Friday, November 20, 2009

An Objective Look At Commercial Real Estate: The Korpacz Real Estate Investor Survey

CRE is possibly the single biggest experiment in "extend and pretend" currently evolving (aside from the US economy itself, which like a drug addict, is fed its daily methadone of fiat money by its enablers Bernanke and Geithner) in America. This is confirmed by the latest Korpacz Real Estate Q3 Investor Survey: far from pig lipsticking in tried and true CNBC fashion, the report tells it how it is. The biggest victim of the ultimate CRE unwind will be all those REITs which for whatever reason are trading at almost bubble levels (SPG at $74 makes about as much sense as AMZN at $130). Dear REITs: 2012 is approaching rapidly and you still have half a trillion in equity you need to raise. Simon Property, as much as it wishes to emulate Goldman's success in the real estate arena, can not bankrupt then acquire all REIT firesale prices. Of course, when the tide of sentiment on REITs turns, it will be short and sweet: straight to zero, do not pass go, do not collect TARP, due to the value burned by these companies by not being in bankruptcy already.

From the report:

So far the deleveraging of the commercial real estate industry has disappointed many equity investors who have been waiting patiently to acquire decent, stable assets at distressed pricing. The current situation, however, could soon change. Due to the huge amount of leverage used to fuel the buying frenzy during the peak of the cycle between 2006 and 2007, many investors sense that it is only a matter of time before the for-sale market is flooded with properties by owners who are unable to cover their debt service obligations and incapable of refinancing. "Over the next year, more and more property owners will be in a position where they can't make their payments and can't supply additional equity to the lender in order to refinance," explains a participant.

While some investors are looking to the looming $153.0 billion of CMBS (commercial mortgage-backed securities) loans coming due in 2012 as the catalyst to jump-start buying opportunities, other investors are expecting near-term defaults with commercial banks to provide some distressed buying prospects. According to the Mortgage Bankers Association, CMBS and other securitized loans account for 21.0% of the outstanding commercial real estate debt while commercial banks account for about 45.0% of the debt total. "Many traditional lenders are not recognizing the huge problem in front of them and seem to have no urgency in finding a solution," remarks an investor. [hip hip hurray for Uncle Ben's doctrine of moral hazard]

Certain investors believe that many banks are playing a "timing game" – attempting to replenish their capital reserves while the economy and industry both strive to recover and bolster property values. If successful, the distressed sales activity that many eager buyers were anticipating would be limited. "It's a terrible time for anyone, including banks, to have to sell an asset," attests an investor. If property values continue to erode in the commercial real estate industry, many investors are hopeful that banks will be unable to continue to "pretend and extend" the troubled loans on their balance sheets and will need to declare their losses and place assets up for sale.

If such buying opportunities do materialize in the industry, the next challenge for investors will be asset pricing. "A bid-ask pricing gap still exists across all property sectors and in nearly every geographic area," notes a participant. Although some participants indicate that this gap is closing a bit, conservative cash flow models and a tremendous amount of uncertainty tied to the economy, the industry, and the unraveling of the debt markets are keeping offers quite low.

And for all those who think that the current 6% implied cap rate (based on stock prices) is even remotely credible, we recommend you take a look at the table below. Compare the 6.5% Manhattan cap rate with the 8% average for the rest of the nation. If anyone thinks New York is immune to the CRE collapse, we suggest you take a quick walk around Madison between 60th and 75th.

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