The Challenges Continue

Moody’s Investor Services reported on Wednesday that its Moody’s/REAL Commercial Property Price Index, which tracks repeat sales, dropped 3.7 percent from March and 13 percent from a year earlier.   Bottom line:  this is strong evidence of the continuing fall of commercial real estate property prices.  Moody’s Index is now 49 percent below the peak of October 2007, and at its lowest point in data going back to December 2000, according to this Bloomberg report.  About 30% of the reported April transactions involved distressed real estate (which might be conservative;  this is defined by Moody’s as only those assets where a known default, foreclosure proceeding or bankruptcy of the owner has occurred).

Bloomberg’s report suggests that the commercial real property market has been bifurcating.  Increasingly, as a practical matter there are two worlds of US CRE:  (a) highly in-demand, fully leased Class A buildings in busy (mostly coastal) markets with a strong economic base (such as New York, Silicon Valley and Washington, DC), and (b) the rest of the commercial real property out there, much of which is struggling.  This tracks what we’re seeing in California:  there seems to be no end of money available for commercial properties of all types that are fully leased to creditworthy tenants.  (In fact, it looks like  there’s a race on among investment funds with huge war chests are fighting to get their money invested in those “winner” projects.)   On the other hand, an awful lot of other projects are severely distressed, and gravity pulls in the direction of a growing chasm between the winners and losers.

If a project’s developer is unlucky enough to lose an anchor tenant or two, the downward spiral can be difficult to overcome, because new tenants in this market often are coming in at significantly lower rents than projected.  We see a fair number of developers trying to hold onto their properties, and a fair number of lenders and special servicers working to try to help them do that – but whether a deal can be worked out depends on the specific deal.

Most lenders and special servicers will only consider workouts if their borrowers will put new money into these deals, which can creating several challenges for the borrowers.  For one thing, they have to grapple with the economic problem of finding more money somewhere (either by selling another property, bringing in new investors or the like, all in a touchy market – but one where new money – at a price — can be found for good deals).  Equally relevant, some have to overcome some resentment, feeling that their lenders encouraged them to overextend themselves in the “go-go” economy, and ought to share some pain.  But that’s not what is happening: the government has been putting a lot of energy into bailing out losses in banks:  not so much in the real estate industry.

This market bifurcation results in continued difficulty in price discovery, particularly at the lower end.  The good news is that, since fully leased projects now are trading again, there’s a growing set of new price data available to buyers and sellers in that market.  (Of course, the Fed’s decision to keep interest rates artificially low also helps make the returns available on real estate more attractive.)   The bad news, from a market information point of view,  is there’s little or no real “trickle-down” effect from that activity, in pricing distressed or not fully leased properties.  So these properties still face a big gap in the bid-ask spread (between what current owners and lenders think they’re worth, and what potential buyers and tenants are actually willing to pay).

We need more deals to close, one way or another, to create comps that provide an accurate baseline for evaluating such properties.  This famine of useful comps makes it difficult for owners, lenders, servicers and buyers to evaluate the present worth of such buildings.  It’s also driving appraisers and brokers crazy.  And it’s keeping deals from closing.  So it’s a chicken vs. egg issue:  we need more deals to close to generate the information that will persuade folks in the industry to close more deals. (credit globe st)


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