Commercial Real Estate Market Correction

[Parsad]

As I mentioned in an earlier post a couple of weeks ago, one of our partners when renewing his commercial leases had to offer across the board 20% reductions in rent to his leasees.  Everyone he knew also had to do the same.  In the article below, it seems as though commercial real estate prices have fallen 27% year over year, and 36% from their peak.  Unlike residential real estate, I suspect the correction in commerical prices has not stabilized and will be significantly greater from the peak.  Cheers!

 

http://www.bloomberg.com/apps/news?pid=20601087&sid=aQ9I9q6Z0DaM

[valuecfa]

Shiller is referring to residential, but acknowledges the possibility of another housing bubble due to affordability:

 

http://www.nbcchicago.com/news/business/US_Housing_Market_Could_Be_Facing_Another_Bubble__Shiller-53697742.html

[jasonw1]

Any specific REIT company which is hurting really bad as described? HRP, which I follow, they don't seem to doing that bad:

 

"Occupancy and Leasing Results (excluding properties classified in discontinued operations):

 

As of June 30, 2009, 89.1% of HRP’s total square feet was leased, compared to 89.5% as of March 31, 2009 and 90.9% as of June 30, 2008.

 

HRP signed lease renewals for 992,000 square feet and new leases for 650,000 square feet during the quarter ended June 30, 2009, for weighted average rental rates that were 2% below prior rents for the same space. Average lease terms for leases signed during the second quarter of 2009 were 7.7 years. "

 

[arbitragr]

the real economy usually lags the market in pricing a correction so in terms of securities valuations, I think we've seen the worst.

However having said that, alot depends on where the commercial real estate is located.

Location location.

Commercial properties in places like Australia or Canada for example, where unemployment is only 5-6% (e.g. Sydney) and there are no supply issues, should recover and stabilize a lot sooner than in some parts of the US. What's more economic growth and demand, is tied to the resources/commodities industry so you'll get a pickup in demand much faster than in say, the UK.

alot of the destruction in stock prices of certain REITs in recent times has more to do with the extent of deleverging and covenant breaches, and thus ... the need to raise capital = fear of dilution.

[Guest Broxburnboy]

the real economy usually lags the market in pricing a correction so in terms of securities valuations, I think we've seen the worst.

 

 

Although this belief about the economy following the market is widespread, it is obviously a fallacy. The highest the S&P 500 ever got was just before the market meltdown.  If markets indicated the future, we should still be enjoying the most robust economy in history.

[dcollon]

I thought some of you might enjoy this Knowledge@Wharton discussing on real estate

 

http://knowledge.wharton.upenn.edu/article.cfm?articleid=2318

 

[gaf63]

Great article , thanks for the link.

One line of many stands out for me:

 

The truth is, you saw relatively few people with 100% of their own money making really dumb decisions -- in any of these. What you always see is a lot of people, with other people's money [making bad decisions], and an incentive structure [to further encourage those decisions].

 

Along the same lines, the FT had an intro the other day:

 

It has been said that congress spends money like a drunken sailor. However to be fair, at least the sailors are spending their "own"

money.

[arbitragr]

the real economy usually lags the market in pricing a correction so in terms of securities valuations, I think we've seen the worst.

 

 

Although this belief about the economy following the market is widespread, it is obviously a fallacy. The highest the S&P 500 ever got was just before the market meltdown.  If markets indicated the future, we should still be enjoying the most robust economy in history.

 

I like the logic your reasoning. i.e. "This belief is common, but it is obviously wrong."

 

Anyways, the market obviously over-shoots and under-shoots. So you just have to be astute enough to pick it off when it happens.

Obviously in 2007 it over shot, and probably now it's a bit frothy. Back in Q109, the bottom was priced, even though unemployment and the real economy was getting worse. It wasn't until July/August that we started seeing unemployment stabilize - if you had invested by then (i.e. now), you would have missed the boat. All the best bargains are gone now.

 

Re CRE, my personal opinion is that the bottom is priced in. But this is all top down stuff. It won't matter at all, in the end if you pick off the wrong companies.

 

[Guest kawikaho]

I met a guy the other day who inherited a street worth of commercial properties in San Jose, CA from his grandfather.  I asked him how they were doing.  He said it's real bad.  Over 50% delinquencies, with no prospects of turnover.  He will most likely have to idle vacancies if he can get eviction notices properly filed and sent.

 

 

[Parsad]

My aunt was in town here for my cousin's wedding.  She works for a hospital in Sacramento.  She said that her private hospital also was seeing significantly lower numbers of patients.  That hospital staff were having their hours cut from 5 days a week to 4 days.  I said in BC, hospital staff are offered more overtime shifts than they can handle! 

 

This is a pretty significant aspect of the unemployment numbers that are missing from the statistics we are provided every month.  There are numerous industries where workers have had their hours cut by 10, 20, 30 percent, yet are still regarded as employed by the economists.  For example, public service sector employees in California will have three rotating days off per month going forward to help balance the budget.  This is not unique, and I would expect many states and municipalities to be doing this, as tax revenues will be significantly lower for the next few years.  Cheers!

[Guest kawikaho]

Hah!  My wife works at a private hospital in Monterey as a respiratory supervisor.  She also has friends in Vancouver that work at BC General, I believe, and they are always busy.  Anyways, she just started a month ago, but already they're talking about having layoffs by next year.  The layoffs are planned and ready to go.  I was like, "WHAT??  WHY'D WE MOVE BACK HERE??"  Haha, well, we'll see how things go. 

[Zorrofan]

 

 

Although this belief about the economy following the market is widespread, it is obviously a fallacy. The highest the S&P 500 ever got was just before the market meltdown.  If markets indicated the future, we should still be enjoying the most robust economy in history.

 

I like the logic your reasoning. i.e. "This belief is common, but it is obviously wrong."

 

Anyways, the market obviously over-shoots and under-shoots. So you just have to be astute enough to pick it off when it happens.

Obviously in 2007 it over shot, and probably now it's a bit frothy. Back in Q109, the bottom was priced, even though unemployment and the real economy was getting worse. It wasn't until July/August that we started seeing unemployment stabilize - if you had invested by then (i.e. now), you would have missed the boat. All the best bargains are gone now.

 

My question is have we missed the bottom? If commercial real estate is the next shoe to drop it could turn the current rally into a bear rally...which is what I think this is anyways. There is still more deleveraging that needs to occur and once the stimulus package is spent then what? Comsumers are still deep in debt, unemployment is high, governments are also deep in debt...what is it Sanj called it? Green poop not green shoots? Interesting times though....

 

cheers Zorro

[Parsad]

I agree Zorro.  I have never read, seen, nor heard about any sort of deleveraging process of this magnitude, without it taking a significant amount of time.  Be it one year, two years, five years or ten years.  You can use various methods to prop it up, but the system will not function smoothly until it is completely cleansed. 

 

Think of it as the worst hangover in 70 years.  It doesn't matter how much gravol, home remedies, eggs & toast, or coffee you consume.  Until it works its way through your liver and out of your system, you can be sure you will continue to get headaches, nausea and a ringing ear for some time!  Cheers! 

[arbitragr]

My question is have we missed the bottom? If commercial real estate is the next shoe to drop it could turn the current rally into a bear rally...which is what I think this is anyways. There is still more deleveraging that needs to occur and once the stimulus package is spent then what? Comsumers are still deep in debt, unemployment is high, governments are also deep in debt...what is it Sanj called it? Green poop not green shoots? Interesting times though....

 

cheers Zorro

 

You sound like you're describing the US market. Perhaps maybe, but not all non-US governments are deep in debt, and not all consumers of different countries are deep in debt ... and might I add unemployment is not particularly high in other parts of the world. But this is, only relevant if you're considering CRE in other parts of the world.

[SharperDingaan]

 

Most would argue that we are only where we're at today because of the massive intervention. Its now > 6 months on, that intervention has now taken hold, & yet the greatest amount of stimulus in history can only only produce this? 

 

Commercial real-estate is rinky-dink, the US powder keg is municipal debt.

 

Worst case a few developers can't sell their buildings to repay their debt, & their funders can't afford the additional provisioning requirements that those fire-sales force upon them. At the end of the day the bankers get forced to roll the loans, and the whole problem dissappears.

 

But munis either have to legally balance their books, or borrow the new shortfall. And because of the rising risk, I will not lend without a fed guarantee - so the muni is going to cut its capital spending (buses, sewer, water, etc.) & cut its services (work 3 days/week, bare essentials, etc). 10-15% of the workforce working only a 3 1/2 day week (to cut benefits) & minimal capital spending is way, way more damaging.

 

Worse still is that even the fed has a finite borrow capacity, beyond which they no choice but to open the presses & introduce stagflation.

 

SD

 

[arbitragr]

This is all macro stuff however.

Bottom up, my view is that CRE stock prices have fallen far more than they should have, regardless of where the macro is heading. Prices are recovering now, though it may take a while before we get some optimism again, but the ones coming out of this better than most will be those stocks that have lower gearing levels with high quality assets whose values should hold up over the cycle.

[arbitragr]

the real economy usually lags the market in pricing a correction so in terms of securities valuations, I think we've seen the worst.

However having said that, alot depends on where the commercial real estate is located.

Location location.

Commercial properties in places like Australia or Canada for example, where unemployment is only 5-6% (e.g. Sydney) and there are no supply issues, should recover and stabilize a lot sooner than in some parts of the US. What's more economic growth and demand, is tied to the resources/commodities industry so you'll get a pickup in demand much faster than in say, the UK.

alot of the destruction in stock prices of certain REITs in recent times has more to do with the extent of deleverging and covenant breaches, and thus ... the need to raise capital = fear of dilution.

 

Oaktree looking to buy distressed real estate assets in Australia and Asia:

http://www.bloomberg.com/apps/news?pid=20601087&sid=aUzfNQQlf4Us

 

Oaktree is looking to buy distressed real-estate assets in Australia, China and South Korea.

Oaktree is set to acquire buildings in Sydney and other major Australian cities by the end of the year, he said, without giving details. It also is seeking investments in the securitized debt market and property trusts, Zulkoski said.

[bttmline]

The bleeding hasn't started yet on most of the private CRE owners. Rents and renewals just started falling about 6-9 months ago. Look for the next 2-3 quarters to be the test for some of the larger Reits as occupany goes from +/- 90% to low mid 80% and you will start to see the picture. CRE is so capital intensive that it becomes more about the financing then the underlying value sometimes. The pure size of some of the Reits and their debt rollover schedule were their biggest enemy. Here is a real simple example of the repricing going on right now. Cap rates going up 2% is over a 22% decline with rent staying even.

 

Net Rent/ NOI: $100,000 $100,000

Cap Rate:          7.00% 9.00%

Sale Price:    $1,428,571 $1,111,111

                             -22.22%

 

[arbitragr]

Buffet buying up Capmark with Leucadia.

Capmark is in the real estate finance business if I recall correctly.

[bttmline]

Capmark was the former commercial mortgage arm of GMAC that was bought by a group of PE firms.  News from today about Capmark/Berkshire and possible Chapter 11 http://www.bizjournals.com/philadelphia/stories/2009/08/31/daily41.html

 

Notes from last filing:

: On September 2, 2009, the Company and its wholly-owned subsidiaries, Capmark Finance Inc. and Capmark

Capital Inc. (collectively, the “Sellers”), entered into an Asset Put Agreement (the “Agreement”) with Berkadia III, LLC (the

“Purchaser”). The Purchaser is a newly formed entity owned by Berkshire Hathaway Inc. and Leucadia National Corporation.

The Agreement provides for a put option (the “Put Option”) whereby the Sellers have the right to sell to the Purchaser the

Sellers’ Mortgage Business and all assets primarily used in, or primarily related to, the Mortgage Business (collectively, the

“Acquired Assets”). The Sellers paid the Purchaser $40.0 million in cash for the Put Option.

 

http://www.capmark.com/CAPMARK/uploadedFiles/About_Us/Investor_Relations/Capmark%20Quarterly%20Report%20063009%20FINAL.pdf

[arbitragr]

Unlike residential real estate, I suspect the correction in commerical prices has not stabilized and will be significantly greater from the peak.  Cheers!

 

http://www.bloomberg.com/apps/news?pid=20601087&sid=aQ9I9q6Z0DaM

 

Unlike residential, CRE's downturn coincides with the Federal Reserve printing massive amounts of money.

Money printing --> filters through to banks --> banks lend out to, among other borrowers, CRE developers ---> CRE developers and investors buy real estate ---> asset prices get pushed up.

 

There is more liquidity right now, and in a liquid environment asset values get pushed up. I personally don't think it's going to be as bad.

[ShahKhezri]

Well, whether the downside in CRE is limited is not the question.  It's the repercussions, which to date have been minimal vs. residential.  In a situation where you can visualize a lower numerator (NOI) and a higher denominator (Cap Rates), it's not hard to consider maximum downside in equity.  I like simple math, and the math with CRE and where the implied cap rate based on current equity prices doesn't make sense. 

 

Thankfully, two weeks ago GS published a positive view on most CRE leaders, volatility was low, and puts were cheap. 

 

S.K.

[scorpioncapital]

The capmark deal has very little to do directly with CRE market, it is more a servicing business and probably will be in some sort of run-off with loss reserves rising. Future originations are going to be the bulk of the profits here.