July 2009 Newsletter

 


Headlines:

Real Estate May Not Recover Until 2017

Here Come the Real Estate Vultures

Value of Commercial Real Estate is Back to 2004 Levels

Distressed Real Estate Tops $97B


Real Estate May Not Recover Until 2017

There is a bomb hidden in the commercial real estate market. Commercial properties--offices, hotels, malls--could suffer a wave of foreclosures like the one that hit the residential market last year. As tenants struggle to make rent, delinquencies are up, bringing down rents and values and hurting the already struggling secondhand market for mortgages that cover these properties.

Since 2007, commercial real estate values have dropped more than 40% nationwide, with retail sectors especially troubled. Rating agency Moody's, which uses different methods to calculate property values, says commercial real estate declined nationwide by 8.6% in April to levels last seen at the end of 2004.

While home foreclosures show some signs of leveling off, commercial delinquencies are rising between 0.3% and 0.5% a month. Anyone looking for a quick rebound in property prices and defaults is going to be disappointed. Issuance of commercial mortgage bonds peaked in 2007. Most CMBs are 10-year fixed-rate loans that mature in 2017, when a huge amount of debt comes due. Until then, though, landlords are facing a tough environment in which rents are slipping but opportunities to refinance are few. As a result, delinquencies, now just under 3%, will likely rise to 5% by the end of the year and could grow to as much as 9%.

Because commercial property tends to follow unemployment, it is estimated that property values won't turn around until 2012 and won't return to their 2007 peaks until at least 2017. The Federal Reserve said it expects unemployment numbers to turn around in three years. After that, the market should see gains. But there could be huge losses for investors and banks before that.

Several changes might come to the commercial property sector's rescue. The government could step in to boost refinancing or take the shaky loans off institutions' books. Many REITs are poised to acquire properties for half of what they would have paid in 2007. Any surge in buying could bring with it higher prices. Lastly, the dire need to refinance many loans means opportunity for investors willing to lend. If none of these come through, it could be a long, slow recovery.


Here Come the Real Estate Vultures

These are tempting times for real estate bargain hunters. Whether it is Tony’s house down the street, or office space at a deep discount, if you have the means, there are deals to be had. Individual investors snapping up foreclosed houses have helped boost home-sale figures sharply in recent months (although prices have remained depressed). And now some real estate investment trusts are raising money to fund acquisitions of distressed commercial properties.

Now some equity REITs with stronger balance sheets are looking to move from defense to offense, building billion-dollar war chests to fund acquisitions of troubled properties on the cheap. Indeed, if you believe that now is a once-in-a-generation opportunity to buy low in real estate, REITs allow you a way to bet on a rebound in the market without getting approval for financing and taking possession of a piece of property yourself.

And there seems to be no shortage of prospective purchases. There is an estimated $90 billion in commercial real estate in the U.S. alone that is distressed. These are properties that have been foreclosed on, or whose owners are in default on their loans or in bankruptcy. On top of those properties, there is hundreds of billions more in debt coming due in the next few years. Some REITs are getting prepared for that.

REITs have raised about $12 billion by issuing stock in recent months. The fact that they have the resources to exploit today's weak market may set them up for years of healthy cash flows. These are the commercial real estate companies that are going to survive. They all have balance sheets that are stronger than average and management teams that have proven their ability to take advantage of downturns.

And anyone who goes bargain hunting in real estate today has to be patient. REITs fell earlier and harder than the broader real estate market. In the two years from March 2007 to March 2009, REIT stocks fell a stunning 75% on average. Lately, however, REITs have been on a roll.Does this spurt mean that REITs are foreshadowing a sharp rise in real estate values? Some experts caution that there is more pain to come. Prices have gotten ahead of the fundamentals in real estate. It has gone too far, too fast and a correction is expected in the coming months.

 

Value of Commercial Real Estate is Back to 2004 Levels

Commercial real estate values have fallen to 2004 levels according to the newly released Moody's/REAL National All Property Type Aggregate Index.

Specifically, the index shows that, nationwide, the value of offices, apartments, hotels, warehouses and malls have dropped to September 2004 levels. The index hit 135.31 in April, down 8.6% from March and 25.3% from 2008.

Declines were steepest in the South, where industrial, office, retail and apartment properties all saw greater than 20% declines. In Southern California all four property types underperformed the western market as a whole -- but the office category was the worst performer with an annual value drop of 22.2%.

The report's authors say the numbers suggest that more owners are beginning to accept the decline in value. But sales are few and far in between because of the difficulties buyers face securing financing.

 

Distressed Real Estate Tops $97B

Distressed commercial real estate in the U.S. — including foreclosures, lender-owned properties and those headed in that direction — totaled $97.4 billion in early June, according to a new report.

Distressed commercial real estate volume has doubled every three months since December 2008, with retail properties representing the largest segment in June, at $29.7 billion.

Commercial mortgages had a 3.2 percent delinquency rate in the first quarter, up from 1.8 percent in the first quarter of 2008. The report also noted that the 12-month trailing delinquent unpaid balance of commercial mortgage backed securities rose by $12.5 billion to $17.1 billion in February.