.
by Rob E. Lee
All trees aspire to grow to the sky; likewise during a boom market the human spirit cannot believe that there will be an ultimate bust. As last year drew to a close the investment environment transitioned from cautious optimism to a heightened level of realization that there was a global credit crisis brewing in the financial markets.
Today, the commercial real estate market has entered a period of declining values, or as any would say "correcting values" in an effort to adjust the risk basis. Many properties are overleveraged or encountering financial difficulty. The collapse of the housing market coupled with fuel and food price inflation are putting tremendous strain on the American consumer, the ultimate driver of our economy.
Hidden behind the creative genius and financially engineered products that drove much of the aggressive view that the economy could do no wrong during the last decade, Wall Street and Main Street have been oversold, especially with respect to securitized single-family residential debt products, or subprime loans. In fact, the housing market was overleveraged more than anyone realized, or even suspected, relative to the fundamental values of the underlying residential assets.
According to Jack Cohen, CEO of Cohen Financial, a leading commercial real estate investment bank, a massive real estate resetting and de-leveraging is occurring during this first quarter of 2008. Some say it is due directly to sub-prime and single family housing troubles. Mr. Cohen says this is not entirely true. The commercial and residential markets are not linked but for three items: 1) space demand is linked by the health of the economy; 2) lending is linked through the capital markets; and, 3) bond pricing is linked through the investor base (supporting the capital markets). Otherwise, no other links exist. Commercial and residential issues are not at all intertwined. "None of the flaws in the sub-prime business model are remotely present in the commercial real estate lending business. To the contrary, the strengths of the commercial real estate lending business model were not present in the sub-prime business model," stated Cohen.
As the residential market's weakness increased in 2007, the commercial real estate market reached its pinnacle to date, with mega multi-billion portfolio deals such as the Blackstone Group and Equity Office Properties (EOP) Trust transaction. When the cracks in the foundation of the credit markets appeared as a result of the subprime mortgage market meltdown, the commercial real estate market took notice and quickly inventoried its own aggressive dealings and pricing during the past five years. Risk aversion quaked throughout the world's credit markets, resulting in the Federal Reserve pumping liquidity into the financial markets and dropping the federal funds rate. The world and domestic commercial real estate investors prepared for new terrain.
The Federal Reserve created the perfect environment and many lenders detached risk from reward in a market where more money was made securitizing the loans rather than holding them. Demand for securitized loans forced lenders to sacrifice underwriting standards and reengineer loan products such as interest-only loans and low or no debt-service coverage requirements. Financing at all levels of the capital stack created more asset demand. Cap-rate compression happened quickly, falling from 11% in 1995 on average to 6.29% in June 2007. Without leverage, investors would demand a higher return.
In the wider marketplace, the subprime debacle has ensnared some of the biggest institutions on Wall Street. Write-downs at Merrill Lynch totaled $22 billion by mid-January, and Citigroup wrote off $20 billion. Citigroup Chairman Charles Prince and Merrill Lynch CEO Stan O'Neal resigned. Even mortgage financiers Freddie Mac and Fannie Mae, stalwarts of the secondary mortgage market, face potential write-downs of $16 billion for the fourth quarter of 2007 because of flawed subprime loans and other investments.
The threat of recession is also taking a toll on the market, further shaking the confidence of bond buyers and sellers. The Federal Reserve's startling, 75 basis point cut in interest rates on Jan. 22 - the largest reduction in more than two decades - quieted turbulent stock markets momentarily, but raised new questions.
"While it's meant to stabilize things, that to me are going to make people more nervous," says Kim Diamond, managing director at Standard & Poor's, since it signals the Fed's deep concern over the economy. "A 75 basis point cut off-cycle is pretty extreme."
Despite a slowdown in 2007's growth rate, the U.S. economy remains resilient beyond most expectations - but that is what keeps market nerves on edge while providing a much-needed stable market influence. Fortunately the global economy is on solid footing and is expected to grow at a faster pace, helping the U.S. weather this slow domestic economic picture.
For borrowers, the call to action is to proceed cautiously and creatively, rather than sit on the sidelines. Forget about an attempt to convince a lender to be "aggressive" or "creative" when financing your next real estate deal. Banks have gone back to basics - solid fundamentals, and nothing less will do.
Although inflation pressures probably will continue in 2008, the Federal Reserve has shown its willingness to accommodate the markets by lowering interest rates and injecting liquidity into the economy to help avoid a recession. Unemployment remains low, but with the continuing housing slump and high energy prices, consumer spending and job growth may slow. Strong employment will favor commercial real estate, keeping vacancies low and providing the necessary support for investment earnings. However, geographic differences in commercial investment markets will play a pivotal role, as some U.S. regions have seen variations in their local economies.
Unstable financial market realities favor commercial real estate. As the financial markets become riskier and less attractive, commercial real estate - as long as it holds its own - becomes more attractive on a relative basis. It does not mean that prices continue to climb, but commercial real estate does maintain a more attractive position relative to stocks and bonds . With average yield rates on commercial real estate investments still higher than those for many other investment alternatives, commercial real estate likely will continue to be a preferred investment vehicle from a risk-adjusted basis. For example, National apartment fundamentals were strong during 2007, thanks to a great deal of help from the subprime lending fallout in the residential market. However, supply may begin to outpace demand, as unsold houses are rented and units slated for condominium conversion re-enter the market as rental units.
With continuing strength in overall commercial real estate fundamentals, it is no surprise that capital still is flowing into the market. However, the amount of funds has slowed, especially highly leveraged debt, and likely will continue to decrease this year. This trend will continue to affect asset pricing, working to move prices below the record-setting levels of the past year. This slow but steady downward movement should help to calm fears of overpricing in some markets.
Although we view debt capital as tightening the hatch and clearly as more discriminating and volatile, there is still an ample amount of debt capital to support the right level of financial leverage for commercial real estate. Further, there is plenty of equity capital from both domestic and foreign sources that is inclined to invest in commercial real estate.
2008: Markets to Watch
The following list of top 10 markets by property type is based on RERC's price/value analysis, which utilizes RERC's valuation expertise, market knowledge, and financial modeling capabilities to identify these markets.
Office Industrial Retail Multifamily
Salt Lake City Kansas City, KS Los Angeles Portland, OR
Austin, TX Sacramento Baltimore Austin, TX
Sacramento Seattle Minneapolis San Antonio
New York Dallas Cleveland Chicago
Cleveland San Diego Charlotte, NC Washington, DC
San Francisco Houston Philadelphia Norfolk, VA
Los Angeles Cleveland San Antonio Seattle
Seattle St. Louis Las Vegas Charlotte, NC
Denver Minneapolis Miami Denver
Portland, OR Los Angeles Sacramento, CA New York
Despite the psychological drama of the credit crunch - from tightening underwriting standards to the global stock market plunge on Jan. 21 - plenty of capital is still available for deals in the $20 million to $30 million range, the core industry size, brokers say. However, overleveraged property investors undoubtedly will face loan defaults, workouts or foreclosures. This is the downside of overleveraging assets in a cyclical business, which forces property owners to go through a detoxification process so that the lending cycle can begin anew.
Industry confidence can be regained if fear doesn't overtake rational decision-making. "We can talk ourselves into recession. If we continue to terrify ourselves, and let this drag out, then it's going to become a self-fulfilling prophecy," said Randy Reef, senior managing director of Bear Stearns, at the CMSA conference in Miami. The CMBS market was overheated and poised for a reversal, but losses can be kept tolerable, he maintains.
Many echo the thoughts of Jack Cohen, of Cohen Financial in that the industry doesn't need new or more capital. Rather, in 2008 we need old capital confident enough to invest. This is only possible if everyone stops pining for the easy lending days of 2006 and the first half of 2007 and accepts the new world we live in for what it really is-good for business! The dislocation of capital happened for technical reasons; let's not make this worse by eroding commercial real estate fundamentals. Accepting the shift is the fastest path to a new foundation of wealth creation. Capital is still plentiful for deals that make sense and real estate investment banks like Cohen Financial are still able to finance deals and provide capital for those buyers and sellers who realize the market is still full of opportunities.
About the Author
Rob E. Lee, M.B.A., CCIM
Senior Associate of Investment Properties for Colliers International's Private Capital Advisors Group in Los Angeles and is currently serving as the President for the Greater Southern California CCIM Chapter. He can be reached at Robert.Lee@Colliers.com or (310) 787-1000. He is a 2006 alumnus from the Graziadio School of Business and Management.
Subscribe to:
Posts (Atom)