By William R. Pollert
Industry May Be Under the Gun,
But It Will Not Last Too Long
THIS YEAR WILL BE TOUGH FOR COMMERCIAL
real estate. The shutdown of the debt markets squeezed
most of the life out of the business last year as transaction volume fell by 75% and cap rates jumped 50 to 300
basis points. The industry now faces the added burden
of an economy that has been in a freefall since at least
the third quarter of 2008. As a result, vacancies are
growing, rents are under pressure and tenant bankruptcies and defaults are on the rise across all sectors.
The federal government is focused on passing an
$850-billion to $950-billion stimulus package. Its ultimate
success will depend on reviving the capital markets.
Stimulating the capital markets, however, has been
difficult. Last year, the Fed cut the Federal Funds rate
to nearly zero and injected over $2 trillion into the finan-
Since most of the sales activity is expected
to come from distressed assets, it may give
the impression that things are a lot worse.
cial system. The Treasury spent half of the $700-billion
Troubled Asset Relief Program money to bail out banks
and financial institutions. While this unprecedented
action did restore short-term inter-bank lending, it did
little to help the capital markets.
Bank balance sheets remain stressed by mark-to-market write-downs of toxic structured debt securities
and rising residential mortgage defaults. But even if the
Treasury’s efforts to encourage lending were successful,
banks do not have the capacity to fill the enormous void
left by the shutdown of the structured debt market.
Three decades ago, banks supplied 75% of loans
worldwide. Before the credit meltdown, that share dropped
to about 33%, largely due to securitization. Given the size
and complexity of the global economies, any meaningful
recovery will require the resurgence of the capital markets.
The key is restoring investor confidence. This is particularly important to the commercial industry, where CMBS
accounted for 27%, or $230 billion, of financing in 2007.
Given investor paranoia about any structured asset-backed security including CMBS, it is unlikely that the
capital markets will restart without aggressive govern-
ment involvement, whether in the form of direct securities
purchases and/or guarantees. Under the best of circumstances, the capital markets—particularly for CMBS—will
not be functional until the second half of the year and a
return to normalcy is not in the cards until sometime in the
second half of 2010, for several reasons.
For one, the government still does not have a clear
strategy on how to deal with the turmoil. Whatever program is decided on, it will take months to implement and
have an impact. Investor confidence continues to be
eroded by the constant stream of worsening economic
data and “bad surprises” in the financial markets.
Rating agency downgrades of CDO and ABS securities are forecasted to rise in the months ahead because
of new rating methodologies for structured asset-backed
securities. These changes have already caused hundreds
of tranches of CDO and ABS securities to be downgraded. CMBS defaults are also expected to soar in 2009, as
close to $20 billion of securitized conduit loans will need
to be refinanced and tenant bankruptcies jump.
Since most of the sales activity is expected to
come from distressed assets, where prices are most
depressed, it may give the impression that things are a
lot worse than they are. This could hamper a recovery
since it may initially accentuate the price gap between
non-distressed sellers and buyers as markets recover.
Once the structured debt markets return to a more normal $100-billion to $150-billion level, borrowers will face
a new world of tough underwriting and lower leverage
loans (50% to 60%), but deals will get done.
The bottom line is that 2009 will be a very tough year,
especially for those who own lesser-quality properties or
have to sell. But as with all cycles, this too will pass. When
the capital markets reopen and the economy begins to
grow in 2010, investors should be well positioned to benefit. In the interim, the strategy for success in 2009 will be
de-leveraging and balance sheet strengthening. ◆
The views expressed in this column are those of the
author and not REAL ESTATE FORUM.
William R. Pollert is the co-founder and president
of CapLease Inc. in New York City. He may be contacted at
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