Commercial Real Estate Weakness / Spreads Widening
A: I would like to talk about the bigger picture again, as I often do here, and discuss some of the problems that seem to be bubbling under the surface in the commercial sector. This is a wide angle lens discussion on this sector and not a spotlight on Manhattan commercial real estate. It's important to note that commercial real estate saw a similar boom that residential saw over the past 4-5 years, and that the debt used to finance many of these deals were securitized and dispersed just like subprime was. As the slowdown occurs, one has to wonder if this may be the next shoe to drop on the books of the financials holding commercial mortgage backed securities.
Yes, all this matters. First, lets take a look at what the CMBS indices have been doing over at Markit.com which shows us the continuing widening of credit spreads in the commercial sector. What does this mean? Well, even with the fed rate cuts, the lending environment for commercial real estate has dried up. Risk is being priced in and as a result, credit spreads are widening signaling unease in the credit markets for this type of paper. The chart on the right shows you the rising spreads: FOR CMBS INDICES, UP IS NEGATIVE.
This is not all. The MIT Center for Real Estate issues a quarterly report, TBI (transactions based index) of Institutional Commercial Property Investment Performance, to measure market movements and returns on investment based on transaction prices of properties sold from the NCREIF Index database.
"Results for the 4th quarter of 2007 show a negative 5% capital return for the properties sold in the NCREIF database. This is the second consecutive negative quarterly price change in the all-property TBI, a cumulative fall of more than 7% since the peak in the 2nd quarter of 2007. The investment total return for all properties in the 4th quarter also registered a decline of 4.3 percent.According to the BostonHerald.com's article, "Commercial Real Estate Prices Tank":
Please note that the TBI is a statistical methodology that produces estimates of price movements and total returns based on transactions of properties sold from the NCREIF Index database."
Commercial real estate prices are tumbling across the country in a decline not seen since the devastating recession of the early 1990s, a new MIT report finds. The value of commercial real estate owned by major U.S. pension funds fell 5 percent in the fourth quarter, according to a commercial market index produced by the MIT Center for Real Estate. The drop was nearly twice the 2.5 percent decline seen in the third quarter. The ongoing credit crunch in the capital markets, which has made it difficult for real estate firms to both buy buildings and develop projects, is a key factor in the price declines, the MIT report finds.Jeff spoke about this last week. In his piece on JAN 29th, Jeff stated:
...the spread (or premium in yield) investors are demanding from 'AAA' Commercial Mortgage Backed Securities has risen significantly. We knew spreads had widened, forcing banks to write down the values of some of these CMBSs, but what really worries me is that the widening has continued even as the fed has slashed rates. Fed cuts rates and borrowing cost goes up, not the math we want to see.There is a point here. We know that forces outside Manhattan can affect us. If subprime defaults rise as national housing prices fall, the entire secondary market for securitized subprime MBS will dry up. This wreaks havoc to the financials, causes billions in losses, tightens underwriting standards, and makes lending rates rise as risk is re-priced. Well, what about OTHER DEBT CLASSES; i.e. Commercial mortgage backed securities?
Since cap rates (mutiples of net operating income) at which properties trade are directly correlated with borrowing rates (increased interest cost = increased cap rate) and increased cap rates equate to lower prices versus net operating income, assuming net operating incomes from commercial properties just stay flat, prices will fall. So even in a market with great dynamics like Manhattan, if borrowing costs rise, net operating incomes need to rise just to keep cap rates stable and keep prices from falling. Again, this equation isn't new news, but you really want to see borrowing costs stop rising.
I did some searching and I saw that Fitch yesterday placed 51 U.S. CMBS deals under analysis with the report concluding within the next 30 days. Here is the story:
"Following its monthly surveillance review, Fitch Ratings has identified 51 of its U.S. CMBS deals as 'Under Analysis', indicating that Fitch will be issuing a rating action within 30 days."What is the potential damage to banks books? According to today's WallStreetJournal story, about $180 Billion. When discussing Blackstone's coming sale of debt for which it used to finance the Hilton deal, concerns are mounting:
"A less-than-successful offering could send the market into a longtime funk, exposing banks to more write-downs at a time when they have recorded more than $100 billion of losses on residential-mortgage-related securities over the past few months. In a report issued Friday, analysts at Goldman Sachs Group Inc. estimated that banks could book $23 billion of commercial-real-estate-related losses this year alone, consisting mainly of write-downs on CMBS's and related securities.So, although this doesn't necessarily relate directly to Manhattan, do you feel this is something worth keeping an eye on? I certainly do!
All told, Goldman Sachs predicts that U.S. commercial-real-estate prices could fall as much as 26% though 2009, driving the total of related loan losses to more than $180 billion over time, of which global banks and brokers might bear over $80 billion."