Real Estate Forum - January 2009

to get money from investors to good, solid investments,” he says. “Certainly the capital markets have been there before, and one would expect them to be there again.”

Only $33 billion of commercial investment sales closed in last year’s third quarter, less than a third of the $110 billion in volume for the same period in 2007, according to George Ratiu, economist for the National Association of Realtors, also in Washington. He points out that CMBS delinquencies, which have remained relatively low, will likely rise next year. “There are $400 billion of commercial loans coming due in 2009, and in an environment of low liquidity, that is going to put even more pressure out there.”

However, most CMBS fixed-rate debt is expected to come due over the next several years, not in 2009. JPMorgan Chase & Co. reports that $16 billion came due in 2008 and $19 billion is coming due this year, reflecting a 10-year maturity rate. Yet scheduled maturities of fixed-rate CMBS debt will reach peaks of $98 billion in 2015, $128 billion in 2016 and $127 billion in 2017, according to JPMorgan.

The CMBS-securitized loans made over the past five to 10 years are considered “good” debt, with enough equity value and debt service coverage ratios to rationalize new borrowings, says Frank Sullivan, managing director of New York City-based ING Clarion Partners LLC. “Their problem isn’t that their loans are underwater. Their problem is that they can’t find a new lender.”

He adds that the CMBS market is not likely to recover until the fourth quarter because it requires public market acceptance, but “when it does, it will really be more conservative so that the paper is more easily sold and the size of the issues will be smaller.” He expects CMBS issuances to return to between 25% and 30% of the previous market peak.

NorthMarq’s Butchenhart agrees that CMBS will make a comeback, saying the technology still makes sense, though “there is going to have to be more thought with regard to how the issues are rated before some bond holders regain confidence.” He adds that the volume of CMBS debt matur-

“Lenders don’t want to step out
in a big way into a market
where they think things are
going to get worse.”

CRAIG BUTCHENHART

NORTHMARQ CAPITAL INC.

ing this year may not be as big a problem as some are predicting, since loans on well-capitalized properties are likely to be extended. “It’s really going to depend on who the lender is at the time that it matures.”

In most cases, special servicers, such as ING Clarion, are sympathetic to not creating a problem where one does not exist, says Sullivan. “The market is giving short-term extensions—some amount of time so that you can find another lender or sell the property,” he says. However, he adds that those extensions may apply only to borrowers with decent assets who can show equity and are able to pay interest rates, likely higher than those on their original loans.

Banks should be willing to extend good loans to counter

the volume of bad debt on their books, he continues, and it is up to them to become more flexible as an alternative to foreclosure. “The banks are going to be very ill-tempered about people who simply want an extension, particularly if the property is not carrying itself or the borrower isn’t willing to put in its own money,” he says. “There will be no mercy and they will move quickly to take the property. There won’t be any more dragging it out forever.”

Whether banks will actually use TARP money to extend commercial real estate loans, or make new ones, remains to be seen. Sullivan says TARP, combined with an expansion of federal deposit insurance, gives banks the opportunity to boost their balance sheets and leverage fresh capital by a

“The banks are going to be very ill-tempered about people who simply want an extension, particularly if the property is not carrying itself.”

FRANK SULLIVAN

ING CLARION PARTNERS LLC

multiple of 12, lending on low-risk situations at 300 basis points or higher over their cost of funds. “The only way they can reprofitize is to get the money out,” he says. “They can’t stick it in Treasury notes; those aren’t yielding enough to make any difference.”

Sullivan believes risk management will be key to bank lending going forward, rather than making loans with little or no recourse or even approving high-leverage deals. “In cases that require a risk element to be explained, or can’t be covered by extraordinarily strong equity or other assets, the loans aren’t going to get done,” he says. Those types of loans may have to be made by non-bank sources that will either charge higher interest or demand a share of the asset being financed, he adds.

Even though values of institutional properties in major metropolitan markets have slipped by 10% to 15% over the past year, Sullivan points out that the performance is still better than many other investments, such as the 34% loss of the Dow Jones Industrial Average last year. “As long as all the buildings aren’t empty and it’s not a disaster, commercial real estate comes out on the other side of the curve. Whether that takes six months or two years” remains to be seen, he adds.

The executive compares the current debt environment to the aftermath of the Resolution Trust Corp. era of the early 1990s, which bears plenty of similarities. He believes LTV ratios will return to the 70% to 80% range over the next five years, by which time people will probably forget these bad times.

“I can’t tell you how many people in 1992 said ‘I’ll never lend again’ or ‘I’ll never invest in real estate again.’ By 2006, those people were right back in it,” he muses. “Things aren’t going to change rapidly, but I believe that eventually everything returns to the other side of the coin.” ◆