 | Commercial Real Estateby Gunners on February 12th, 2008 at 3:56 pm |
(43 votes, average: 4.77 out of 5)
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I’d like to share some info about commercial real estate with you guys. This is my inaugural post, so be kind. Also, I should disclose that I have only been trading stocks since May 2007, and have made very few of my own decisions on what stocks to buy and sell. I have done quite well, thanks to The Fly and many of you that comment and post here, so thank you for the education and the winners.
The commercial mortgage backed securities (CMBS) market is in complete shambles. In 2007, CMBS had a record year, originating $230 billion in commercial loans. Most of that was in the first half of the year, and a lot had to do with the Blackstone takeover of Equity Office and the subsequent flips. This year, at the beginning of the year, projections were for that to be cut in half for 2008 to approximately $113 billion. But considering the industry is 99% shut down, and barely a single CMBS loan has been originated this year, that number has to come down. The new guess is that MAYBE $80 billion in CMBS gets done this year, but people in the know think that it could be much less and as low as virtually nothing until 2009. Now we know that the $230 doesn’t need to happen again. But let’s say that $200 billion needs to happen. That is a gap of $120 billion dollars of loans that need to be placed in 2008 in a best case scenario. Life Companies and Commercial Banks can’t take it all.
The truth of the matter is that there is a large slice of the pie for Commercial Real Estate Loans that will go unfilled in 2008. The other possible meltdown comes when Life Companies run out of their allocation for the year. The absolute earliest that CMBS will be back in full swing is in about 8 months, more likely 12-18. I’ve heard that a life co that shall remain nameless, has originated $1 billion in mortgages during the first 40 days of the year. Their allocation for the entire year is $4 billion. At that rate, they will be out of money by May. There is extreme risk that there will be an even much smaller mortgage market come May and June. The other situation is, with the CMBS paper that is selling and will be selling at extremely large yields, it is better business for these Life Companies to be buying the AAA paper off the top of the securitization than to originate whole loans. Why take the risk of a full loan at a 250 bps spread when you can buy just the AAA piece yielding 250 to 300?
CMBS shops will not be originating mortgages until the “old school” underwritten loans are off their books. They have tried securitizing pools of “old school” with “new school” but the buyers are too smart for that now. This was the first January in the history of the business with no domestic CMBS issuance, and the pipeline is virtually empty. They need to take the writedowns, and they have not announced these writedowns yet.
$22 billion dollars of CMBS loans are maturing this year. Most of which will not be able to be re-financed without the Borrowers taking a loss. This will lead to REITs, Institutions and Funds shelling out equity to refinance or they will have to foreclose. Both crappy situations for the market. They can try to sell, but they won’t be making great returns because the financing market has driven property values down up to 20% in some markets.
More Layoffs are coming. I’ve heard that a CMBS office in new york that will go unnamed just laid off 1/3 of their shop. This news is coming in often, and it doesn’t show any sign of stopping. These people are NOT DOING ANY BUSINESS right now. NOTHING. NADA. How can they continue to pay all these people to do nothing? They hired and hired to handle the $230 billion in originations. what happens when that goes to $80 billion (best case). Well, that means they need to fire 65% of their help. These people are sitting in their offices, waiting for their phones to ring to hear if they can come back to work tomorrow. I know there aren’t any borrowers calling them, because they are OUT OF BUSINESS. Lehman Brothers, Bank of America, JPMorgan, Merrill Lynch, Morgan Stanley, Goldman Sachs, Wachovia, Credit Suisse, Deutsche Bank, Bear Stearns, Citigroup, RBS Greenwich, UBS. That is the top 12 in global CMBS origination in 2007 (not in order). THEY ARE DOING NOTHING RIGHT NOW. They go to work, twiddle their thumbs, and go home. Soon they will just do step 3. I’m not going to even get into how completely screwed the lenders that relied on a CDO exit are.
There are more real estate funds than ever right now. These funds have shelf lives, which means they HAVE to sell eventually. However, there is a 10% to 20% bid/ask gap that needs to be filled. Guess how that will be filled? Sellers have to lower their ask. Which means a lot of these funds will be not hitting their desired returns. Property Sales volume has slowed considerably. It will continue to be slow until at least the 3rd quarter.
The good news for real estate is that volume HAS to pick up. I would ride this down until the summer and then think about getting long a few choice names in real estate. The reason it has to pick up is the same reason that people will have to sell. There are more real estate funds than ever right now, there are approximately 400 funds, with raised equity capital of almost $250 billion. If you ask some of these fund managers, “so now that the market sucks, are you going to give the money back to your investors?” The obvious answer from everyone is a resounding “no.” So these funds will have to start deploying their equity. A lot of them are now turning their funds into mezzanine debt funds, because they can get equity like returns in a secured position. There is also a gap that needs to be filled by these Mezz moneys. 80% financing does not happen anymore, it is more like 60-65%. So mezzanine lenders are in high demand for equity players that refuse or can’t put in more than 20%-25% themselves.
To slightly contradict myself, the only 80% lending going on right now is agency lending by Freddie and Fannie. Which is why I’m glad that The Fly found (CMO: 9.50 +6.74%) for us. I went long the minute he did, and anyone else that did is quite happy right now. Freddie and Fannie are absolutely SWAMPED with business right now.
I am not a guru on the secondary debt markets, but what I do know is that large financial institutions have not even come close to announcing all their writedowns and layoffs in the Commercial Real Estate sector, which leads you to believe that other sectors aren’t done either. Commercial Real Estate deal flow is at a snail’s pace, but will pick up in the second half to end of 2008, because it really has to. But the struggle will be to decide whether or not there will be enough financing available.
Long (SRS: 113.31 -18.94%) and long (SKF: 158.00 -12.94%) should be a great idea for the first half of the year. Wait until at least July to go long commercial real estate. At which time I would choose a prime NYC REIT like (VNO: 78.23 +15.04%) or (SLG: 55.00 +16.95%).
Another idea will be to choose a prime Commercial Real Estate services firm like (CBG: 9.25 +27.59%). CBG has been crushed lately, but when you think about it, they are sitting around picking up new clients by the day. This market is so tough to navigate, that even the most sophisticated sellers and borrowers need capital market expert help because they can’t access capital or sell things on their own. Deal flow is slow right now, so CBG will struggle in the near term, but if they are smart, they are picking up clients and picking up market share and doing people favors now that won’t be forgotten when the market picks up.
Older and wiser people that I know are actually quite excited by this. They have been through similar situations, and extreme growth comes after down markets in real estate if you are smart and aggressive in the tough market. When it bottoms, there will be extreme value in some choice names.
Well, if this post is received well by you guys, perhaps I will continue to update you on the commercial real estate markets as things happen.
I wanted to make that Arsenal crest my avatar, but couldn’t figure it out
February 12th, 2008 at 4:02 pm[...] admin wrote an interesting post today onHere’s a quick excerptCommercial Real Estate deal flow is at a snail’s pace, but will pick up in the second half to end of 2008, because it really has to. But the struggle will be to decide whether or not there will be enough financing available. … [...]
February 12th, 2008 at 4:04 pmNice inaugural post!
SRS, to the moon, Alice!
or 160, whichever comes before the summer.
February 12th, 2008 at 4:40 pmfinally someone with insider info., however, for all you Arsenal fans I say: Bayern Muenchen forever
February 12th, 2008 at 5:23 pmLuckily for you, the great content of your post outweighs that eyesore Gooner crest at the top!
February 12th, 2008 at 5:28 pmGunners,
February 12th, 2008 at 5:32 pmExcellent read! I’d give you ten stars, but that would be illegal. Thank you for some real insight.
I’m not an expert in any fashion, but if a bubble has been popped won’t the recovery time take much longer for things to get back into “full swing?”
Peace
Great post Gunners.
February 12th, 2008 at 5:33 pmI remember when I used to come to this site to laugh out loud.
Green Writer,
its a good question. but the thing is that the commercial real estate fundamentals are still very good. there is good rent growth, low vacancy. Commercial Loan Defaults are very very low. This is mainly because even though lenders used extremely aggressive underwriting over the last 2 years, they were still mostly making loans to capable borrowers. they weren’t writing a sub-prime loan to a “poor, unemployed, 5 points adrift, homeless manchester united fan.”
The secondary and terciary markets will suffer more, but the big market making funds and institutions will have no problem getting through this. It was just that the underwriting principals were so bad. they are just going to have to retreat back to historical levels, and until the entire market is ready to handle that change, we will be going down. But it shouldn’t take as long as the housing market, due to strong fundamentals.
Sorry for those of you that don’t enjoy the football banter. I’m guessing one of you guys was a man u fan, since you talked shit about the crest. unless you’re a spurs fan, then i will just laugh.
oh, and these comments and posts are just my opinion. you can read more about it in the papers, daily, and make decisions for yourself. but i’m happy to give my opinion
February 12th, 2008 at 5:44 pmGunners,
So now the question is if we have a full blown recession won’t vacancies go up?
Also I have read that even though the credit and income docs are solid it has become a problem to refinance all together.
Can and will those clients sustain non benficial terms due to liquidity freeze up. Perhaps they may sell all together to avoid a potential worst case scenario. Which then floods the market and continues the downward spiral in price.
If I bought a building on 5th ave for say $50 million that is now worth $150 million and I have trouble refinancing my loan maybe I could get $125 million for quick liquidation purposes rather then speculate any further.
February 12th, 2008 at 6:17 pmPeace
Great post, but I disagree a bit with your timing as far as looking at companies come summer time and maybe you can give me your thoughts on how closely commercial tracks residential. I’ve always thought that commercial lags on the way up and the way down.
If that correlation is indeed there, commercial has a long way to go. Regardless of what anyone thinks, residential has no chance of bottoming, much less rebounding, until we reach historical norms.
I too would like to figure out how a deep consumer recession plays into things, retail will undergo a wave of closings, layoffs and consolidation for a while and at the most commercial will be lucky to continue a slow bleed.
Go Blackburn!
February 12th, 2008 at 7:13 pm[...] Trader Mike wrote an interesting post today on Commercial Real EstateHere’s a quick excerptBoth crappy situations for the market. They can try to sell, but they won’t be making great returns because the financing market has driven… [...]
February 12th, 2008 at 7:49 pmGunners,
FRE & FNM are involved only within the residential markets…what is your point with regards to the CMBS market?
jog
February 12th, 2008 at 7:49 pmDucati,
Multi-family is very much a part of CMBS. CMBS has been a competitor of freddie and fannie in the past. CMBS is gone, so freddie and fannie are the masters of multi-family, therefore they are swamped with business. that’s the point. Apartment complexes are considered a Commercial Real Estate product type. anything but when the buyer or seller is a single family home owner/seller is considered commercial. so apartments, condo sales, townhouse complexes, etc… are commercial.
wow,
you may be right. i wouldn’t go full in positions during the summer, but i would think about starting them. i could be totally off on timing, i’m just speculating, but with somewhat of a sense of data behind my speculation. feel free to disagree.
Green,
i have not been around along enough to fully understand the complete effect a recession will have on vacancy rates. it would be naive to say it wouldn’t have any effect, but in select markets, new york, la, dc, chicago, san fran, i don’t think they will suffer very long. speculative construction will definitely go down, and perhaps if developers can control themselves, that is all the markets will need, no new supply. demand is strong and demand projections remain strong, especially in supply constrained markets.
February 12th, 2008 at 8:16 pmGunners - you’re spot on as to the state of the market.
For the macro perspective, the out-performance of commercial RE since 2000 was due to a seismic shift into real estate as an asset class. Many Funds (pension/Life) had little or no allocation in real estate, so the funds flow into the sector was huge from 2000-2006.
With real estate basically fully allocated now, there is no real driver for fresh equity in the space. The Lower leverage CMBS deals will also effectively be a drain on equity.
Real estate people love debt. To them, a dollar borrowed is a dollar earned. They will pay any price for Mezz debt to avoid putting more equity in a deal, or to get a deal done.
Enter the Mezz guys. My favorite in the space is SFI. The next 5 years plays right into SFI’s sweet spot - quality borrowers with quality collateral in need of capital.
It is still being sold down hard (14% yield). This is a total gift.
February 12th, 2008 at 9:03 pmGunners,
Not sure I agree.
Freddie Mac is a stockholder-owned corporation established to support homeownership and rental housing. Freddie Mac purchases single-family and multi-family residential mortgages and mortgage-related securities, which it finances primarily by issuing mortgage-related securities and debt instruments in the capital markets. Freddie Mac finances its purchases primarily by issuing a range of debt instruments in the capital markets. The Company has two business activities: portfolio investment activities and credit guarantee activities.
Federal National Mortgage Association, operating as Fannie Mae, is engaged in providing funds to mortgage lenders through its purchases of mortgage assets, and issuing and guaranteeing mortgage-related securities that facilitate the flow of additional funds into the mortgage market. The Company also makes other investments that increase the supply of affordable housing. It is a government-sponsored enterprise (GSE) chartered by the United States Congress and is aligned with national policies to support expanded access to housing and increased opportunities for homeownership. The Company’s business includes three integrated business segments: Single-Family Credit Guaranty (Single-Family), Housing and Community Development (HCD), and Capital Markets.
Now certainly, up until their last Quarters financials, they were doing slighty LESS business than usual, based on Revenues & Cashflows.
While I accept that the development of an apartment complex is certainly commercial, that does not fall within FNM & FRE remits.
I also agree that commercial, traditionally a much more volatile market than residential hasn’t even really started to approach historical default rates currently.
jog
February 12th, 2008 at 9:08 pmLeawood,
How safe is that dividend do you think?
The payout ratio is 90%+
The business has gone cashflow negative.
jog
February 12th, 2008 at 9:17 pmDuc -
The fact that the yield is 14% tells you that the market sees risk in the divi. I’m not worried about it.
When commercial real estate gets stressed, crazy shit can happen, so I give the benefit of the doubt to a strong management team and their approach to risk. These guys are the best in mezz.
February 12th, 2008 at 9:44 pmLeawood,
Interesting, I’ll have a closer look at this one later when I have a bit more time.
jog
February 12th, 2008 at 9:59 pm[...] post by Stock Discussion, Trading Ideas, Stock Talk at iBankCoin.com A.at_adv_here_7881, A.at_pow_by_7881 {font-family: Arial; font-size: 10px; font-style: normal; [...]
February 12th, 2008 at 10:23 pmHa! Spurs…I shall laugh with you.
Chelsea are my boys, Desailly & Zola my heroes.
February 13th, 2008 at 12:30 amDucati,
They originate commercial mortgages on Apartment complexes daily. This is a fact. they are the most active originator of multi-family mortgages today. they don’t just buy mortgages, they originate them. Fannie usually through institutional partners, for example, a Wachovia Fannie Mae program. so i guess if you want to get technical, it is wachovia originating it, but it is 100% fannie’s deal, and wachovia only gets a fee. they do not hold the paper. you can go to freddie direct (if you know how, but you will probably need a strong commercial mortgage broker to get anything done with them)
Freddie and Fannie continue to ORIGINATE commercial multi-family mortgages with strong borrowers and strong underwriting principals. You can disagree with me, except that I see it happening daily. I’m not really sure what effect that will have on their stock prices or the stock market in general, but they are in that business.
February 13th, 2008 at 6:41 amGreen Writer: This article talks about the recession vs. vacancy
Last updated: February 12, 2008 04:01pm
Richard Mack: ‘Equity Must Be Repriced’
By Paul Bubny
NEW YORK CITY-A repricing of equity will be necessary to return liquidity to the system, and the pricing change will have to come from the capital markets. So said Richard Mack, partner with Apollo Real Estate Advisors, at Tuesday’s breakfast presentation sponsored by the Real Estate Lenders Association and held at Club 101.
“We’re sitting on the sidelines in the equity business, and I think that is the most telling sign” of how Apollo views current market conditions, Mack said. He noted that out of $3.2 trillion of debt outstanding in commercial real estate, 10% is mezzanine and 25% of the mezz debt, or approximately $77.5 billion, will mature each year.
Mack, who’s responsible for new investments and investment management at Apollo, aligned himself with those who believe “things are going to get worse before they get better.” He added, however, that this presents many opportunities for lenders to make prudent loans with equally prudent spreads.
The uncertainty in the market has led to mixed signals in a variety of areas, among them the question of whether the US is headed toward a recession. Mack said he believes it is, but added that he doesn’t think the effects of a recession will translate into substantial increases in the Manhattan office vacancy rate. The last time major financial institutions gave up a lot of space in Manhattan, in the downturn of the late 1980s and early 1990s, they soon came to regret it, he said.
“So I don’t see a huge vacancy rate coming,” said Mack. “But I do see that New York office space is mispriced.” In response to an audience member’s question following his presentation, Mack extended that characterization from the sale of office buildings to the asking rents at many properties. “The rents of $100 to $150 per sf have been achieved in only a very few buildings,” he said, adding that even if landlords post three-figure rents, tenants often negotiate them down.
If the US market is headed for a recession, Mack said, it will recover more quickly than Europe. “Lenders there are completely shut down,” he said. Even in Asia, where national economies are quite strong, there has been some pullback on credit, he added.
February 13th, 2008 at 7:10 amthis website takes all articles about commercial real estate each day and posts them on one site. pretty NYC centric, but worth a visit daily for those interested: http://www.therealdeal.com
February 13th, 2008 at 7:21 am[...] This ties into what Gunners was saying. By the way, the “Gunners post” may go down as the best ranked post ever— on the PG. It may get framed and put on the [...]
February 13th, 2008 at 8:06 amThis post could have been improved had it included a video by the Village People or something…
Other than that, it was pretty nice.
-DT
February 13th, 2008 at 12:50 pmGunners,
Commercial mortgages are not multi-family mortgages.
FNM is involved in HCD mortgages, and this I guess could qualify as commercial.
jog
February 13th, 2008 at 12:55 pmDuc,
we might be confusing each other. here is what i’m trying to say:
1 year ago today, JPMorgan would have offered an 80% loan on a 100 unit for-rent apartment complex (multi-family) at Treasuries + 100 to the owner of the complex (which would be a commercial RE institution, fund, or reit). 1 year ago today, on the same complex, Freddie would have quoted an 80% loan at Treasuries + 125. JPMorgan would have won that deal and securitized it in CMBS.
Today, Freddie is offering an 80% loan on the same complex at Treasuries + 205. JPMorgan is offering nothing. Life Companies are offering a 65% loan at Treasuries + 275. Freddie wins all day long
February 13th, 2008 at 1:21 pmOh my, somebody voted a non-5!
February 13th, 2008 at 5:27 pmSacrilegious!!
guns - nice post. can you school me on the mezzanine piece? how does it work?
February 13th, 2008 at 7:26 pmGunners,
Ok, now I’m on the same page.
Having looked at the last 4 quarters up to I believe Sept 2007, there was a fall-off in business for both FNM & FRE
Are you saying that the latest quarter [yet to be released] will show this upsurge in business?
jog
February 13th, 2008 at 8:21 pm[...] …for ruining Gunners’ perfect post ranking. [...]
February 14th, 2008 at 12:50 amit should
February 14th, 2008 at 6:13 amforeclosure prevention…
Every one would seem to have instant access to the world wide web….
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March 16th, 2008 at 10:56 pm