Korpacz Investor Survey Finds Pricing Gaps Narrowing, but Industrywide Recovery Not Expected Until 2012
Commercial property investors may finally make the long-expected move off the sidelines and back into the real estate investment game as building owners and their lenders are forced to face the music and unload distressed assets next year, according to the latest quarterly investor survey by PricewaterhouseCoopers.
With commercial real estate conditions expected to weaken into 2010, many commercial banks that provided loans during the commercial real estate buying spree now face capital shortfalls and will be forced to stop extending loan due dates and begin cleansing their balance sheets of troubled assets, according to the third-quarter survey PricewaterhouseCoopers Korpacz Real Estate Investor Survey released this week.
That's more than a year later than many opportunistic investors expected. A number of Korpacz respondents expressed surprise and dismay that banks have continued their practice of extending maturity dates for on fixed- and floating-rate loans, hoping that the economy will bring some relief for leveraged property owners.
But with most of the commercial real estate industry expecting to feel the effects of the current recession for another two years or more, time may have run out. Korpacz respondents predicted that impending defaults and looming loan maturities will force a wave of foreclosures and distressed sales over the next year. Leading the charge will be commercial banks, which hold the vast majority of the real estate debt that fueled the 2005-07 buying frenzy. Some $153 billion in commercial mortgage-backed securities (CMBS) loans are also coming due by the end of 2012.
"Over the next year, more and more property owners will be in a position where they can't make their payments and can't supply additional equity to the lender in order to refinance," said one participant.
"Many traditional lenders are not recognizing the huge problem in front of them and seem to have no urgency in finding a solution," adds an investor.
While some investors are looking to the $153 billion of CMBS loans due in 2012 to spur buying opportunities, commercial banks account for a much greater percentage of the total looming debt. The expected action by commercial banks to address those loans may finally jump-start distressed asset sales next year as property owners are forced to sell or walk away from their properties leaving lenders with few options other than shopping them to prospective buyers, according to the Korpacz survey, which is based on responses from 115 real estate investors representing a broad spectrum of REITs, pension funds, private equity and other capital providers.
"There's been a lot of focus on securitized lending, which is also very stressed and unraveling now. But there's an even bigger portion of lending related to traditional lending institutions," Susan Smith, director of the real estate advisory practice at PricewaterhouseCoopers and editor-in-chief of the survey, tells CoStar. "A lot of the smaller regional banks are having the most stress right now and will be forced to take action."
Some investors are still in no hurry to dispatch capital, figuring they'll have a relatively wide window to pick up troubled assets. "The chance to buy at steep discounts during this downturn will be here for a while, so we are focused on maintaining and improving our existing cash flows," explained an investor.
The prices those properties will fetch in the marketplace remain anything but certain, however. There's still a wide gap between asking and bid prices across all property types and all U.S. regions, despite recent improvement in debt markets. Some investors said they have to remain tightly focused on maintaining occupancy and squeezing income out of their existing portfolios before acquiring any more buildings.
That said, the spread between buyers and sellers might be starting to narrow. Investors feel confident that the worst of value loss and depreciation is over, Smith said. Nearly 80% of survey participants believe that the market now favors buyers, up sharply from about 21% a year ago. At the same time, the percentage of respondents who feel the market favors sellers dropped from 54.4% a year ago to just 7% in the third quarter.
"This is the first quarter where investors have told me they see the gap narrowing. Not by a huge margin, but there's a willingness, mainly on the part of sellers, to come to grips with what's going on with pricing," Smith added.
Investors predicted that while the multifamily sector will begin to recover next year, fundamentals for office and industrial properties won't see significant improvement until at least 2011, with solid recovery not coming in retail until at least 2012. All 28 U.S. markets in the Korpacz survey saw declines in rents and occupancy in the first year of new ownership, a key metric of property level income and financial performance.
Specifically, investors in national suburban office properties expect market rents to drop as much as 20% in coming months, followed by a decline of up to 10% in CBD office, warehouse and distribution, and retail power centers, and up to 5% for regional malls.
Office rent declines will be the most steep in Manhattan and San Francisco, up to 20%, with an up to 15% drop in Phoenix and 10% declines in Boston, Chicago, Denver, Los Angeles and San Diego. Rent is expected to remain flat in the office markets of Dallas, Northern Virginia and Pacific Northwest. The Washington, D.C., San Francisco, Philadelphia and Long Island office markets are expected to recover first, while pain may linger in Sacramento, Denver, Cleveland and Fort Lauderdale.
In the warehouse and distribution sector, West Coast portals such as Oakland and Orange County, CA, and Portland, and Salt Lake City further inland will lead the recovery.
Retail is expected to make an early recovery in just a few regions, including Oakland-East Bay, CA; Fort Lauderdale, FL, Nashville, TN and Houston. However, the Portland, Los Angeles and Minneapolis apartment markets will show some strength.
Demand for U.S. lodging, feeling the effects of "staycations" and cautious spending by businesses, will likely decrease more than 5% in 2009, with occupancy and average daily rates (ADR) in the second half of the year below last year's levels, according to the Korpacz survey.