Alvarado: The unprecedented level of public policy support, with $4 trillion already provided of $12 trillion pledged to restore the financial markets and create economic stimulus, has effectively halted an economic free fall, but it has also stalled a recovery in the commercial real estate capital markets as banks continue to extend maturities for their borrowers, avoiding foreclosure in a practice jokingly known as “delay and pray.” Banks need to write off or dispose of these loans to clear their balance sheets and create the capacity to write new loans. We also need to restart the CMBS market, which will require new standards for underwriting and for the rating of underlying securities.
A recovery in values could be delayed until 2012 and beyond, based upon the lag effect typically seen in the investment property market. The market will first need to see positive results in corporate earnings growth, followed by rehiring, which will lead to absorption of surplus lease space and, ultimately, leasing and absorption of new commercial space.
Dallas is faring better than most markets because it entered the down cycle with significantly better economic and real estate fundamentals than during any previous downturn. The Dallas economy is well-diversified and did not sustain the massive layoffs seen in other markets that have heavy concentrations in manufacturing or financial services. The market also had a historically low amount of commercial space under construction this time, which will limit the amount of oversupply. Finally, the Dallas market did not experience the exuberance seen in coastal markets where rents and prices doubled in less than five years.
Gillespie: Tenant demand will be the primary market driver for most commercial property types. Recovery in sales volume will require improvement in employment rates, leading to positive space absorption, which will spark some market optimism. As long as new construction remains controlled, we can expect low to moderate supply-side pressure on rents. Although access to capital is advantageous, we do not expect more favorable underwriting standards to be the primary market catalyst — it’s jobs.
Although there has been some slight movement recently, we expect underwriting standards to remain conservative when compared to the standards in place during the market peak. Moreover, we are not expecting lending practices to relax to their previous standards. Potential investors will have to adjust to the “new normal” characterized by lower loan to value (LTV) rates, higher debt service coverage requirements and higher implied cap rates. Investors with ready access to cash as well as the ability to rely on longstanding relationships with a more diverse group of lending sources will be in an advantaged position.
Greene: Those life (insurance) companies that have not re-entered the market as lenders need to do so. Also, the Fed must recognize that the commercial banks play a critical role in providing commercial real estate mortgages, especially short and intermediate term. To dramatically curtail their lending at this time would be a further detriment to an already difficult situation.
Long term, we must have an active commercial mortgage backed securities platform. The life companies and commercial banks combined do not have the capacity sufficient to fund the need for commercial mortgages. At least one major investment bank has announced its attempt to reintroduce a CMBS platform in 2010. It would be in an improved structure in which the originator retains a portion of the risk of the loan made. This would be a definite enhancement to the previous CMBS model.
We all know many lenders got too aggressive in underwriting loans back in the 2006-2007 time frame. Now, the pendulum has swung too far in the other direction, with underwriting being too conservative. Most lenders are looking to conservatively finance the same deal — institutional quality real estate with strong cash flow, great tenants, minimal vacancy and near-term rollover, etc. — the “very low risk” deal. Underwriting will eventually settle somewhere in the middle of these extremes, and this is already starting to occur. More real estate transactions will close in 2010 due to greater availability of viable financing.
Hardage: I understand the financial institutions wanting to delay and extend their troubled loans in hopes of an economic rebound that will slowly lift all boats. But until they and we “take the pain,” acknowledge the loss in value of a huge number of commercial loans and assets, then discount and sell those assets at pricing that attracts the mass of private equity that has been assembled, it doesn’t seem the market can heal, or that transaction volume will return. The expeditious formation of an “Resolution Trust Corp. No. 2” that can absorb and redistribute these assets is a concept that I believe must occur in order to free up or remake the lending institutions and restart transaction activity as well as new lending.
Kartalis: Well, everyone will tell you that the CMBS market or something similar must reappear on the radar screen or buyers will be limited on how much they can buy. There are institutions lending today, but loan-to-value ratios are low and personal guarantees are required. This means more cash is required up-front and personal guarantees pollute your financial statements as guarantees that reduce your borrowing power. Without non-recourse loans, large transactions will be difficult for all except institutions.