Commercial Real Estate Blog

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.

A Bloomberg article today predicted a 15% drop in commercial real estate prices as a result of the increased costs of debt. The article cites the delayed Archstone-Smith transaction and the failed Mission West transaction as evidence that deals are beginning to fall apart. Of course this is true and a lot of money in the form of deposits has surely been lost as the markets saw a tightening of credit.

The article continues on to give an example of the repriced debt:

About six months ago, a 30-year commercial loan with 5 to 10 years of interest-only payments would have cost the borrower about 120 basis points more than the yield of the 10-year Treasury note. A similar loan would now cost about 160 to 200 basis points more than the 10-year Treasury’s yield of 4.6 percent, data compiled by New York-based Cushman & Wakefield Sonnenblick Goldman show.

As credit markets reprice risk and the cost of leverage increases, cash buyers and those with more traditional levels of debt will likely be seeing a more hospitable environment to invest in. Pension funds and large institutional money fund managers have generally stayed away from the riskier value-add and opportunistic investments and focused on “core” investments traditionally meaning those properties with stable and predictable cash flows.

The rise of cheap debt coupled with a general bullish market sentiment on rents had transformed many core assets into value-add plays and thus invited fierce competition from opportunistic real estate funds who often looked for opportunities to raise rents, renovate, or other catalyst which would allow them to quickly add value.

An article in yesterday’s P&I outlines what will likely be a reversion in the profile of the buyers of core asset real estate.