Commercial Real Estate Blog

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.

There have been a lot of articles over the course of the past month and a half outlining the tightening standards lenders are enforcing for both commercial and residential property transactions. Many of us in the business were aware of acquisitions taking place involving loan-to-value and debt-service coverage ratios which deviated from what credit markets were typically accustomed to seeing. An article in last week’s Wall Street Journal however shed light on the extent to which underwriting standards had loosened.

Macklowe Properties, a large real estate holder was able to secure funding for a $7.6 billion dollar acquisition of NYC property with only $50M of equity put into the deal by Macklowe. While the loan is a recourse loan, it is an excellent example of how loose lending standards had gotten. So long as commercial property prices continued to increase, lenders had a safe exit and borrowers continued to make huge returns on investment quickly flipping properties. As the market has now turned, it seems Macklowe Properties might be left without a seat if the music does ultimately stop and they are unable to find a way to repay their loans.

The 50-basis point decrease in interest rates by the Federal Reserve should provide a short-term catalyst for REIT shares to move higher and commercial real estate activity to resume.

The rate decrease makes the dividend paying shares of REITs more attractive for the time being.

The risk is that it will take some time for the short-term rates to affect long-term rates, and the risk remains that during this time we could see a further slowdown in the economy, more troubled housing numbers, and a reverse in commercial real estate leasing activity.

The world’s largest bond fund has reduced its holdings of commercial paper to zero as of late last month. Bill Gross, the manager of the Pimco Total Return Fund had eliminated its holdings of commercial paper by the end of August.

Concerned about the impact of mortgage defaults, investors have fled commercial paper leading to demands of higher spreads over “risk-free” interest rates. Bill Gross went so far as to say last month that the market for commercial paper “is basically history”, quite a telling statement.

While the market for asset-backed securities will undoubtedly survive, we will likely see overhauls in rating standards and the criteria used to assign ratings. In the meantime, the rate spreads will continue to have an impact on those seeking commercial loans in the former of higher interest rates and more stringent requirements.