Monday, November 23, 2009

Commercial real estate finance

Today I went to the Fairmont Hotel in San Francisco, to listen to the speakers, sages and pundits at the Fisher Center's annual Real Estate and Economics Symposium.

The main economic take-away was that the recession is over, employment is not falling as fast and may soon start growing and the housing market has bottomed out.

Great news then: but not for commercial real estate, which has a whole different set of problems. CRE values are down 41% from the peak. RCA's Robert White estimated there's $1.8 trillion of real estate loans originated over the last 6 years where values have fallen more than 25%, effectively wiping out any equity holdings. The value drop hasn't led to many foreclosures yet because net operating income remains cushioned by long leases. Also, banks are choosing to "pretend and extend" while properties can still cover their debt service payments.

This won't continue for long. Around $800 billion of CRE debt will need to be refinanced over the next two years, and commercial vacancy rates are rising and rents still falling. While the banks' cost of capital is essentially zero, they are willing to extend the loans on any property that is cash flow positive, and only foreclose on the weaker under-performing assets. But zero percent Treasuries aren't sustainable. Once they rise (and Ken Rosen expects T-Bills to be at 2.1% by the end of 2010) the performance hurdle will also rise and that will result in many more foreclosures of commercial properties. Only then will the real CRE losses begin to be recognized.

And it'll also be a great time to buy.

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