Could commercial real estate be the next big leg down?

Rising unemployment causes office vacancies and retail stores to close. Some private equity guys seem to be in a state of denail on this. Some think problmes in the commercial real estate industry are strictly about the capital markets.

Some investors selling their assets don’t believe their overpaying and overleveraging back in 2005-2007 has left them vulnerable to the current economic recession. Some actually believe that when money starts flowing again, they can easily refinance because they are not under water.

Sounds like a state of denail to me. These investors should walk around Manhattan and the malls in the suburbs to check out all of the store closing signs. They should ask realtors about any calls they might be getting for condos. Then quiz a few office leasing brokers and hear about all of the excess office space they can not lease out becuase of rising unemployment.
 
Denial is part of the reason we are where we are right now. In 2009, the commercial real estate industry should expect a reduction in demand for space, negative absorption, and higher vacancies. This will bring about more distressed property on the market and sales should start to increase as vulture investors start buying.
 
In the office market, tenants will have the advantage over landlords because there is so much inventory to choose from. Retail will struggle right into 2010 as retailers remain even more cautious about expansion. Class “A” apartments will experience higher vacancies as those units compete with single family homes entering the market as rentals. Class “C” apartments should see a rise in occupancy in many areas as many foreclosure victims opt to rent lower priced housing.

More adults seek roommates to share expenses instead of buying houses

This is a case for rental properties. Instead of buying houses, people are doubling and tripling up in houses for rent. If there were a time in history when being a landlord of single family homes was king, that time is 2009.

The massive layoffs, businesses filing for bankruptcy, and home foreclosures has some people trying to make ends meet by sharing their homes with strangers, friends and family members.

In November 2008, the number of Craigslist ads for roomates were up 29% in the Raleigh/Durham North Carolina area. Nationwide, Craigslist postings have jumped up 62% and may rise higher as more businesses layoff workers and more homes go through foreclosure.

2009 is the year to own single family homes as rentals. Some need assistance with bills because their incomes have fallen and the cost of utilities and rents have increased. Others have found it “cool” to be frugal again. In some Mexican communities, they pool their minimum-wage checks together and live under one roof.In some Senegalese communities, they take weekly donations from group members to help each other in an emergency, such as a needed car repair, utility bill, or groceries.

At many luxury condo complexes, renters are welcome with open arms. Many people are renting units they could never afford to buy. In some luxury condos, you can rent for about 50% to 60% of what it would cost to own that same unit.

In Miami-Dade County Florida, over 10,800 condos are categorized as rentals on the Multiple Listing Service. This number will likley rise higher as more foreclosures hit the market and if companies continue to lay people off. Lease-to-own deals are on the rise in many luxury condo buildings.

In a lease-to-own arrangement, the rents are typically paid every month for a year and go toward lowering the potential buyers closing costs or the set purchase price. The buyer pays an upfront, nonrefundable fee as consideration. Lease-to-own programs are also popping up in overbuilt parts of Brooklyn, New York. In Brooklyn’s trendy Williamsburg section, Homebuilder Toll Bros. (TOL) is pushing rent-to-own units in its new luxury condo tower.

2009 is the year to be an owner of single family homes in certain areas. Stick with areas where the median home price is under $150K and you should be able to find properties that will cash-flow at HUD section 8 rental rates.

What the commercial real estate market can expect in 2009 – PART 3

More Distressed Property

This is the last part of our three part series on what you should expect in the commercial real estate market in 2009. More Distressed Properties are sitting out there, with more to come. According to CoStar, there are approximately 1,200 commercial real estate loans that are either behind on payments or past their maturity date without being refinanced.

In commercial real estate, most loans are 5 or 10 years and then the owner needs to refinance the loan. Some lenders are holding off any foreclosure process as long as the loan is being paid. A loan in good standing is better than foreclosing.

There are an additional 6,100 commercial loans that servicers have identified as a possible concern, which represents over $57.8 billion dollars. Will these loans go bad? I think a good portion will go bad before the credit markets loosen up. But, even if the credit markets loosen up, the value of some of these commercial properties, especially office and retail, have fallen in value so much that there isn’t enough equity for a new lender to fund the project. This means the loan may ultimately fall into default and become an REO.

Going Green
 

There is some-what of a bright spot for commercial real estate. Going green seems to be the theme for 2009. The world is going green (as it should) and commercial property with the proper green certifications continue to enjoy a premium in the marketplace in terms of higher occupancy levels, rental rates and sale prices compared with “non-green” properties.

Only about 1 in 15,000 buildings are LEED certified. This number will rise because there is a new federal mandate to take effect in 2010 to have federal agencies occupy office buildings that are certified green. CoStar recently did an analysis of 9.8 billion square feet of office space and found that buildings which are certified green, enjoyed a 3% to 6% higher occupancy rate than non-green buildings. The rents were as much as $18 per square foot more per year. These are just averages.

Owners are starting to recognize that green development can be a cost saver as well as a revenue booster to their properties. This is why many are starting to follow the changes the US Green Building Council has introduced in its LEED certification system. Developers have found that achieving a Gold LEED certification doesn’t cost much more to implement, plus the higher rents can compensate for the higher building costs. Tenant operating expenses are reduced in green buildings which reduces vacancies.

Some features you can expect in green buildings are:

• highly efficient lighting
• recycled aluminum, concrete and steel
• Lobby windows with sunscreen solar panels
• Restroom lights on sensors
• Atrium lights on timers

Could 2009 be the bottom in the housing market? Maybe, but I don’t think 2009 will be the bottom in the commercial real estate market. The worst is yet to come for commercial. We might have to wait until 2010 before we can start speculating on a bottom in commercial. When the news starts talking about all the commercial REOs and non-performing loans, then investors can start thinking about “bottom-fishing” for new commercial property to buy for their portfolios.

What the commercial real estate market can expect in 2009 – PART 2

This is Part 2 in our series, “What the commercial real estate market can expect in 2009″. In previous recessions, it was over building that caused the commercial real estate market to sink. In today’s economic climate, it is the unrealistic rise in property values and then the burst of that bubble that will sink commercial real estate prices.

Commercial office space went through a huge rise in values, but those values did not rise as high in percentage terms as the residential housing market. Housing values till have a ways to fall, but commercial office space has somewhat returned to values closer to reality.

Office values may fall lower as company’s layoff workers and close their doors. Because the S&P 500 index is down 38% from its highest levels, corporations are less likely to expand their operations without increasing stock prices. This means means that IPOs that normally are the engine behind the growth of new company’s have dried up for 2009. This means as office vacancies will not fill anytime soon, which keeps office values low.

The U.S. employment picture is not looking to good either. The U.S. economy already lost more jobs (1.9 million) in 2008 than during the dot.com bubble burst in 2001-2002. According to Economy.com, they are forecasting as many as 3.3 million job losses in 2009.

There is a small spot of hope for the commercial real estate industry. There was not much over building leading up to this current recession. So the commercial real estate market doesn’t have to absorb as much supply as the residential market. Because of the rising unemployment, office supply inventory will increase. Some U.S. markets will see higher office vacancies then others. For example, CoStar predicts that the Phoenix and Detroit vacancy rates may exceed 20%.

Clarity in the markets won’t occur until vacancies peak and prices have bottomed. The commercial markets must establish some sort of new bottom before there will be a recovery. The sooner this occurs, the sooner values can start to rise again when investment activity picks up.

This is the end of Part 2 of this series. I Part 3 I will address more of what to expect in the commercial real estate market in 2009.

 Attention Banks: We buy non-performing and REO product in bulk (Residential and Commercial)

What the commercial real estate market can expect in 2009 – PART 1

I can tell you one thing to expect. Expect to see massive loan defaults. These defaults will only make life at financial institutions tougher. I called a bank in Missouri the other day about buying their firms non-performing and REO product and the bank president almost jumped through the phone to hear want I had to say. I’ve never seen a banker so eager to speak to me about selling his bad loans.

Many banks are closer to the brink of collapse which often fuels fear in the banking industry and then banks start selling their assets at fire sale prices. Now, there are some delusional banks out there who want par for their bad debts. Well, as long as they have enough cash to ride out this financial crisis, they should do fine. But, out of pride, some banks would rather go down with the ship and file bankruptcy than to let a vulture firm like mine buy their bad debts at fire-sale prices.

It’s usually the male bank presidents who let ego get in the way of sound business decisions. The female bank presidents are more realistic about their banks financial picture.

At some of the nations largest REITS, the income of their income-producing properties are not looking too good. Especially, since most of them purchased their property at inflated prices during 2003-2005. The rising lay-offs and flat economy has forced many people to double (and triple) up in houses and apartments, instead of renting a place for themselves. Although, the rental market has grown because people can not buy a house (or stay in their current house) – some apartment buildings are still seeing rising vacancies because some rental units are housing 2 households in one unit.

 

This leads some multifamily landlords to slash rents and give concessions to fill their vacancies, which results in lower net operating income for the property, which mean the property is worth less when the owner wants to sell.

 

Construction of new multifamily buildings are at an all time low. There is almost no competition from new projects. The pain occurring in the residential market right now (which has been going on for the last 2 years) – is going to start affecting the commercial real estate market in 2009. There will be spikes in office and retail vacancies as businesses lay-off people and people reduce spending at the malls.

 

You should expect to see the following occur in the commercial real estate market in 2009:

 

* more tightening in the credit markets

* a massive buildup of commercial property as bank REOs

* tons of empty office and retail space

 

The outlook is now for the current recession to take a higher toll, for a longer time, on commercial real estate than did the dot.com bubble burst of 2001-2002. This will be a 3 part series so check back with this Blog in a few days for the rest. I didn’t want to write a book in this Blog.

Attention Banks: We buy non-performing and REO product in bulk

Mortgage Financing Still Available For This Real Estate Type

I’m sure you already know that every commercial property type is affected by the current financial crisis. Financing to buy commercial property isn’t as easy as if was back in 2005 when banks were almost giving the money away. However, apartment building financing is more easily obtained today than financing for other commercial property types.Attention Banks: sell us your non-performing and REO asset pools

This is not to say it’s easy to get. It’s just easier to obtain than getting financing for other commercial property
types. This is made possible through the financing programs offered by Fannie Mae and Freddie Mac. These two Government Sponsored Enterprises (GSEs) are the main source of multi-family mortgage debt right now. You can still get financing for your apartment deals through insurance companies, banks, and even HUD. These sources don’t seem to be as reliable as the GSEs.

If you try to obtain mortgage financing from Banks, you will have to accept less attractive loan terms, like a short
loan term. Forget about a 10 year loan. And, you will need to bring more of your own cash to the table to make the deal happen. Expect to bring 30%-40% of the purchase price to the table. In the case of Insurance companies, your purchase must be a big one, like over $10 million. And, Insurance companies want A or B class property so don’t approach them about the “D” class apartment you are looking to reposition.

Fannie Mae and Freddie Mac over apartment financing in more markets across the U.S. and will fund purchases in all property classes. I’ve seems some estimates say that these GSEs are financing 85% to 90% of all apartment mortgage debt today.

When will the financial markets become normal so the real estate market can start to rise again?

Although the financial markets are still in shambles, there are signs of life. The federal government has given more money to US banks to help grease the financial wheels of the economy. With the Citigroup breakup and Bank of America needing much more cash to handle their purchase of Merrill Lynch, I believe it will take several years for the credit markets to start operating in any type of normal fashion. What does this mean for real estate? Well, don’t expect a sudden rise in prices or bank lending.  

The US government has started buying mortgages from banks to help the banks balance sheets. Is this a good thing for the real estate markets? Can you imagine the US government foreclosing on families that can not pay their mortgages? Just imagine the news headlines: “Federal government boots out single mom and 2 kids from their home”. 

What I think will happen is the government will need real estate investors to buy these non-performing assets quickly. Firms like my company are well capitalized and we have the expertise to buy these properties and find renters and buyers for the homes. The last thing we want to do is foreclose. So we try to work with the owners to keep them in the house. The government doesn’t know the first thing about how to properly modify the terms on a note (and neither do banks). There’s a human element to helping a homeowner get current on their mortgage that the government (and banks) know nothing about. 

In hopes of getting the financial markets moving again, the fed has dropped rates to levels that got us into this mess in the first place. Making credit cheap was suppose to make consumers want to go out and borrow and help make banks feel comfortable that borrowers will pay them back so the bank makes more loans. But, with people losing their jobs, consumers don’t feel confident adding debt to their plates and banks don’t feel comfortable adding debt to their balance sheets if consumers may not have a job to repay any new loans. 

The end result is the same credit freeze, which keeps home values low and causes more homes to lose value. There will be another round of mortgage resets on ARMs that will cause a huge wave of foreclosures. We’ve only seen the tip of the foreclosure problem. Some banks see the handwriting on the wall if they don’t improve their balance sheets immediately, and my firm buys their non-performing assets. But there are still some banks my company buys non-performing and REO assets from that are not willing to lower their price expectations. They will when their books get hit with hundreds of additional non-performing loans. 

A bank in Virginia who wanted us to Bid on their non-performing pool of assets was only willing to drop their asking price 10%. Shocking. This guy must thing this is 2005. But, he will get the picture soon. I simply told him I will contact him in another two months to see how things are going. He might see reality when a few hundred more bad loans hit his books in a few months. 

Some banks lie and say everything is fine and they haven’t seen a bad loan on their books in 10 years. But, when I check the FDIC website and check their financial statements, I see plenty of bad debt on their books. Reality hasn’t hit them yet. They are living in a world of denial.

After we get out of this recession, there will not be a spike higher in home prices or the growth of the economy. We should expect to see a “muddle” through type of improvement. Real estate in many areas will just be flat. No real appreciation except for areas where there will be job growth. These are some serious times. Only time can allow both the housing market and the credit markets to heal. Don’t expect a noticeable improvement in real estate or the economy for the next two years. The psyche of the American consumer will be forever changed.

 Attention Banks: sell us your non-performing and REO asset pools

Could 2009 be the death for retail property? Expect More Retail Pain

This past holiday season has seen dismal sales. Although retailers gave deep-discounts to shoppers, the shoppers just didn’t show up. The situation could get worse for retailers when cash-strapped consumers start returning their gifts for cash. Oh, yes, it will happen.

Here’s how the scenario plays out: Your cousin Jeff buys you some gloves he “thinks” you will love for the holidays. It cost him $18. The original price was $55.98 before the retailer slashed the price for the holidays. Now, because you really don’t like the gloves your cousin gave you, and you could really use the cash to fill your gas tank, you return the gloves to get the $18 cash. The gloves now comes back as inventory to the retailer. Inventory they thought was gone. Multiple this times many gift items people get and retailers will be hit hard.

Any of you thinking of buying retail centers, may want to think again. Retail is not the best property type to buy right now. Sales at stores are still falling. Stores are still closing up. People are still not shopping. Now, if you must buy a retail shopping center, do you homework carefully. Real estate is locate and there are sections of the country where retail will do well. Areas where there has been good job growth for some time is where you should start.

Job growth brings people with money to the area. When retailers see a certain area has a large population base and income, they want to open stores in that area. People with money to spend will shop. If you own a retail center in that area, you have positioned yourself well and you should have a great cash flowing property.

The apparel retailers will be hardest hit in 2009. Expect many of these stores to close. If a shopping center has many apparel retailers inside, you might want to avoid buying that center. Retail property could be hit with vacancies which hurt NOI and the value of the property will fall. When the value falls, this makes it difficult for the owner to refinance his loan. If the owner can not refinance his loan, the lender may foreclosure and take the property back as an REO or the lender may have a non-performing loan on their books because the owner can not meet the debt requirements because their cash flow is too low.

I’m not sure what’s worse for retailers. Will the deep markdowns in prices hurt their 4th quarter numbers or will it be the massive gift returns from people looking for cash? It could be the combination that gives retail property the one-two punch. One analyst says to expect 200,000 store closures in 2009, up from 160,000 this year. KB Toys is closing down all 460 of its stores.

I believe we will see record bankruptcies in the retail sector this year. The malls will be like ghost towns as retailers close their doors. Take a look at your locate malls. What do you see? At my local malls I see at lot of empty space. The retail industry could be facing its biggest contraction in 35 years. Banks will next have to deal with all the retail REO property and non-performing loans on their books as will as the residential products.

Why Medical Office Buildings Will Continue To Perform Will In 2009

Is the U.S. getting older? Yes. Do more people need medical treatment than in any other time in modern history? Yes. Are people willing to pay to feel and look better? Again, yes. While other real estate sectors are decaying with the current economic downturn, there is one bright spot that will continue to shine in 2009. I’m talking about medical-related real estate.

Now, this niche isn’t exactly bullet-proof. However, it has shown itself to be somewhat recession-proof. This is especially the case as baby boomers continue to age, live longer , require more health care, and desire to live a feel years younger. Because of these facts, medical real estate will likely weather the economy better than other commercial real estate.

Health care tenants are typically strong credit tenants. They have cash reserves and they have a reason for being there. There reason is to treat patients. With retail property, shoppers can decide not to shop, which hurts the cash flow of the retailers who may decide to not renew their lease. With office property, a company may elect to lay people off. But, medical office buildings sell a product that patients will move heaven and earth to acquire. People want to feel good and look good. Those needs are very emotional.

Another aspect of medical real estate is the tenants themselves, typically doctors, are involved in the Tenant Improvements. This means they aren’t about to go anywhere any time soon. Medical tenants don’t want to move all their equipment once installed in the building. As a result, bankers and financial institutions like to fund health care real estate.

It’s much easier for a Banker to justify to their committee the viability of a medical related building project, then the viablity of an office building or retail shopping center. Investors will feel safer putting funds into health care properties than typical office and retail properties that might be more impacted by the economy.

The Bank is much less likely to have medical office buildings as REOs or non-performing assets on their books. The type of owners who sell their medical related building, do so to pull their equity out. As opposed to many Apartment owners who sell because they paid too much in 2003-2006, and they can’t refinance their loans. Medical office owners don’t sell out of distress. They sell to move their capital to another property to get a better Return-On-Equity.

There are some who have to sell because they can’t meet equity requirements of a refinance. But, that is a very small number. You also have a third type who sell because they can’t met their rent thresholds or lease-up times. Therefore, they can’t get permanent financing on their properties. For the most part, you should see medical related real estate do well in 2009.
 

To Cut Down On Expenses, People Are Searching For Roomates Instead Of Houses

More layoffs, business bankruptcies and home foreclosures have forced people to take drastic measures to stretch their budgets. They are sharing their homes with strangers.

I know of a doctor, in a $2.1M house, in Alexandria, VA who just decided to rent the top floor of his home to total stranger. Why? Because his daily living expenses were eating him up.

Take a look at Craigslist. Have you noticed the increased postings for roomates? I have. November showed a 28% increase in roommate postings for the Raleigh-Durham-Charlotte, North Carolina area. And, if you know anything about NC, they have a “good” real estate market. Values have actually gone up slightly. Just imagine the number of roommate postings in areas like Vegas, DC, and San Diego where home values have fallen 20%-30% over the last 2-3 years.

Nationally, craigslist postings have ballooned 62% and will probably rise higher as the housing market gets worse before it gets better. Some people, like the doctor from VA, need a little assistance paying their bills. For some people, the “frugal life” is back in style. Trying to save a few bucks is now cool again.

In the Latin community, they have pooled their minimum-wage checks together and moved in with family members. This is not to say that only Latin people make minimum-wage. This is just an example of people coming together to help each other and live under one roof to stretch their incomes.

This does not help the Banks at all. They are still taking back homes and commercial property in an alarming rate. With no new buyers out their, these Banks end up holding property that doesn’t pay them a return on their investment.

What’s a Bank to do? Well, some Banks have decided to sell their defaulted loans or sell their REOs to investors who can buy in bulk. This helps the Bank improve its Balance Sheet and liquidity, and may even help keep the lights on a few more months.

African immigrants are also pooling their incomes in weekly donations members make to help each other in cases on an emergency, such as a car repair bill. What makes matters worst for the housing market is when homeowners who can’t sell their homes, decide to rent them out. This creates extra inventory that just sits their, further bringing down home values.

Luxury condo complexes are now (have been for a while) accepting renters with open arms. If you crunch the numbers, it can be cheaper to rent than it is to buy one of these luxury homes. Many people are renting luxury condos they could never afford to buy. In some cases you can rent for about 50% to 60% of what it would cost to own.

According to “Condo Vultures”, in Miami-Dade County, Florida, there are about 10,778 condos categorized as rentals on the multiple listings service. Throughout 2008, more than 2,000 condos were rented. In 2005, only 82 were rented that year. Notice how the number of rentals have really jumped up and there are still over 8,800 units still waitingto be rented. And, this is just Miami-Dade.

Lease-to-own programs are popping up all over the country with many condo developers looking to get some capital to pay their Bank loans. Related Group in Florida and Toll Brothers in Brooklyn, NY are offering some very attractive lease-to-own programs for condo units that have not sold.

Will Banks have to take back more of these condo complexes as REOs and non-performing loans add to their books before this mess is over? I think so.