Drop the Puck!

What’s Holding up Commercial Real Estate Investment?

As a native Minnesotan and a Minnesota Wild fan — with a son who plays hockey — I can’t help but view the current real estate investment market as a financial hockey game. Buyers and sellers are squaring off in the face-off circle, ready to go. But the referee — lenders — will not drop the puck!

No puck, no game.

Lenders: Frozen in Fear

It started with housing. News of a possible significant oversupply of homes, land, and vacant condos caused lenders to review their portfolios to determine their exposure to these markets. They became very nervous.

Soon the words subprime mortgages and toxic debt entered the vernacular. Bank examiners increasingly pressured lenders and rating agencies to determine how much subprime paper they had in their portfolios.

Commercial mortgage-backed securities lenders had a more serious problem. They packaged good loans together with the subprime mortgages and sold them to Wall Street investors as diversified loan packages. All that money financed the glorious run-up in the commercial real estate values.

But the subprime question nagged at portfolio buyers. Did they weight the risk enough given the current housing crisis? How much of a problem do we have? What are we buying? These and other questions flew through the market “arena.”

In response to the pressure, mortgage portfolio buyers started to write down the value of their holdings. The problem was that no one really knew the true value of the write-offs. Investors balked at purchasing additional mortgage packages, drying up the capital, causing many conduit lenders to close their doors.

We are now more than two full years into this state of suspended capital animation. The referee is still holding the puck and the buyers and sellers are afraid to even play in the game. They want off the ice! Why do they keep skating around the face-off circle? Why won’t the lenders lend? Why won’t the investors buy and why won’t the sellers sell?

Properties: Declining Values

There has been significant property value deterioration. This is partially driven by the rising rate of delinquencies in legacy CMBS mortgages and in some measure due to lack of investor interest and, more importantly, lack of new available debt capital. It is like a circle of death, feeding on itself, augmenting an already crippled commercial real estate marketplace.

Recently, Deutsche Bank estimated that 65 percent of the maturing CMBS mortgages would not qualify for refinancing. Not a big deal, until you realize there is more than $1.4 trillion in legacy CMBS debt coming due in the next three years. This is creating more distress, driving values down further.

Mortgage delinquencies are a major threat to the market and are wreaking havoc on commercial property values. Realpoint LLC estimates that the annual delinquent unpaid balances on the CMBS debt has increased by 585 percent! Regional and local banks are thought to be holding even more debt, and are watching, mystified, as property values plummet and their collateral dissipates. According to Deutsche Bank, they stand to lose more than $140 billion in construction loans as well.

This price uncertainty and the downward spiral of values keep the referees from the game. The lenders will not put the puck into play without knowing where the plunge in property values will end. Until benchmark pricing is determined and loan portfolio and package buyers are comfortable, they will not buy these loan packages. This price uncertainty virtually stops the flow of capital from the lenders who are stuck with bad legacy loans and no buyers. No puck, no game.

Sellers: On the Bench

Sellers, on the other hand, have another source of deal paralysis. Well-capitalized private or institutional sellers have little if any reason to get in this game. Their high-quality portfolios and/or individual investment properties are in peril. It’s like owning a nice home on a block with 10 neighboring homes that are going into foreclosure. Their value dropped, yet nothing they did caused or could prevent the fall. The sellers also are stymied by a lack of comparable sales data. With a dismal number of marketwide, meaningful, non-distressed transactions over the last two years, it is difficult — if not impossible — for sellers to be sure their properties would trade at a fair market rate. A Moody’s report published in December 2009 suggests a decline in prices to 2002 levels — a drop of 47 percent! Although this data suggests significant valuation deterioration, every commercial property is unique. Various factors such as rent rolls, location, demographics, age, and construction quality contribute to the incomparability of a property or transaction, making generalities like those expressed by Moody’s very difficult to use as a benchmark.

The sellers are afraid to sell in such a climate. Instead they continue to skate circles….

Buyers: Players on Waivers

On the other side of the puck, standing in frozen animation, are the investors. They are “chirping” about deals, about wanting to buy, asking brokers to bring them opportunities, but it’s all talk and no action. They will not really buy until they are convinced the market is at the bottom.

The buyers lack confidence, plain and simple. How can they be expected to get into the game and play, when the steady drumbeat of doom thumps from our papers, trade publications, online news sources, and blogs? They can’t attend a conference or cocktail party without being told the end is near for commercial real estate and that what they own is worth far less than before and still dropping.

They have fear: deep, down-to-the-core fear. They need a dose of good news. Was the recent Fed announcement that “the recession is over” or the downtick of the nation’s unemployment figures enough to break the standoff and start the game? Only time, availability of capital, an overall source of market stability, and valuation clarity will dispel the fear and get them back to the face-off circle.

Cash Is King

As already determined, lenders are not in the game unless the investor mitigates most, if not all, of the risk. The lenders require more equity, a significant balance sheet, and a hefty personal guarantee. Thus, the only buyers in the game are cash buyers. Meanwhile, the sellers sit tight, the lenders are frozen in fear, and the buyers refuse to play.

In the meantime, hockey fans, kick back and enjoy the game.


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