Emerging Trends in Real Estate 2010 - Part III
My view of real estate is organic based on market-driven developments with profits generated from the successful execution of fundamentals. Huh? You know, finance it, build it, sell it, and go to the bank. But that was yesterday. Today developers are sidelined on the links with TaylorMade replacing shiny towers. Financing for new projects is as elusive as a hole in one.
So where flows the trickle of capital that lurks out there? The lead statement on Capital Flows from the Emerging Trends in Real Estate 2010 suggests that investors must get ahead of available capital in order to score:
“The key to success in real estate investing is to follow the capital flows, not the fundamentals. Anticipate what capital wants and be there.”The hens are chasing the fox. The play has changed but the game changer is still leverage.
ET predicts it will be a slow comeback for lenders in 2010. Debt markets will start to resuscitate but will remain “far from normalized in the wake of unprecedented deleveraging.” The survey respondents agree that the debt markets will bottom this year and any lending will be “conservative, expensive, and extended only to most-favored relationships.”
With credit on a shoestring, commercial real estate markets in 2010 will be led by all-cash investors buying quality properties from distressed borrowers or directly from lender’s REO portfolio. Distressed sales will help the market find firm footing in a bottom and form a foundation for a recovery.
Before financing can regain a substantial foothold for commercial real estate, a monumental remodeling will have to effected on the CMBS market ...
The next big fix will be the commercial mortgage backed securities. Assuming a recovery of the financial sector, the real estate industry will have to figure out what to do with the collapsed CMBS market, “a classic example of a good idea gone horribly wrong.”Lenders loosened underwriting standards and off-loaded risky loans into securities markets, fueling deals, ballooning prices, over-borrowing and over-building. “Ironically, CMBS was a solution for recovering from the last real estate debacle, but got us caught in a worse trap because the structures became too complex.” Now mired in litigation hell, special servicers and multitranched borrowers will fight it out for years.
With the bubble blown sky-high, hundreds of billions of dollars of CMBS loans will come due over the next five to 10 years and there is ZERO appetite by bond buyers to return to the CMBS orgy. In virtual unanimity, the Emerging Trends respondents agree that the overall real estate industry revival depends on reconstituting the CMBS markets and restoring confidence. But there is no quick fix on the horizon. “Reinventing a new detranched, ‘back-to-basics’ CMBS model could take several years at least.”
The unraveling of the CMBS market may require government intervention for survival. Most of the respondents believe that the government will come to the rescue to backstop the mass of loans coming due. After all the feds came to the aid of Fannie and Freddie. The difference being that Fannie and Freddie is the darling child of every politician in this country and the American Dream, although battered, is still alive and well.
Here are the top capital markets’ lessons learned by investors as they scramble to stay alive:
- Diversification doesn’t overcome systemic risk.
- In the global marketplace, all regions and credit markets inextricably link.
- High credit ratings don’t necessarily mean high-quality investments.
- Mathematical models cannot fully simulate or manage risk.
- Risk of borrowing short to invest in illiquid assets cannot be hedged.
- “Tails” on bell-shaped curves exist for a reason.
“When you justify a deal based on financial engineering, it’s the kiss of death,” says an interviewee. “The industry did leverage entirely wrong, putting increasing amounts of debt on riskier and riskier deals. For leverage to really work, you should put it on the least-risky deals in the early part of market cycles.”For the small sliver of the debt market that is still in the lending business, the loans look like a different species from the issuances of prior years. We’re talking about 60 to 65 percent loan to value ratios, 7 to 7.25 percent interest rates and 1.4 debt-service coverage. The recent aggressive financial models for commercial real estate deals can’t be supported on the shoulders of the “New Deal.”
Currently in its 31th edition, Emerging Trends in Real Estate 2010 is collaboration between the Urban Land Institute and PricewaterhouseCoopers and is a highly anticipated annual industry review. The report was based on surveys and interviews with more than 900 top industry professionals including developers, investors, brokers, analysts, researchers, appraisers, and academics.