Commercial Real Estate Blog

The Fed’s recent actions to help stabilize economic conditions are not impressing foreigner’s holding US debt instruments. The inflationary actions of the Fed have resulted in foreign buyers of US debt to essentially boycott government auctions for treasuries.

Over the past eight weeks, the share of foreign buyers participating in these auctions was somewhere around 25%. In last week’s auction, they represented only 5.8%.

Additional steps the Fed has taken or will take this week include bailing out Bear Stearns by essentially financing a JPMorgan takeover of Bear Stearns. The emergency overnight rate for bank’s was cut by 25 basis points, and in the Fed’s next meeting, they might cut interest rates by as much as seventy five basis points.

Unfortunately though, the Fed can only control short term rates. What the Fed cannot do is control long term rates and that is what will affect commercial real estate going forward. The current economic conditions, compounded by inflationary pressures and increasing long term rates does not bode well for holders of such real estate. What we see is people continuing to be bullish in certain market sectors, but it is hard to see how they envision that some sectors, such as Silicon Valley, will escape unscathed.

Time will tell who is right, but with a weakening dollar and thereby increasing commodity prices (for those priced in US Dollars), the effect will be felt in Silicon Valley. We are seeing some Venture Capitalists increasingly wary of their ability to raise any more money in this market and have become increasingly conservative in placing investments.

This has already and will continue to have an impact on the Silicon Valley Market.

NREI is reporting that in January, not a single CMBS was priced in a one-month period. This is the first time in the 20-years since CMBS product was introduced that this has happened.

Also telling is that despite this lack of activity, some $37B in securitizations remain in the pipeline. In the face of this prices have seemed to remain resilient. Longer term though, it is difficult to see how prices will be able to withstand the financing conditions if they continue. Goldman Sachs analyst James Fotheringham doesn’t see it happening and has forecasted that commercial real estate prices might be susceptible to a drop of up to 26% in value through 2009.

For months now we have been hearing of the downturn in the residential market and the subprime woes that have put a stranglehold on credit. The media has been all to focused on the residential market because that is what most people on the streets are concerned with.

We are starting to see the mass media picking up more stories related to commercial real estate woes that exist in the market. The Wall Street Journal has published an article discussing some of the problems that the credit turmoil has created in the commercial property market.

The fallout has hit some players in the commercial property market hard, amongst them Centro Properties, the fifth largest owners of shopping malls in the US. Centro’s stock price dropped more than 90% in two days after it was revealed that it is struggling to refinance $6.2B of short-term debt it took on to finance its acquisition of New Plan Excel.

The difficult Centro faced was that it initially planned to issue CMBS (commercial mortgage backed securities) to convert its short-term debt into long-term debt. With the CMBS market in the tank, Centro and other players are facing an uphill battle in raising new debt, and existing property owners are facing drops in property values.

Earlier this year we detailed Harry Macklowe’s time bomb as he is also trying to secure financing to cover the short-term debt he took on earlier this year in his $7.1B acquisition of Manhattan properties.

The dry up of the CMBS market leads to the drop in sales activity, and ultimately in sales prices. In fact, according to Real Capital Analytics, sales of large office properties fell 55% from November 2006 to November of 2007.

Too many risky acquisitions have taken place based on future cash flow projections and until that “backlog of inventory” is flushed out, the CMBS market will likely remain in its current state. That is not to say deal won’t get done, but they’ll be far and few between and any buyer’s will likely command a premium spread.

The sentiment has been changing for sometime and it will likely continue to deteriorate as seller’s willingness to drop prices is only a function of the time it takes for them to realize that.

An article in Barron’s highlights that a short-term institutional bond fund run by GE Asset Management is offering investor’s the ability to redeem their holdings at 96 cents on the dollar. Short-Term bond funds such as this typically strive to maintain a NAV (net asset value) of $1.00 and provide a market yield. In an effort to enhance the returns, this particular fund took on what was thought to be mortgage debt with high credit ratings. As a result of the sub-prime mortgage fallout and the ensuing lockup in the credit markets, the NAV of the fund has fallen below $1.00, essentially erasing any yield.

This just about sums up what is going on in the credit markets. Holders of mortgage debt are at the mercy of credit markets which for the time being have severely discounted the value of such debt. Thus the value of government debt has greatly increased and nobody wants to touch mortgage debt, resulting in a situation which certainly does not bode well for real estate investors seeking leverage.

The sub-prime woes plaguing Wall Street firms is undoubtedly likely to continue. Citibank is expected to report approximately $11-12B in write-downs. Taking a quick sample of what has happened to the stock prices of companies such as Washington Mutual and Citigroup, it is without a doubt the case that those firms with large amounts of commercial paper on their books are keeping a close eye on the market.

The increasing difficulty with which commercial paper can be re-traded, coupled with the fallout in the residential market is unlikely to lead very many lender’s to relax the tightened standards anytime soon. While defaults in the commercial sector have remained relatively static, the fear alone of what might lurk around the corner is enough to keep lenders in their current state of hibernation.

Shorenstein has purchased a $40M stake of the $216.8M construction financing debt package provided to Jay Paul Co. earlier this year for the construction of the Moffett Towers Project.

The Moffett Towers project includes about 900,000 square feet of Class A Office Space and will eventually include an additional 900,000 square feet as well as a 40,000 square feet fitness center for tenants.

Although no leases have been signed at the project to date, it is rumored that Google has signed up to take a piece of the project.

The developer of Moffett Towers, Jay Paul Co., was also responsible for the construction of Pacific Shores Center in Redwood City. PSC is also a 1.8M SF office project which was recently sold early this year to Starwood Capital for approximately $830M. Starwood Capital recently flipped a portion of that project to Shorenstein.

Bank of America, Citigroup, and JP Morgan are expected to announce as early as today the establishing of an $80 Billion Commercial Paper fund. The fund is aimed at helping unlocking the asset-backed paper market from its current condition.

The fund might also help avoid units setup to provide subprime debt from selling off their assets at “fire-sale” prices. The several months subprime lending has become essentially not available with lending for things such as vacant buildings extremely difficult to place.

My guess is the $80 Billion funds initial goal will be to inject confidnece into the marketplace so that prices of commercial paper stabilize and provide reasonable exist for the investment vehicles that originally issued or purchased the debt.