Sense on the Dollar
From the November 2009 Issue
Are you seeing any signs of life in the CMBS market?
No. However, the good news is that TALF (Term Asset-Backed Securities Loan Facility) has unlocked some of the legacy CMBS and tightened spreads considerably. Some form of CMBS will need to emerge to account for the massive debt maturities we will experience over the next several years. CMBS represents roughly 23 percent of the $3.5 trillion commercial real estate debt market in this country. Banks account for 50 percent, insurance companies are 10 percent, and other sources represent 17 percent. We will see roughly $1.3 trillion in debt maturities over the next four years. While CMBS has been a driver for the industry because it was so plentiful and aggressive, it has now become the poster-child of what went wrong. The delinquent CMBS balance in August was $28.2 billion. That’s more than ten times the low point in March 2007. The federal government will have to influence the commercial mortgage market more going forward and will need to expand on TALF and PPIP (Public-Private Investment Program).
Do you expect to see some new financial products emerge to serve the commercial real estate market?
Yes. Most recently there have been several debt funds and mortgage REITs (real estate investment trusts) that have raised capital to buy existing performing and non-performing notes and to provide new senior mortgages. There is a lot of talent on Wall Street that has lost jobs, and those guys have gone out and raised money. There is a huge opportunity to buy and originate senior mortgages. These funds are trying to offer higher leverage, say 65 percent to 70 percent, but are also more than 100 basis points higher in rates than insurance companies and banks.
How will the Bay Area fare compared to other U.S. metro areas?
The Bay area is resilient because Silicon Valley always reinvents itself. That said, with continued layoffs, unemployment in the double digits, and virtually no venture capital funding, there is still considerable downside. On a positive note, opportunities are going to be plentiful. Even in the last 30 to 60 days I’ve started to see deals finally shake loose. Long-term investors are seeing an opportunity to come into the San Francisco real-estate market for roughly half the price of 2007.
Are the steps we are taking to restructure financial markets and banks going to solve the problems we’ve seen?
CMBS will be much more simplistic. Rather than splicing the loan into multiple tranches with multiple owners, it will be less complicated and more transparent. It was way too complicated, and the originators did not have enough skin in the game. Right now the big problem with CMBS is that you can have upwards of 10 players involved in a single mortgage. Unwinding these deals is extremely difficult because you have competing interests up and down the capital stack.
When did it become apparent to you that we were in trouble in commercial real estate?
It wasn’t obvious until the middle of 2007 that it was going to end badly. I realized it with the Blackstone purchase of EOP (Equity Office Properties Trust) and the flip out to multiple investors and the same products changing hands multiple times for rising prices each time. People were betting on cap-rate compression and didn’t focus on operations. Going forward, operations will be the key. I don’t see rents rising and cap rates falling for a long time.
What is happening with new originations?
There are very few, and the box is very tight for what you can do. Recently the life-insurance companies have stepped up a bit and are looking for plain-vanilla deals with best-in-class borrowers and real estate. They want only stabilized assets in major metropolitan markets. Rates on 10-year money are between 7 percent and 8 percent, and leverage is 55 percent to 60 percent. Regional and community banks are focused more on the strength of the borrower than the real estate and are providing three- to five-year terms. But they want very liquid borrowers, best-in-class assets and recourse.
Will people who have given back their properties or not paid debts suffer long term?
Short term, yes, long term, I don’t think so. I know many excellent operators who have lost assets and filed bankruptcy in previous cycles only to come roaring back. Investing is risky, especially in the Bay Area, where the highs are very high and the lows are very low. It’s all timing. You could have done everything right in the last cycle and still gotten burned. If you sold in the first quarter of 2007 you are a hero, but most people did not. While a correction was obvious, nobody foresaw the magnitude of what was coming.
