Experts Discuss Whether ‘The Sky is Falling’ for Commercial Real Estate

By Keat Foong, Executive Editor New York—A webinar recently addressed the question “Is the Sky Falling on Commercial and Multi-Housing Property Developers?”While the answers may not have been a resounding “yes,” the presenters were grave in their analyses. Speakers at the webinar, organized by Commercial Property News, Multi-Housing News and Contract magazines, generally agreed that although at the beginning of the year the forecast for the economy may have started to look up, and the housing market had seemed as though it may begin to bottom, the prognosis has worsened considerably since then. “In just the past few months, as the credit markets have tightened further and borrowing costs have continued to increase, the spillovers from the tightness of credit have spread to other aspects of the real economy,” said Sam Chandan, chief economist of Reis. Chandan said that the most recent forecasts call for economic growth to be -0.3 to as low as -2 percent on an annualized basis in the fourth quarter. And most recent forecasts are predicting unemployment to reach 8 percent by the end of 2009. Chandan presented a graph that showed that apartment prices have fallen 17 percent from their peak in 2007 to the third quarter. “The upward adjustments in cap rates are only now in mid-course,” warned Chandan. “We have a ways to go here.” Jon Southard, principal director of forecasting for Torto Wheaton Research, presented an analysis of the government’s financial bailout efforts. He said there is a lack of trust in the entire financial system. As a result, spreads have jumped all out of proportion to their risks, and interest rates are as high as 9 percent even on mortgages backed by collateral that have hardly any risk.  Southard warned that worries include whether there will be enough capital to refinance maturing loans in 2009. That maturing loans may not be able to be find refinancing next year “is a very imaginable concern,” he said. He explained spreads are higher than justified by the real estate fundamentals also because the securities market is concerned about a potential fire sale of commercial mortgage paper by Lehman Brothers, and other banks and institutions such as AIG. Chandan said that among the 65,000 mortgages that his company tracks, he is seeing signs that there will be increasing discrepancies between the cash flows of the properties and the debt service obligations. There properties were funded at a time when they were underwritten to higher future cash flow expectations, but those increases in income are now not going to materialize, and escrows are going to be drawn down. Chandan said these problems are expected to arise by the end of 2009 and into 2010. Richard K. Green, Lusk Chair in Real Estate at the University of Southern California, suggests that the current crises will not abate soon as home prices may continue to fall given the new tightening of credit for homebuyers. Because the mortgage markets were heavily affected by the bankruptcy of Lehman, it is now more difficult to obtain Fannie Mae and Freddie Mac mortgages for homebuyers, who need minimum down payments of 20 percent and sometimes 25 percent.  Suzann D. Silverman, editor-in-chief of Commercial Property News, pointed out that this time around, commercial real estate is not the cause of the economic crisis, unlike the recession that began in the late-1980s, and fundamentals have remained strong. Silverman said that there are still many well-capitalized investors who are able to acquire properties and willing to spend now for the right opportunity. These include fund managers, institutions, foreign investors, public and private REITS and private entrepreneurs.  “Though those opportunities may include distressed assets, there is also an interest in safer bets, such as multi-family properties near transit hubs, medical office properties, seniors housing and well-leased, well-located commercial space,” said Silverman. She also suggested it is unlikely some type of CMBS vehicle will become available in time to meet the wave of maturing loans. “There is pretty widespread thought that some type of CMBS-like vehicle will eventually have to become available, but next year will be difficult,” she said.