Ut roh: Could commercial RE be next?

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graphrix_IHB

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As an avid reader of Calculated Risk, as many of you are, I or we are all aware of how commercial RE may be next. Well, professor Roubini adds his thoughts, and has some great links. The spreads on the CMBX have jumped up. Unlike the ABX, that mimics the MBS portfolio, the CMBX is inversely traded, or the spreads have widened, and up is bad.

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CR posted about the CMBX, and on Coutrywide's CRE portfolio.

I guess it really does come down to fundamentals, and those 2% or 3% cap rates never really made sense in the first place. In OC we have a huge negative absorption rate, and yet they keep building.
 
"I guess it really does come down to fundamentals, and those 2% or 3% cap rates never really made sense in the first place. In OC we have a huge negative absorption rate, and yet they keep building. "

Is there an wasy way to explain the above to those of us who are mortgage business challenged?
 
Negative absorption is when they build units faster than demand increases and thus cause in increase in the vacancy rate.

Cap rate is the return on the invested capital. A 2-3% cap rate means people where speculating on appreciation or rent increases as the current return for owning the property is lower than using treasury bills or CDs.

Or in plain english, buying a Commercial property as a rental penciled out about as well as buying residential property in Irvine in 2005 for rental as an investment.
 
NSR,

Your thoughts are correct, and I see this every day in the apartment rental business. My cap rate is only 3.8% and will only rise about .5 to 1.5% per year. This next year I'm expecting a modest 1.1% increase. BUT you must also remeber that most banks will not lend you the money unless you have a good amount down. Usually 20-40%. They also force you to show a good amount of profit.

The real risk from then on is keeping your operating costs from rising out of control. One or two bad clients/tenants and you could quickly be in the negtative for a good while. This is also a good sign that most people are under capitalized and don't have enough liquidity to absorb any bumps in the road. SAVE, SAVE, SAVE! Anyways good luck

-bix
 
The drops in commercial lending are due to the same credit crunch. The secondary market is just not functioning so cmbs has completely dried up.

The difference is that the commercial loans are still performing, versus residential loans that are not. Loan delinquency in commercial is still very low. Fundamentals are still pretty solid. I don't think you'll see much increase in non-performing loans. The result should be a calming down of some of those spreads in the lower rated tranches of commercial paper.

They are still building here. But that is all stuff that started a year or two ago. Nobody is breaking ground on anything new here. Office vacancy will go up as a result....but it shouldn't go up too far. The total volume of space under construction wasn't that big....nothing like the 80's.
 
More proof of the coming recession, possibly depression. The contraction of credit will affect ALL industries. Even if you're a company like Microsoft and have ZERO debt, your customers and business partners have lots of it.

I honestly can't believe my ears when I hear these so called "experts" on CNBC denying the chance of recession. Can they be this misguided? Is it more likely that they are just afraid their clients will start pulling money out of their funds? How can people sit there and watch company after company write-off billions of dollars and shrug it off?? How can Larry Kudlow stare into the teleprompter and tell the world... "I think this is a beautiful time to buy financials"?????????
 
"The total volume of space under construction wasn't that big"

I have heard that over 2 Million square feet of office is coming on line in Orange county with the bulk of that in Irvine. Just driving around and seeing all the high rises and tilt-ups, it looks like an awful lot of space to me.
 
The credit crunch is causing business investment to grind to a halt. I don't think we can stay out of recession. Decisions being made by businesses right now are all on the conservative side.

With business activity slowing, we know the consumer is not going to bail out the economy. The only growth is in exports, and I don't think that's a big enough of an engine to keep us out of recession.
 
IR,

I know 2 million square feet is a lot, but even if that entire amount was delivered 100% vacant, I don't think it would have a huge impact on the county's vacancy rate.

How many total square feet is the market?
 
In the first three quarters of the year approximately 2.65mil sqft. was constructed, and that leaves 3mil sqft. in the construction phase.

The absorption rate YTD is negative nearly 440k sqft., and last quarter it was negative 800k sqft..

There is currently 15.5mil sqft. available, with 10.4mil being vacant. The vacancy rate has jumped to 10.8% from 7% YOY, and the availability rate has jumped to 16% from 11.5%. The greater airport area has a vacancy rate of 12.9%.

There is 1.35mil sqft. under construction in the greater airport area, and 1.5mil sqft. under construction in South OC (this includes parts of Irvine).

Certainly not a positive picture. With flat, to possibly negative, job growth it will only get worse.
 
So if 10.4 mil sf is a 10.8% vacancy rate, there is plus or minus a 2% to 3% increase in vacancy from the supply pipeline. I agree that is not good....I guess what I was trying to say was that is not enough to cause a noticeable increase in cmbs delinquency rates.
 
The greater airport area has a vacancy rate of 12.9%.

I work in this area and I'm amazed at the vacant commerical and light-industrial footage boxed-in by Main/Barranca/Jamboree/55. Some of these buildings have been empty for several years.
 
We have joked on this blog in the past about the Marquee Towers being dark at night. Have any of you noticed that you can see through all but a few of the floors on the new office tower right on the corner? New Century was supposed to lease all this space, and now it is sitting vacant. I remember there were stories after the S&L disaster about all the see through office towers in Houston, Texas.
 
I could see Orange County being quite similar. Seeing 1/2 of the mortgage lender's space become vacant is entirely possible and just look at how many mortgage companies you see on buildings here. Then think of how many homebuilders and developers you see....
 
in the office sector, keep in mind that it often takes time for changes in the mkt to get reflected in their valuations. this is partially due to long term leases getting renewed at current rates. for nearly all of the publicly traded office reits, while vacancy rates may go up, the leases that are being rolled over are getting re-upped at rents substantially higher than they were previously. so however counterintuitive, these companies have all been reporting decent earnings growth. but the tide chgs once rent growth is unable to hide the vacancy rates, or worse yet, the growth isnt there at all.

the other issues is comp. no credit = no transactions = no comps = no cap rate adjustments = no change in valuations. at some point, earnings growth will slow down enough for someone is going to realize how ridiculous it is to be getting a sub 4% return on these cumbersome assets. once people try to unload, we'll see revaluations across the board and prices plummet. its just a matter of when...
 
Heh... looks like I was maybe... just maybe correct about CRE back in 07. I dunno... I've been told I have been wrong month after month, but this seems like I was right. Was I right, or am I just imagining it? This was in 2007, a full year and a half ago.

Oh... BTW... the spreads on the CMBX are increasing again, and for a refresher, up is bad mmmm kay...

Here is the 07 AAA CMBX:

http://sf.markit.com/cache/curves/8481ba28c53875085b4f7fe9108.png
 
HT to CR.

Maguire Properties Warns of Loan Defaults

Creditors to Get Seven Buildings With $1.06 Billion in Debt; Vacancies and Falling Rents Pressure Landlords

Maguire Properties Inc., one of the largest office-building owners in Southern California, is planning to hand over control of seven buildings with some $1.06 billion in debt to creditors, the latest sign that rising vacancies and falling rents are causing stress in the commercial real-estate sector.

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Maguire, which borrowed heavily during the go-go years to make disastrous top-of-the-market investments, mostly in Orange County, notified the buildings' mortgage holders Friday that it expected "imminent default" on the loans. The buildings are all worth less then their mortgages and aren't generating enough cash to pay debt service and finance leasing expenses.

Maguire's problems are an example of the mounting pain among owners and lenders to office buildings, stores, hotels and other commercial real estate that is causing concern among banks and regulators that the sector may drag down a hoped-for economic recovery just as it is getting started. Initially, a dearth of financing caused the distress. But Maguire's problems show that falling rents and rising vacancies are causing landlords to run out of cash.

Robert Maguire, the developer who founded the company and took it public as a real-estate investment trust in 2003, bought properties during the years before the bust on the assumption that rents would continue rising. But just the opposite has happened in Orange County, where the vacancy rate hovers around 20%, up from 6% three years ago, according to Maguire.

Chief Executive Nelson Rising, who was brought in by the company's board last year to succeed Mr. Maguire, said in an interview that restructuring the debt on six of the buildings, located in Orange County and Los Angeles, is one possibility. But he said the most likely scenario is that the mortgage holders will take over the properties and try to sell them. Maguire already has a deal to turn over one of the buildings, Park Place One, in Irvine, Calif., to LBA Realty, a real-estate company that acquired the debt on the property at a discount in the spring. A telephone call placed to LBA's principal wasn't returned.

http://s.wsj.net/public/resources/images/MK-AX696_McGUIR_DV_20090809213917.jpg

Among the office buildings that Maguire will turn over to creditors is Stadium Towers Plaza.

The debt on the other six properties was packaged by Wall Street firms and sold as commercial mortgage backed securities, or CMBS, to dozens of institutional investors. Mr. Rising said that Maguire would work closely with the servicers of that debt to transfer control of the buildings. The seven buildings, with 4.2 million square feet, make up about 20% of Maguire's portfolio.

Maguire, scheduled to release its second-quarter earnings Monday, will take a $345 million charge on the properties' loss in value. The company also is set to report a net loss of $380 million for the quarter, compared with a net loss of $110 million a year earlier.

Mr. Rising has succeeded in reducing Maguire's debt by about $1.6 billion. His plan has been to sell or give back to lenders troubled properties and shore up Maguire's balance sheet to the point that it is able to raise capital like other real-estate investment trusts have been doing.

But Maguire's future still looks dicey. The company still has $3.5 billion in debt, and some analysts say that amount exceeds the value of its remaining properties. "Almost every building in [Maguire's] portfolio is under water," says Michael Knott, an analyst with Green Street Advisors. "I don't envy some of the choices that they are having to make."

Maguire's stock, which traded around $12 a share one year ago, has been trading below $1 a share in recent months, a sign that many investors expect the company to fail.

Mr. Rising acknowledged that Maguire is encumbered with properties that are cash-flow negative, including three recently constructed buildings. But he expressed cautious optimism that the company would be able to dig out of its problems. "With this particular initiative we've made a big step," he said.

Landlords throughout the country are watching the cash flows of their buildings dwindle. Office vacancies nationally hit 15.4% as of June 30, up one percentage point from a year earlier, as businesses dumped 25 million square feet of space on the market, according to Colliers International.

Not only are vacancies rising, but landlords often have to cut rents when tenants renew their leases to keep the tenants. Owners also have to lay out incentive packages to attract tenants by offering them interior build-outs and months of free rent. Mr. Rising estimated that it would have cost Maguire about $31 million a year to keep the seven buildings because they weren't generating enough money to pay these and other expenses and debt service.

While these trends are clobbering landlords, tenants who have the good fortune to be in the market for space are getting deals. For example, accounting firm Moore Stephens Wurth Frazer & Torbet signed a $3.35 million, seven-year lease a few months ago for 19,000 square feet of space in a Maguire-owned building in Brea, Calif.

Maguire cut its initial rent offer by about 20% to $25 per square foot and offered generous incentives: footing the bill for the space's renovation and charging only a $10,000 monthly rent for the first year, according to John Metzen, Moore's administrator. "We got what we thought was an incredible deal," said Mr. Metzen, whose firm was represented by CB Richard Ellis.



For the CRE bulls from 2007, who said I didn't know what I was talking about and that CRE would be fine during this recession... What say ye now? Don't be silent, speak up!
 
The market seems to like it when these companies hand back the keys on properties because it means they'll be staving off bankruptcy for the time being. Why, I have no clue. Their debt-ridden carcass is still on life-support and investors are happy they cut off a few frostbitten toes.
 
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