Will commercial real estate values cause another wave of bank failures? Are we heading into a deepening recession or depression? Should I jump in and buy now?
I have been struggling to come up with definitive answers to these questions as the pace of change has created a very tumultuous environment.
I was convinced, as recently as two months ago, that there will be a major collapse of commercial property values. To date it seems that the drop is manageable as CAP rates have risen from sub 6 to over 8 on good quality properties.
We continue to assume falling rents and rising vacancies in our analysis models of commercial deals and loan requests. Perhaps the impact of the residential bloodbath was so severe that it caused a massive reaction by the FED and thus has made the commercial loan impact less of a concern at this time.
Investors and lenders have been forced to focus on their residential portfolios and this distraction has caused them to back off on enforcing their rights when commercial loans are defaulting. We need to comprehend that the volume of commercial loan debt is less than one-third of its residential counterpart. This may make it possible that the bad debt can be absorbed by our economy without the catastrophic impact many fear. This becomes even more likely if the economy actually is growing and the recession is declared at an end.
My belief is that there will be many more bank failures ahead, especially on the regional level. The most likely candidates are those lenders who have a portfolio of loans originated in 2003-2007. For those lenders, as with private individuals, the difference between a recession and a depression is whether it is you or your neighbor. In the private sector, if your neighbor loses a job, it is a recession; if you are losing your job, it’s a depression. For a public financial institution, depression starts when regulators come in and ask questions about the portfolio’s health and valuation- it is at this point that jobs are on the line.
I still sit on the fence thinking things may improve because I have seen, first hand, how many investors with capital are beginning to jump in on any real opportunity. One recent example was a bank sale of an apartment community being liquidated on an all cash basis for a $10mm opening bid. There was a 5 day window to bid- 35 bidders qualified with proof of funds during that short period. I am always working with our institutional partners and I have seen how little attention an “all-cash” and “quick closing” offer gets because many sellers are well aware that the money is readily available.
I recently read that at an Expo in Munich, Germany, there was overwhelming interest by European investors to jump in on the US Real Estate discounts. In the 2008 Expo there was very little attendance and no interest for those exhibiting. Our international relationships have also surfaced and are now requesting that we bring them deals to partner on. There is no question that the aggressive focus is on distressed assets only. However, earlier in the year this was not the case as people were looking for blood.
Now looking over to the other side of the fence, there are plenty of clear indicators and opinions that we are only in the 3rd inning of the value declines and that the worst is just around the corner.
The following are some of the key considerations:
- During the next 15 months approximately $2 trillion of commercial mortgages will be maturing
- Between April and August 09, the value of commercial loans placed in “special servicing” doubled to $50 Billion
- Office and retail vacancies are soaring
- Rents are declining in all sectors
- Flow of new credit remains very tight
- In recent years large project loans have been broken up into layers of securities and if they go bad they will have a very wide impact
- Many projects are standing in various stages of completion and will take months of recovery to justify their completion
- Mark to Market has not been enforced and many lenders are reluctant to reduce values
The market can be kept afloat by the willingness of lenders and the Fed to do modifications, etc. and “extend and pretend”. The idea behind this is to put it off for a later date and not bite the bullet today. Many will argue that things cannot actually improve unless the bad debt is dealt with now and taken out of the system. The prolonged down market is caused by the band-aid approach. The jury is out on this theory.
In summation, I do not feel like we need to jump into deals due to a fear that the “Ship of Opportunities” will sail away if we don’t. However, I must admit that the anchor may be close to being pulled up making us more aggressive in pursuit of investment opportunities in the very near future.
“Still on the fence- but looking for a soft spot to land”. Decisions, Decisions, Decisions.
Gil Priel
Managing Director
Peak Corporate Network
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