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REAL ESTATE Commercial Pricing

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Bronze Contributor
Aug 9, 2007
hope all had nice holiday season... my kid made out like a bandit!

I just read this article and have to admit in hindsight that cap rates in single digits were hard for me to justify associated risks. Commercial property is only as good as the return you get...

SteveO, there has just got to be more opportunities on the horizon... I know you said that Fannie and Freddie are filling the voids after many mortgagers went out of biz or just vacated the scene, but can they really meet all of the demands?

short term financing looks like that's the next area that will get squeezed dry after getting burned... banks are eliminating risks everywhere... here from today's WSJ...

Credit Downturn Hits the Malls ; Centro Properties' Woes Underscore the State Of Commercial Market
December 26, 2007; Page C1

The credit crunch triggered by the downturn in the housing market is creating problems in commercial real estate, driving down prices of office buildings, shopping malls and apartment complexes, and leaving some owners scrambling for cash.

One victim is Centro Properties Group, the fifth-largest owner of shopping centers in the U.S. The Australian real-estate company saw its share price fall by 90% in two days last week as it struggled to refinance short-term debt it took on to fund its $6.2 billion acquisition of New Plan Excel, one of the biggest owners of strip malls in the U.S.

Centro had planned to pay off the short-term loans by selling long-term debt via the commercial mortgage-backed securities market, but the lack of buyers forced it to get a two-month extension from its creditors. Commercial mortgage-backed securities, or CMBS, are pools of loans that are sliced up and sold to investors as bonds.

Residential mortgages are packaged and resold much the same way, but so far the CMBS market hasn't had any significant problem with defaults.

In another high-profile case, the clock is ticking for Harry Macklowe, the New York developer, who is struggling to raise financing by February to replace $7.1 billion in short-term money he borrowed to finance his heavily leveraged acquisition of seven Manhattan office buildings this year.

The predicament facing Centro, Mr. Macklowe and numerous others underscores the state of the once-unflappable commercial real-estate market. For the past few months, the sector has been in a state of near-paralysis, as financing has nearly dried up. The number of major properties sold is down by half, and many worry that the market will continue to deteriorate as property sales remain slow, prices continue to drop and deals keep falling apart.

Where the Fog Is

"Where we're really in a fog is on the capital markets side," said Michael Giliberto, a managing director of J.P. Morgan Chase & Co., on a conference call last week about the state of the commercial real-estate market.

The CMBS market was the engine that drove the commercial real-estate boom. Over the past few years, the issuance of CMBS allowed banks to get rid of the risk on their books, lend with cheaper rates and looser terms and that made it easy for private-equity firms to do huge real-estate deals.

Between 2002 and 2007, CMBS issuance rose to an estimated $225 billion from $52 billion, according to Commercial Mortgage Alert, a trade publication that compiles its own statistics.

Real-estate investors aren't the only ones feeling the pain. Many big banks issued short-term loans to buyers and planned to sell them off later, much the way they do with loans made to private-equity buyout shops. But the banks have gotten stuck with an estimated $65 billion in fixed- and floating-rate loans on their books, according to J.P. Morgan. Some of the largest issuers have been Lehman Brothers Holdings Inc., Credit Suisse Group and Wachovia Corp.

Lehman has said that about half of the $79 billion in mortgage debt it was holding at year-end is CMBS-related. Wachovia and Credit Suisse declined to comment.

'Cognitive Dissonance'

Prices, however, haven't appeared to fall, though much like residential real estate, there is often a period where buyers stop buying but sellers refuse to lower prices.

There is "cognitive dissonance" between buyers and sellers, says Dennis Russo, a real-estate attorney for Herrick Feinstein. "There's a period of time in which the seller cannot psychologically move his price down. They haven't accepted what's happening in the market."

Baybrook Gateway Webster, Texas
According to Real Capital Analytics, sales of significant office properties plummeted to $7 billion in November, a 55% drop compared with November 2006. So few deals are getting done that many market experts say they don't know how to put a value on many buildings right now -- but almost everyone is in agreement that the valuations are dropping.

Often, deals aren't done because financing either isn't available or is so expensive that buyers are insisting on price reductions that sellers won't accept.

For example, Ackerman & Co., a brokerage, just pulled a suburban Atlanta office building off the market after bids came in below estimates. Developer Michael Reschke has so far been unable to get financing for a J.W. Marriott planned down the street from the Chicago Board of Trade, despite his willingness to put more cash into the deal than originally planned.

The commercial real-estate market was still soaring in early 2007, long past the peak of the residential real estate market. But a combination of frenzied deal making, high prices and credit worries combined to sink the sector.

First, private-equity firm Blackstone Group LP made its record-breaking $23 billion purchase of Sam Zell's Equity Office Property Trust, the nation's biggest owner of office buildings. Then it turned around and sold off many of the properties at even higher prices. The frenzied deal-making surrounding the EOP portfolio came to symbolize frothy valuations, which triggered a backlash in the lending markets.

In April, Moody's Investors Service said lenders' underwriting standards had become too lax during the run up in prices. The warning scared investors and prompted bankers to raise interest rates and required borrowers to put in more of their own money into deals.

Timing of the Hit

The subprime-mortgage downturn hit last summer, prompting fears that the problems plaguing the residential market would spillover to the commercial side. Banks were caught holding debt on their books, making them less willing to lend.

Superior Marketplace Superior, Colo.
Centro Property got caught in the crunch. Its billion-dollar acquisition of New Plan Excel, a U.S. shopping center real-estate investment trust, came in February -- a moment many experts believe was the height of the commercial market.

Now its lenders, primarily Australian banks, are pressuring Centro to sell assets before they will consider refinancing.

"Certainly the private-equity players played that game for a time, and they could have been caught in a similar situation but they were very quick to turn around and sell their assets," said Paul Adornato, a real-estate analyst with BMO Capital Markets Corp. Centro's chief executive, Andrew Scott, didn't return calls for comment.

Credit was so plentiful when Mr. Macklowe purchased his Manhattan office buildings from Blackstone, he only needed to put in $50 million of equity to secure $7.1 billion in debt, which included a bridge loan and the senior mortgage, people familiar with the deal say.

He is now looking for an equity partner, people said. A spokesman for Mr. Macklowe declined to comment.

Write to Kemba J. Dunham at

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Legendary Contributor
Summit Attendee
Speedway Pass
Jul 24, 2007
The following is an excerpt from an article at Torto Wheaton. You will likely need to join them in order to read the full article but they have some worthwhile information:

The 3rd quarter results for cap rates show that capitalization rates for the various property sectors have stayed at roughly the same level (between 4% and 5%) nationally over the last three years. During that time, commercial property markets experienced extreme cap rate compression, which is considered out of line with the long-term trend in the market. On cursory examination, the stability in cap rates into the 3rd quarter might appear counterintuitive, since financial market volatility increased significantly during the same period as a result of the subprime mortgage troubles. Given this increased financial market volatility and uncertainty in the debt markets, one might have expected strong increases in cap rates.

This analysis demonstrates that the flat trend is due to inertia from rent growth that was in place before the subprime crisis hit. This residual rent growth has been counteracting the negative effects of market volatility, keeping the cap rates at the same level.

One thing I have found is that you can always find articles and information to support what you wish to believe.

Without a doubt, there has been some cap rate compression. I have felt for a while that cap rates will climb. I also agree that they will tie into the lending environment and interest rates.

Where we disagree is the magnitude and the ensuing issues around it. I do feel that job growth and retail spending have slowed enough to do some damage to the office and retail commercial fields. There has been a significant amount of overbuilding in some areas to go along with this. I would not buy into these sectors for a while myself.

Apartments are still a different animal. Many areas are still showing improvements in occupancy coupled with rent growth. This is what I hang my hat on. A rise in cap rates can be overcome with strong fundamentals. If the fundamentals for the area are strong enough, a significant increase in cap rates is unlikely. In fact, downward pressure usually occurs in improving areas.

I have and will continue to factor in cap rate fluctuations in my analysis. It is important to look at the downside potential as well. All investments have some risk to them.

The idea that a cap rate must be in double digits is very limiting in my opinion. That would limit me to geographic locations and parts of town that are of less interest and typically have less upside potential. If you note the cap rate quote in the article it states them at 4-5%. I have hit home runs with properties that are less than 5%. Granted, my pro forma showed a strong 7.5% with improved financials.

There is no harm in waiting if that is what your data tells you to do. My plan is still wrapped around buying underperforming properties in improving areas. I like the national demographic for renters over the next few years. A slowdown in development would be very welcome in supporting more growth in the rental market.


Legendary Contributor
Summit Attendee
Speedway Pass
Jul 24, 2007
SteveO, there has just got to be more opportunities on the horizon... I know you said that Fannie and Freddie are filling the voids after many mortgagers went out of biz or just vacated the scene, but can they really meet all of the demands?

There are always opportunities. You need to determine the cycles of the apartment market for given metropolitan locations and capitalize on them. It is always a plus if you can catch the macro apartment cycle in an upturn. The areas that I look at usually have fairly motivated sellers.

I had a long conversation with a Freddie lender about the current lending climate. I expressed concern about them potentially getting overloaded. The answer that I got was that they are charged with providing loans for affordable housing. There are less loans for single family these days. Their resources are shifting over to the apartment side to provide for their charter. According to this source, there is plenty of liquidity out there being provided to them and they are trying to place it.

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