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Dean Hurley , SVP
Capital Markets Group
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State of the Commercial Real Estate Lending Markets
Like most things in this market, MIAC is seeing a mixed bag of data regarding what is happening in the market and what may happen in the near future.
If you want a good gauge on where the demand for commercial real estate is going, just look at employment data. Forget the unemployment rate, it has been corrupted by politicization. Clinton fixed that by dropping those seeking work . Job levels and jobs creation tells the real story. This is because so much in our economy is dependent on the number of jobs in the economy. We tend to look more at the US Employment Situation Report.
This is because companies needing to downsize look for less office and industrial space, not more. The story is the same in the world of multifamily properties: if people are afraid of losing jobs or of not getting one, they don’t move out from space with mom and dad, or upgrade from one bedroom apartments to two bedroom apartments.
THE BAD NEWS . . .
Business Insider runs a chart every month when the jobs data comes out. It compares the current level of the jobs inventory as a percentage of the peak employment level just prior to each recession since 1948. The story is the ugliest one on record.
Add to this picture the continuing possibility of a double-dip recession, the Fed scrambling to find ways to become more accommodative with target rates near zero (and all those funds created by buying securities sitting in reserves), declining consumer confidence and the bull market in stocks now over on Wall Street (the S&P “gapped” in mid-September and is now showing a declining trend despite the recent October upticks) and you have a recipe for more declines in real estate prices.
Why is this happening? We all see many reasons. Some blame the politicians past or present, or the regulators or events in Europe and China. But when the potential causes are all evaluated, it comes down to one thing: we have a climate of continuing uncertainty. No one expects their taxes to be lower in a year. There is business uncertainty over the changing accounting and regulatory environments. Cap and Trade remains on the horizon. Individuals and businesses remain uncertain about the future costs of health care and health insurance.
Other measures of the current trend abound. One that we follow closely is the Moody’s/REAL CPPI. The latest data is as of July. As Dr. Sam Chandan of Real Capital Analytics points out in a recent article, the index fell 4% then, its first decline in same-property sales prices since March. The CPPI index as of June was 4.2% below the last low in October 2009 and is 41.4% below its October 2007 peak. CPPI declined a further 3.1% in July.
Chandan cautions that the share of distressed transactions has been increasing over the last 18 months and is creating downward pressure on the overall CPPI index of same-property prices. We note the point that non-distressed property sales have not weakened anywhere near as severely as the overall measure shows (see the graph).
THE GOOD NEWS – SORT OF . . .
There is good news. According to the MBA's Quarterly Survey of Commercial / Multifamily Mortgage Bankers Originations, a sharp increase in loan originations by conduit lenders and insurance companies pushed the index up slightly (1%) against where it was for the 2nd quarter a year ago and up significantly (35%) over where it was in the first quarter.
The general economic uncertainty has a silver lining: increased institutional interest in commercial real estate as a means of diversifying risk according to a survey done by Real Estate Research Corp. This interest is occurring even though survey participants believed that a sustainable recovery and jobs gains would not occur for at least nine months. Although IPCRE lags the economy, the fact that occupancy is up slightly from 1Q 2010 implies that we should be at or near the bottom. The current 18% national office vacancy rate in the second quarter (according to Robert Bach of Grubb & Ellis) is the highest since the third quarter of 1991. Asking rents are expected to continue declining into 2011. In short, savvy institutional investors are concluding that now is the time to get in at the bottom.
Other good news includes a drop in the volume of loans in special servicing, which fell in July for the first time in two years to $88 billion from $88.4 billion according to Realpoint. Because the overall CMBS universe also shrunk, the percentage of loans in special servicing increased from 12.69% in June to 12.75% in July. Fitch predicts that by the end of 2010 about $1,110 billion in loans, or about 15% of all CMBS loans, will be in special servicing. Some of this decline was due to the sale of about $1 billion of small-balance loans to investors including Deutsche Bank and Bayview Capital. For those of us who maintain optimism, the story is like the rest of the market, a mixed bag of good and bad which we expect to continue into 2012 and beyond.
According to Commercial Mortgage Alert, a pipeline of commercial MBS transactions is in place. There are five U.S. deals totaling $6.9 billion in the queue to price and close over the last three months of the year. The tables below show the expected offerings:
Upcoming Deals
Deal pricings continue to show good levels. The tables below show the recent JP Morgan Chase / Centro Properties pricing of a 72 retail property deal and the JP Morgan Chase 2010-C2 mixed-type deal (62% retail, 16.5% office, 10.3% industrial and 5.3% mixed use) of 30 loans on 47 properties.
Previously, Vornado’s CMBS offering of retail properties priced August 10 at higher levels than dealers expected. This reflected investor confidence in the underlying collateral and the structure of the transaction. The table below shows the recent pricing of that deal.
Impact on Commercial Loan Values:
On the whole loan and property side, MIAC continues to see evidence that more bidders are entering the market on asset sales. To date, this has not had a pronounced impact on prices because the assets are usually impaired by the large drop in underlying collateral values since the assets were originated. But the influx of capital that had largely been on the sidelines is a positive indicator that more players have judged – for now - the worst seems to be passed, even if the economy faces a double-dip. This has sparked a relative wave of selling as compared to the sales levels of the past two years.
As with everything these days, this isn’t a perfect picture. We note that BB&T pulled a $1 billion sale from the market on August 18 that was being offered through First Financial Network of Oklahoma City, a highly unusual event. The package consisted of a broad mix of collateral types. While all the loans in the BB&T package are considered distressed, many are performing, and some may face upcoming maturities. The average size of the loans was $2.5 million. We also note the just-completed sale of roughly $230 million of debt sold by Anglo Irish Bank that is backed by two Manhattan hotels for $180 million. Alexico Group owns the Alex on East 45th Street and the Flatotel on West 52nd Street. It also owns another Manhattan hotel, the Mark Hotel at 25 E. 77th St., which backs another $270 million of debt from Anglo Irish. This pricing is broadly consistent with the levels we see underlying properties selling at in New York City. Another seller, ProLogis, is reportedly close to selling a portfolio of 180 industrial properties to Blackstone Group for roughly $1 billion.
While sale prices are often not disclosed, the recent property cash flows provide the clues pointing to deep discounts on many of these sales. An example is the purchase by a Fidelity Real Estate Group and Hotel Asset Value Enhancement venture fund of the 231 room full service Northland Inn in Brooklyn Park, MN, which was built in 2001 and has some of the largest meeting space in Minnesota. The deal was securitized in 2006 by Credit Suisse’s unit Column Financial with a $20.5 million loan amount, and had $2.6 million of net cash flow then. In 2008, servicer reports showed it only had $665,000 of net cash flow. Last February, the hotel was appraised at only $2.5 million according to Realpoint.
Perhaps another way to look at the recent entry of new bidders is this: Two years after raising $100 million for an investment fund targeting retail properties from distressed sellers in East Coast markets, Hutensky Capital Partners funded its first deals. The reason? They state that they have not seen the right deals until recently. The fund management at Hutensky has been operating since the 1980s, and is experienced at making poor performing worn properties perform well while partnering with existing owners. They aren’t newbies who don’t know how to find the right deals. That, and similar stories we hear, tells MIAC that market conditions are changing.
One more positive item: More loan originators are entering the market – not a move to be taken lightly if you don’t believe you can write new loans and not have values fall out from under you post-closing. On August 18, Cantor Fitzgerald and CIM Group LLC announced that they are forming Cantor Commercial Real Estate, which will write fixed- and floating-rate mortgages and engage in the CMBS securitization of those loans. On September 28 Principal Real Estate Investors announced that it will return to originating loans for securitization, with Wells for now. In 2007, Principal contributed $5.2 billion of loans to 12 securitizations under the PWR, TOP and IQ shelf registrations led by Morgan Stanley and Bear Stearns. Each of these deals also included deals contributed by Wells.
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