State of Commercial Real Estate

Jeffrey Walkenhorst over at Seeking Alpha has a great post up detailing his thoughts, observations, and conclusions from the recently held U.S. Real Estate Opportunity & Private Fund Investing Forum.

Some of the more powerful observations from Mr. Walkenhorst:

1. Conflicting view that we’re both entering a period of tremendous buying opportunities, yet also a long way from the bottom as mountains of debt come due and can’t be refinanced amidst deteriorating fundamentals;
2. Government support to financial institutions could be delaying distressed sales and preventing market clearing prices;
3. Reluctance of note holders (e.g. banks) to take losses (related to point #2);
4. Property deal flows near all-time lows, although perhaps somewhat better than several months ago;
5. Not surprisingly, fundraising is difficult and fund structures are changing;
6. Well capitalized REITs may be relatively better positioned to lead the way through the next several years.

A few additional thoughts from Walkenhorst:

Real estate runs in long cycles – typically seven years up, seven years down, seven years up…. We seem to be in year two of a down cycle. One conference speaker commented that real estate typically lags GDP by approximately 12 months and, therefore, if US GDP turns the corner in late 2009 or early 2010, a real estate recovery may not materialize until late 2010 or early 2011. The best case scenario relayed by one speaker called for net space absorption in 2011 with rent growth returning in 2012 or later.

.....the real zinger: $1.5 to 2.0 trillion of mortgage debt is coming due over the next four to five years (*figures and timeline vary depending upon source) and new lending remains constrained (or nonexistent).

In the new lending environment, underwriting may be 50-60% LTV on new (lower), adjusted values. Example: $100M property in 2007 ($8M NOI at 8% cap rate) with 75% LTV ($75M loan) might now be valued at $78M ($7M NOI at 9% cap rate) with 60% LTV supports a loan of only $47M (requires more equity). Still, several Forum speakers noted that many buildings might be valued at 50c on a 2007 dollar, far less than the 78c in this example and implying credit losses.

Very few transactions are taking place and bid-ask spreads remain extremely wide given uncertain valuations on declining NOI figures.

Potential buyers “don’t want to look bad” if values decline further and are largely waiting to see forced selling.