Industry Report on Commercial Real Estate

Here’s a great read on commercial real estate trends from the CoStar Group and by Randyl Drummer of Jones Lang LaSalle.

CRE Sales Will Pick Up, But Values Expected to Stay Flat Through ’12 Jones Lang LaSalle Study Finds Banks Will Eventually Be Forced to Stop Delaying REO Foreclosures and Begin Taking Back the Keys of Distressed Assets Credit markets for office, industrial, retail, hotel and multifamily property should see the effects of a gradual return of liquidity during the second half of 2009, Jones Lang LaSalle predicted in its U.S. Midyear Capital Markets Bulletin released last week. In it, and in a separate report on global market performance issued this week, JLL noted that several trends are expected to help begin to restore capital markets over the next year, including the $33 billion in equity raised and $5 billion in debt issued through the first eight months of 2009 by global REITs. Also, with the world economy starting to recover, JLL noted foreign real estate investors are again circling select U.S. markets, and real estate companies are finally tapping into government programs such as the Federal Reserve’s Term Asset-Backed Securities Loan Facility (TALF). For the first time in what seems like ages, meanwhile, the gap in price expectations between buyers and sellers is starting to narrow in the third quarter, JLL executives said. But while all that may sound great, “it is unlikely that any true debt liquidity will return to the market until mid-2010 at the earliest” with the recession and unemployment continuing to batter occupancies and drive down rents, cautioned Kenneth Rudy, president of Jones Lang LaSalle’s Capital Markets practice. Still, that may be welcome news to investors battered by the dramatic decline in U.S. property sales volume and prices that occurred in the first half of 2009. According to CoStar data, the value of Class A office buildings declined by 57% in the first half of 2009 compared with prices paid at the peak of the market in 2007. Industrial and retail property sales volume, meanwhile, declined even more sharply, falling 71% and 80%, respectively, since their 2007 peaks. By mid-2010, JLL predicts investor interest in U.S. markets will slowly begin to return. But transaction activity likely won’t reach the dizzying levels of the 2005-07 market “for a generation or longer,” Josh Gelormini, vice president of capital markets research, tells CoStar Advisor. And that may not be such a bad thing for players who manage to fight another day after surviving the current downturn, following an era in which cheap and easy credit and overzealous speculation led to the latest and worst commercial real estate price bubble. “We’re definitely still in early stages of the distressed asset game, working out the assets most likely to have been bought during the boom years, and it’s going to take a while to work itself out,” Gelormini said. “The fact that large investors around the world are starting to see attractive values and act on the opportunities will help speed the process some, but it will still take several quarters for sales activity to stabilize.” “Although we feel transaction volumes have very likely bottomed and will be turning upward the next quarter or two, values will still have some more downward pressure into next year before we see stabilization.” Although the $4 trillion in public funds already committed to shore up financial markets has halted the economic free-fall, it’s been a double-edge sword, JLL said. Uncertainty over TALF has also helped delayed recovery in capital markets as banks continue a tactic of “delay and pray” extending loan maturities and extending loan maturities and postponing foreclosures and loan write downs in hopes of keeping distressed property off their balance sheets. However, this “a rolling loan gathers no loss” approach also means that, with an estimated $2 trillion in commercial mortgages set to mature between now and 2013, banks have neither the risk appetite nor the capacity to write new loans. “Banks will eventually sell [assets] as they cannot extend into perpetuity and the chances that the market will rebound to their highs are unlikely anytime soon,” said Bart Steinfeld, managing director of JLL’s Real Estate Investment Banking practice, adding that he expects smaller community banks to be the first to begin selling off their small-balance loans. At the same time, certain banks boosted by stronger second-quarter earnings are ready to cautiously reenter the lending market, with some beginning to originate conservatively underwritten mortgages, Steinfeld said. “We have met with a number of lenders willing to dip a toe in the water and pursue new transactions with gold-plated sponsors collateralized by top-quality real estate. Capital is available but it is directed toward higher returns and prime product and major markets,” added Steinfeld. Asset types showing the most distress at present are hotels, particularly luxury or upper upscale properties; construction loans, especially condominium projects; and shopping centers, particularly those not anchored by grocery stores, JLL said. But office and industrial buildings will experience increasing distress as the recession plays out. Property and mortgage REITs, which have enjoyed rebounding share prices, will fill a good portion of the void in real estate debt and equity. Real estate investment trusts are amassing capital and could be the first groups to swoop in to pick off distressed assets and source capital for other hungry buyers, said Gelormini. “Improving REIT performance should lead to value recovery in the overall commercial market. Much like in the mid- 90’s, we’ll likely see an increasing number of private real estate companies or investment funds that need capital look to the public markets by converting into a publicly traded REIT in the next three to five years,” Gelormini said. REITs will also be the first CRE investors to ease back into the securitization market by selling bonds backed by the TALF. Some sectors, meanwhile, remain relatively strong, with healthcare, senior housing and corporate sale-leaseback properties holding the attention of investors. Also, foreign investor interest in U.S. property is slowly starting to build, as evidenced by Hong Kong’s Keck Seng Investments’ purchase of the W San Francisco. Also this week, the Wall Street Journal reported that China’s $200 billion sovereign-wealth fund, China Investment Corp. (CIC), is looking to invest up to $2 billion in U.S. real estate. CIC has been talking to private-equity fund managers such as BlackRock, Invesco and Lone Star about investing in distressed property and mortgages, the Journal reported. The SWF is also considering investing in distressed assets through the governments PPIP (Public-Private Investment Program) set up to help banks unload toxic assets. Billionaire real estate investor Sam Zell, whose success in buying distressed assets earned him the nickname “the Grave Dancer,” and whose $39 billion sale of Equity Office Properties in February 2007 marked the peak of the real estate boom, is also back in the market to buy distressed assets through a privately raised $625 million fund.