Is the lending faucet beginning to open?

According to a story in today's Wall Street Journal (via MarketWatch.com), the lending faucet may be finally squeaking open -- at least for certain commercial real estate projects. From the article:

An influx of fresh capital into U.S. commercial real estate is bringing some long-stalled development projects back to life and launching new construction of apartments, office buildings and shopping centers.

The moves show that the industry, in a deep slump just a year ago, has entered recovery mode—at least in the nation's largest and healthiest markets. Analysts say the improved economy is giving rise to pockets of demand for new commercial space, while low yields on other investments prompt investors to seek higher returns in real estate...

Of course, the U.S. still is dotted with thousands of stalled construction sites, ranging from struggling apartment projects on the Brooklyn, N.Y., waterfront to shells of buildings in suburban Sacramento, Calif. And it will take years to replace more than two million construction jobs, or about 30% of the 2006 peak, lost since the real-estate bubble popped...

But office buildings and other projects could help cushion the U.S. economy if public-sector building declines, as expected, due to government budget cuts and waning economic-stimulus aid...

Click here for entire article.

Why that bomb in the commercial markets keeps on ticking...

For months now we keep hearing about this impending train wreck in the commercial real estate market. According to a story at CNN.com, however, banks have already recognized about 50% of their potential losses, meaning this is a train wreck that's already in motion -- albeit quietly. From the story:

Banks have already recognized about $50 billion in losses, or about 60% of the estimated cumulative losses, according to real estate research firm Foresight Analytics.

And despite a steep drop in the price of apartments, office buildings and industrial properties nationwide over the past year, there have been recent indicators to suggest that the market may have finally hit bottom.

After 13 months of consecutive declines, overall commercial property values climbed 1%, according to the most recent monthly reading by Moody's/REAL Commercial Property Price Index...

Unfortunately, the consensus is that neither prices nor occupancy rates will improve anytime soon.

Estimates published last November by the Urban Land Institute and PricewaterhouseCoopers suggest that commercial real estate vacancies will continue to increase in 2010, while prices could tumble further during the year. Prices could fall as low as half their peak levels from 2007.

If that happens, that would only darken borrowers' hopes that banks will refinance their outstanding loans. And some $1.4 trillion is commercial real estate debt is expected to come due over the next three years.

Matt Anderson, partner at Foresight Analytics, said that can mean only one thing for banks: more losses...

Commercial loan losses starting to escalate

Given the huge job losses and the retailing brands going out of business, it's little surprise that commercial real estate landlords would be taking a hit. And how that damage seems to be escalating. So what will 2009 look like for them? From a story in the Wall Street Journal:

The delinquency rate on about $700 billion in securitized loans backed by office buildings, hotels, stores and other investment property has more than doubled since September to 1.8% this month, according to data provided to The Wall Street Journal by Deutsche Bank AG. While that's low compared with the home-mortgage delinquency rate, it's just short of the highest rate during the last downturn early this decade...

Some experts say it now looks as if the current commercial real-estate slump will rival or even exceed the one in the early 1990s, when bad commercial-property debt played a big role in dragging the economy into a recession. Then, close to 1,000 U.S. banks and savings institutions failed. Lenders took about $48.5 billion in charges on commercial real-estate debt between 1990 and 1995, representing 7.9% of such debt outstanding.

Since late 2007, a total of 47 banks and savings institutions have failed, of which a dozen or so had unusually high commercial-mortgage exposure. Foresight Analytics in Oakland, Calif., estimates the U.S. banking sector could suffer as much as $250 billion in commercial real-estate losses in this downturn. The research firm projects that more than 700 banks could fail as a result of their exposure to commercial real estate.

Commercial property may not be hit as hard as many fear if the economy pulls out of recession more quickly, driving up rents and occupancy rates. And greater availability of financing -- a key goal of the Obama administration -- could lift property values...

Commercial real-estate debt is potentially more dangerous to the financial system than debt classes such as credit cards and student loans because of its size. The Real Estate Roundtable, a trade group, estimates that commercial real estate in the U.S. is worth $6.5 trillion and financed by about $3.1 trillion in debt. Partly because the commercial real-estate debt market is nearly three times as big now as in the early 1990s, potential losses in dollar terms loom larger...

Click here for full story.

Say goodbye to mezzanine debt

Over the last decade, a type of debt for development projects called 'mezzanine' -- which filled in the financial hole between a borrower's equity and the first mortgage -- was responsible for funding many residential and commercial development projects. But given the high default rates in the commercial sector, 'mezz' has become a four-letter word and may not return for a long time. From a Wall Street Journal story:

Firms made an estimated $50 billion to $75 billion in mezzanine -- dubbed "mezz" -- loans, debt that fills the gap between the borrower's equity and the first mortgage. Billions of dollars already have been lost and the figure is likely to balloon as the steep downturn in the commercial-property market deepens.

The losses are sending shock waves through the rough-and-tumble world of office buildings, shopping centers, hotels and other commercial properties, which are only now facing the full brunt of the recession. Mezz debt was one of the biggest culprits that enabled commercial real-estate investors and developers to participate in the broader speculative binge on Wall Street...

The attraction of mezz debt to investors was twofold: the rate of return on such debt -- once levered up -- was in the teens if the borrower kept current and, if the borrower defaulted, the investor in the debt would have the right to take over the property...

But that strategy isn't working in many cases because properties are no longer generating enough cash to cover the first mortgages, much less the mezz debt. For the mezz investors to take over the property, they would have to reach into their own pockets to pay debt service on the first mortgage...

Most recently, borrowers have begun to default on mezz loans, forcing the mezz investors to try to foreclose. But this isn't easy even in cases in which the mezzanine holders believe their position is worth something. Often the mezz debt is broken up into slices with different degrees of risk and claims on the property.

Also, for the mezz holders to take over the property, they often have to pay what is owed or refinance the first mortgage, a difficult feat in this credit-starved environment...

Click here for full story.

Commercial developers joining the bailout crowd

Due to an inability to refinance loans for commercial property developments (which generally run for well less than 10 years and must be rolled over) and reduced income from higher vacancy rates and lower retail sales, developers are asking to be included as part of a federal rescue plan. From a Wall Street Journal story:.

With a record amount of commercial real-estate debt coming due, some of the country's biggest property developers have become the latest to go hat-in-hand to the government for assistance.

They're warning policymakers that thousands of office complexes, hotels, shopping centers and other commercial buildings are headed into defaults, foreclosures and bankruptcies. The reason: according to research firm Foresight Analytics LCC, $530 billion of commercial mortgages will be coming due for refinancing in the next three years -- with about $160 billion maturing in the next year. Credit, meanwhile, is practically nonexistent and cash flows from commercial property are siphoning off.

Unlike home loans, which borrowers repay after a set period of time, commercial mortgages usually are underwritten for five, seven or 10 years with big payments due at the end. At that point, they typically need to be refinanced. A borrower's inability to refinance could force it to give up the property to the lender.

Click here for full story.

Falling consumer confidence now having an impact on all real estate sectors

It looks like the retail and commercial office sectors of the real estate industry are about to join the funeral dirge that has been the housing market over the last 18 months. So when will each of these sectors revive? From a BuilderOnline.com story:

Another cascade of business bankruptcies in the housing, retail and commercial real estate sectors could happen during the next six to 12 months if consumers' confidence doesn't improve soon, both in terms of the economy and their personal finances.

However, the likelihood of that happening appears slim, based on the dismal assessment of current and future market conditions by three real estate experts during an hour-long teleconference yesterday presented by the American Bankruptcy Institute.

“Asset and price recovery are several years away” for the housing industry, predicts Rebecca Roof, a managing director with the New York-based business advisory firm AlixPartners. During her comments, Roof dredged up the usual suspects behind housing’s deterioration (price appreciation, overbuilding, lax mortgage underwriting), and added another co-conspirator: consumer confidence, or lack thereof...

Consequently, she says, many builders “are just trying to find enough cash to make it” through the downturn, which is why when builders finally decide to file for creditor protection under Chapter 11, “they are really at the point of liquidation." And with so many banks having their own financial and corporate problems, she says “it’s hard to get their attention” to renegotiate debt or new financing...

All three panelists don’t see much immediate improvement for their respective spheres of influence. “Home building is going to be a very tough, wounded sector for many months to come,” says Roof. “We have not seen the bottom yet, and if consumer confidence continues to erode, home building will not enjoy its traditional spring rebound.”

While she doesn’t expect any sustainable recovery for the next 24 to 36 months, Roof says builders’ survival will be contingent on realistic sales projections and asset valuations. “They will need good, early communication with lenders before they trip a covenant, and they need to make sure that all available cost reductions are made in ways that protect banks’ value....

“Home builders will be able to wait out [the recession] if they can negotiate forbearance with lenders,” says Roof. However, she also thinks that “a lot” of small builders will eventually liquidate, which would open the doors for developers with cash to pick up land bargains.

Economic downturn now hitting hotel properties

With 363 locations, you've probably seen the signs for "Extended Stay" hotels along various freeways. But with the chain highly leveraged (no surprise there) and the economic downturn impacting hotel properties (especially over the last two months), management is now talking about simply handing the keys back to the lenders. "Hotel jingle mail," anyone? From a Wall Street Journal story:

Extended Stay Hotels Inc. is in early talks that could result in turning the hotel chain over to its lenders, a sign of the deep trouble awaiting the commercial real-estate business.

Extended Stay's difficulties signal a new phase of distress in commercial real estate, because they arise directly from the weakening economy. Until now, problems have mostly involved developers unable to obtain refinancing for otherwise healthy operations...

As conditions deteriorate, Extended Stay has been forced into discussions with its lenders, and people involved in the talks say a transfer of ownership could come within a month or two. Extended Stay has recently hired Lazard Ltd. as financial adviser and New York law firm Weil Gotshal & Manges as bankruptcy counsel.

One wrinkle in negotiations is that Extended Stay isn't likely to file for bankruptcy protection, because of provisions common in commercial mortgage-backed securities deals that would expose more properties of its founder, David Lichtenstein. A more likely path is for Mr. Lichtenstein to turn Extended Stay directly over to lenders or to swap enough equity for debt to give bondholders control of the company.

Click here for full story.

Although San Francisco California's strongest economy, home prices still falling

According to a conference on October 21st at the Hyatt Regency in San Francisco (for which MetroIntelligence authored the real estate sections), the region's economy remains the strongest in the state and is not expected to experience a repeat of the tech-related bust earlier in the decade. Although home prices in the City of San Francisco are not expected to decline as other parts of the state, the neighboring counties of San Mateo and Marin are projected to suffer some additional pain through 2009. From a story in the San Francisco Chronicle:

Home prices and taxable sales will fall in the San Francisco metropolitan area while rents rise and unemployment climbs.

But the 1.8 million residents of Marin, San Mateo and San Francisco counties still live in California's strongest economic region and should suffer less from the housing bust than the rest of California, says a forecast being issued Tuesday. "Things will be rough here, but not nearly as rough as the Inland Empire (in Southern California) or in Contra Costa County," said Chris Thornberg with Beacon Economics...

The 113-page report calls the three-county metropolitan area "the strongest economy in the state of California at the moment," but warns that it still will be hurt by the housing collapse that has crippled the global financial system and undermined the world economy.

The forecast tries to predict economic conditions in the three-county zone through the first quarter of 2010 and suggests that:

-- Home prices will fall roughly 25 percent from their peak.

-- Taxable sales will drop by 10 percent across the region.

-- Payrolls will shrink by 2.5 percent over the next two years.

-- Rental rates are likely to continue to rise, particularly in San Francisco, where 60 percent of households are renters...

Economic softness is expected to hit commercial real estate, which had begun to recover from the dot-com bust. But the forecast assumes that the region's prestige and proximity to Silicon Valley will merely slow the growth of rental rates in the metropolitan area - put at 11 percent last year - rather than lead to a collapse.

"Rent growth is expected to fall to just 1 percent over the next year, although over a five-year horizon it should average a more moderate 3.5 percent in the region," according to the forecast.

But individual renters will get no such relief as the region's relative economic strength and desirable lifestyle draws job seekers and shrinks the vacancy rate which, at about 4.3 percent, is among the lowest in the state. "Over the last two years, average asking rents have continued to rise," noted the report, which expects the landlords' market to continue for now.

Click here for full story.

If you missed the conference, you can still download the book and the presentations here:

• San Francisco Economic Forecast Book (PDF - 39M)
• Christopher Thornberg Presentation (PDF)
• Jon Haveman Presentation (PDF)
• Fred Silva Presentation (PDF)
• Event Agenda (PDF)
• Speakers' Bios (PDF)

Commercial property market following residential market trends

From the Wall Street Journal:

The next shoe? After years of plunging residential property valuations, commercial real estate is heading into the danger zone as office vacancies rise, stores close and hotel bookings fall.

This could mean another body blow to already struggling financial institutions. Alan Todd, head of research on commercial-mortgage-backed bonds at J.P. Morgan Securities, projects commercial-property losses of as much as $250 billion over the next 10 years, or about 7% of the $3.4 trillion outstanding debt. That would rival the roughly 9% cumulative loss rate during the real-estate carnage of the early 1990s.

Commercial real-estate values have fallen since the beginning of the credit crunch, by as much as 20%, due to more expensive and less available financing. Financial institutions have already taken more than $15 billion in commercial property-related write-downs this year.

There are bullish points. Unlike the early 1990s, the commercial market hasn't suffered years of overbuilding. Defaults on commercial real-estate debt remain less than 1%, compared with more than 10% at the worst point of that earlier collapse. Rents and vacancy rates have so far remained solid, enabling most properties to pay their debt service...

Click here for full story.

Commercial real estate sector now also feeling the pinch

For months there's been a debate brewing about if, when and how much commercial property values would plummet due to softening economic fundamentals and the drying of up credit. A story in the Wall Street Journal reviews:

For the commercial-real-estate players that were in hot water before the capital-markets crisis of the past two weeks, the temperature is rising...

After these and other market crises, cash-flow projections for properties are being scaled back in anticipation of a greater economic slowdown. The sales market -- long considered the last hope of many distressed players -- has virtually ground to a halt.

Even creditors that were willing to make real-estate loans before the upheaval are pulling back, having witnessed the spectacle of some of the biggest names in finance and banking vanishing in a period of days...

To be sure, commercial real estate so far has fared better than residential properties. Many office buildings, shopping centers, warehouses and other income-producing properties are generating enough cash to pay their debt, and their default rates remain low.

Nevertheless, values have fallen because of the credit crisis and economic uncertainty, which is in particular creating headaches for investors who bought at the top of the market with short-term debt. Financial institutions holding mortgages backed by commercial real estate have suffered tens of billions of dollars in losses and face more.

In the long run, liquidity might be restored to the market by the government's proposed $700 billion financial-bailout plan, which partly involves buying troubled commercial-real-estate debt. But many institutions may be reluctant to accept the government's price if steep discounts are required because the underlying real estate may still be performing well...

In the near term, commercial-real-estate markets have been particularly devastated by the bankruptcy of Lehman Brothers. The firm owned more than $32 billion of debt and equity assets -- running from land in California to apartment buildings in Boston -- that will now be liquidated, putting downward pressure on prices.

Complicating things further, Lehman pledged many of its real-estate assets as collateral on loans for desperately needed cash in the days before it collapsed. For example, Swedbank AB, a Swedish bank, was left holding 70 commercial loans valued at $1.35 billion, which were backed by properties including partially built developments. It is unclear if Swedbank will fund the balances to keep construction going.

The financial crisis of the past few weeks also has hurt the economic outlook for many properties, particularly office buildings in New York and other financial centers.

In a worst-case scenario, in the New York region, vacancy will hit 19% by 2011 and values will scale back over 13% through 2009, according to a projection scheduled to be released Wednesday by Property & Portfolio Research Inc...

Richard Coppola, managing director of commercial-mortgage investments for TIAA-CREF, the largest U.S. retirement system, predicts lending costs will rise. "We want to make sure that we're compensated for the risk we take on over the long term," he says.