Commercial Real Estate Professionals Try To Sort Through the Disarray in Financial Markets
Marty Busekrus, a senior associate
investment properties for CB Richard Ellis | Capital Markets in Boca Raton, FL, got a call this past Monday morning from a potential
office building buyer as mania struck the stock markets. The buyer, who has been trying to buy an office building from one of Busekrus' clients, said his seller better sell quick as the stock markets were tanking.
Busekrus contacted the seller who responded with a different take, saying instead that everyone is shifting to hard assets so he's thinking about raising the price.
What's a broker to do? From the range of responses we received for this article, Busekrus' experience is not an isolated incident.
Jared Williams, asset manager for Acquired Asset Group of the BB&T Asset Resolution Division in Palm Beach Gardens, FL, said he has halted the search for buying commercial property for now, saying he plans to remain liquid and start to evaluate more international investments.
Luke Wood, partner with Haverwood Management in Austin, TX, was glad to see the markets recover on Tuesday and said his strategy on
commercial real estate investments has not changed. He expects to continue acquiring properties for the remainder of 2011.
Those dichotomies pretty much sum up the disarray in commercial real estate markets this week following Standard and Poor's expected but nevertheless staggering move to downgrade the U.S. debt ratings.
For a related discussion of the impact on commercial real estate of S&P's downgrade, see article by CoStar Senior Real Estate Strategist Chris Macke.
"There is no doubt that we have entered into a period of uncertainty, as the S&P downgrade of U.S. debt ignites a new round of confidence crisis globally," Tim Wang, Ph.D., senior vice president of Clarion Partners in New York told CoStar Group. "This news couldn't have come at a worse time after the recent GDP downward revisions, indicating a much deeper recession in 2008-2009 and softer recovery from 2010 through Q2 2011 than originally anticipated."
"Although the long-term impacts of U.S. debt downgrade are unclear at this moment, investment risks have elevated substantially over the past few weeks," Wang said. "A double-dip recession would widen risk spreads, shrink capital availability, discourage consumer spending, and reduce demand for commercial space."
"While we always use sensitivity analysis in our underwriting process, today we are paying particular attention to the downside scenarios in our investment selections," Wang added.
Based on the Federal Reserve Board's words this week, it sounds like real estate as a business could be in for a bumpy ride over the near term.
The Federal Reserve's Federal Open Market Committee met this week and issued a statement saying "economic growth so far this year has been considerably slower than the committee had expected. Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed."
The FOMC now expects a somewhat slower pace of recovery over coming quarters than it did just a month ago. Moreover, downside risks to the economic outlook have increased, it said.
The FOMC said it decided to keep the target range for the federal funds rate at 0% to 0.25% at least through mid-2013.
"The U.S. faces multiple challenges including tepid economic growth, gridlock in Washington, and an unsustainable debt trajectory. The inability to enact a comprehensive solution to the economic and debt concerns led Standard & Poor's to lower the long-term rating of the U.S. debt from AAA to AA+," said Asieh Mansour, PhD, CBRE's head of Americas Research. "While we anticipate continued stock market volatility, commercial real estate will not fare as poorly because it remains a preferred asset class, within a well-diversified multi-asset institutional portfolio."
Andrew Little, an investment banker with John B. Levy & Co. in Richmond, VA, said that although the downgrade has made market participants more anxious, and the immediate impact is widening spreads, the cost of capital for better quality commercial real estate has not gone up.
"The bond market certainly doesn't believe there will be any U.S. Treasury default, but prospects of continued political gridlock and further downgrades has investors of all kinds trying to figure out where to put money," Little said. "Commercial real estate doesn't look too shabby when compared to many of the alternatives."
However, Little added, "The unfortunate reality, double dip recession or not, is the U.S. economy is weak. That means we will continue to see weakness in commercial real estate related to corporate belt-tightening, consumer pull back and tenants failing."
CoStar contacted commercial real estate professionals across the country this week to assess how the week's dramatic financial developments are impacting the CRE markets.
Consumer Confidence Can't Afford Another Hit
Garrick Brown, Northern California Research Director, Cassidy Turley BT Commercial, San Francisco, CA
The destructive nature of the debt ceiling debate was already playing out in the stock market before Standard & Poor's downgrade. This just adds another piece of bad news into the mix and it is hard to tell how much of an impact this will eventually have on interest rates.
My big fear now is about confidence -- investor confidence and consumer confidence. A month ago, I would have discounted the possibility of a double-dip recession. Today, I would have to assume the chances are somewhere between one in two and one in three.
The real question in the days ahead is when the stock market will stabilize. If not soon, it is bound to take its toll on consumer confidence (and eventually) consumer spending.
There is no doubt that consumer confidence is already taking a hit. The question is whether sentiment will sour to the point where consumers finally pull back on spending… and make no mistake about it, consumer spending has been one of the few bright spots of the economy. All I know is that if consumer spending drops off a cliff that we will go into that double-dip.
We All Know the Problem
Michael Louis DiFede, Director of Acquisitions, Bergman Real Estate Group, Iselin, NJ
The S&P downgrade is just the latest bit of bad news for the economy. This only adds yet another element to the uncertainty that has stifled job growth and investment and stifled space absorption in New Jersey. It is really just recognition of the problem that we all know we have - we need to reform entitlements (Medicare, Medicaid and Social Security) to insure long term viability and we need to get the government out of the way of business to create jobs.
Further Slowing of the Economy
Randy A. Rauch, President, Rauch Realty Group, Pompano Beach, FL
A lot of my clients as well as me are not sure yet what impact this will have since this situation is new and new financial crisis the U.S. will have to deal with. This compounded with the financial difficulties we are already dealing with is very concerning. I believe the business climate will continue to be cautious in investing in the U.S. market and will slow the economy further. I don't believe that we ever were out of a recession, going on now for four to five years as it began in the Bush administration. A serious financial depression is unfortunately more likely.
Washington Didn't Do CRE Any Favors
Mac McCall, Regional Managing Director, Franklin Street Real Estate Services, Atlanta, GA
Many clients felt we were at or near the bottom as some good news from retailers and company financial reports were indicating a slight recovery. Washington didn't do Americans any favors with their latest political sparring and this has led to shaky consumer confidence and kind of ended any momentum we had built up.
I don't think any specific changes have been made by the private investment community. There is still a tremendous amount of capital ready to be deployed for sensible investment opportunities. Many investors predict more product from lenders and special servicers to come to market as early as the fourth quarter as there is visible bottom in NOIs and more loans being foreclosed, forcing REO owners to liquidate some assets.
I envision good commercial real estate being a great substitute for other investment options. With yields for bonds and equities in the low single digits, the real estate market should see continued high demand as investors thirst for a reasonable yield. Class A product and net leased investments to strong corporations should see continued demand.
Acting in Advance of Rate Hikes
Ray Turchi, Senior Investment Associate, Marcus & Millichap, Orlando, FL
Clients who were thinking of holding property now and selling to a better market down the road are giving more thought to selling now due to a prolonged market recovery, and also, the potential rise in the capital gains tax rate when the Bush tax cuts expire. In addition, clients are getting commitments on loans ASAP in case of a significant rise in long term interest rates.
The "Crowding Out" Effect
Brent Tharp, Senior Vice President, GE Healthcare Financial Services, San Diego
I'm more concerned about employment and end demand for space than I am about the U.S. debt rating, as I have been for the last couple of years.
The only worry I have is that the U.S. cost of debt issuance will increase and thus the total debt, including interest payments, will increase further and faster. As a result, the "crowding out" effect on private spending will be even greater than it already is.
Last week, U.S. credit default swaps were priced where BBB is, which indicates that future auctions may have to give a yield that is more in line with that type of rating, but from week to week, it's not possible to know for sure.
Could Bring More Product to Market
Brian Merzlock, Valuation Manager, Williams & Williams Real Estate Auction, Tulsa, OK
Clients seem to have anticipated this well ahead of the actual events. Some of them have been waiting for this knowing that it would eventually come to fruition. Most clients are holding their cash and seeking only lucrative markets with extremely strong NOI.
Concerns over the actual cost of recent commercial real estate are major topic - some of the commercial buildings are the most appealing structures in our cities… This cost is transferred to the consumer and we know consumer spending has been reduced significantly. Consumers will eventually determine whether emotion is enough to separate with their cash but eventually they end up spending less and less in the retail markets regardless of the setting. Only in the USA do you find every marketplace air conditioned and decorated with marble tiles.
We hope for the best but anticipate that the continual credit crunch will bring actual 'market value' to a very realistic band of price action instead of the 'hype' that commercial real estate has brought in previous years. You will see more partnerships formed to limit risk and increase transparency.
Foaming at the Mouth
Howard Applebaum, President, Corporate America Realty & Advisors, Rutherford, NJ
The biggest fear that I would have is for lenders to maintain or tighten credit restrictions for businesses and real estate operators that don't have access to "major capital markets" and for "disinflation, and stagnation to occur in our economy. Today's Federal Reserve / Bernacke announcement not to raise interest rate until 2013, in my opinion was similar to the "foam" that emergency crews spread on a runway to try and prevent a plane that is making an "emergency landing" from catching fire... and we know the possible results that can happen.
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