"Huge Commercial Real Estate Crash" - Posted by Jon

import · October 30, 2009, 1:57pm

Posted by Jon on November 02, 2009 at 15:29:42:

Thanks as always for your response. I completely agree that there is always opportunity for those whose skin is not yet in the game to try to drive prices down further, and their history gives them a large pulpit to do so. I think however that they are seeing truly fundamental issues that could create a crash, even if the long term value of the property is well above the current market prices.

This makes me recall the John Maynard Keynes quote, “The market can remain irrational for longer than you can remain solvent.” As you said, the reform necessary to restore confidence and ultimate price stability is going to be painfully long in the making. Even assuming some degree of price stability on a fundamental level, you will undoubtedly see downward pressure simply from the remarkably smaller pool of capital willing to finance (or more importatnly, refinance) the shorter term debts on these properties.

I just see the cascade being inevitable, as the weak hands will be shaken out, exacerbating their pressures on the even relatively stronger hands. Something is only worth X dollars because the market says it is, and unlike the residential market, long term fixed debt is almost non-existent, so refinancing is going to have to take place, at increasingly lower rates. Commercial real estate, unlike residential, has no intrinsic value in what it offers the owner, aside from the cashflow or appreciation, making strategic default all the more compelling.

I understand the intuition behind the deep value presented relative to replacement cost, but without demand, this seems rather meaningless, placing a huge emphasis, like you said, on research and demographics. I would think someone like you would love the opportunity to have far fewer adversaries competing over the compelling deals. The truth is only time will tell, but time could wind up being the greatest headwind in a niche that often uses time as an asset.

JOn

import · October 30, 2009, 1:57pm

“Huge Commercial Real Estate Crash” - Posted by Jon

Posted by Jon on October 30, 2009 at 13:57:32:

Wilbur Ross came out today and basically said that we are on the precipice of a huge correction in the commercial market. George Soros basically said the same thing, and posted a link below. I consider these people to be two of the smartest market minds in the world, so when they talk I think we should all listen. Any thoughts on whether or not we have even begun to see teh worst?

http://www.bloomberg.com/apps/news?pid=20601087&sid=amPXzjQV3nGQ

import · November 20, 2009, 7:47am

Re: Crash Update: Zell on Ross - Posted by ray@lcorn

Posted by ray@lcorn on November 20, 2009 at 08:47:57:

Here’s an interesting take on the comments by Wilbur Ross from the Gravedancer himself…

http://www.sddt.com/News/article.cfm?SourceCode=20091119fac

import · November 9, 2009, 4:55pm

Re: “Huge Commercial Real Estate Crash” - Posted by john

Posted by john on November 09, 2009 at 17:55:45:

Wilbur and George are wrong. Yes there might be a few bankruptcy’s such as Capmark, but remember capmark started it’s business in 2006…I.E. the peak of the boom.

If anything we should see a soft landing/correction. Remember commercial real estate is based on cash flows, unlike residential. Even though there may be a lot of debt most of these properties are still cash flowing nicely.

import · October 30, 2009, 6:08pm

Re: “Huge Commercial Real Estate Crash” - Posted by ray@lcorn

Posted by ray@lcorn on October 30, 2009 at 18:08:41:

Jon,

Thanks for the link. Great article, and there seems to be at least one a day all over the media just like it. I did see a piece in the WSJ today that Treasury Secretary Geitner said the markets could handle the commercial real estate crisis just fine. Now there’s a reassuring voice, eh?

I find it interesting that the article quotes come from some of the greatest vulture investors out there, e.g. Ross and Soros. If I were them, and sitting on the billion dollar war chests they are, I’d be spreading panic like peanut butter at a grade school picnic too. Look at what they are buying… distressed debt and properties, on their terms and at their leisure, all the while preaching doom and gloom. That’s a pretty good business model, eh? Sam Zell didn’t name himself the Gravedancer back in 1991 just to be funny.

There is going to be a shakeout, without a doubt. There are billions in commercial mortgage backed securities (CMBS) loans maturing, the bulk of which will start hitting in mid-2010 and peaking in October 2011. These are the vintages of mortgages on properties bought at the top of the market with just plain stupid valuations. As of right now there is no viable exit strategy available in the capital markets right now other than foreclosure. There hasn’t been a CMBS issue since July 2008, and until that market is functioning again chaos will reign. (And don’t miss the fact that the group poised to ride to the “rescue” is the banks, which is exactly what happened with the S&L’s… need I say more?)

Honestly I expected CMBS to be straightened out by now, but I was way too optimistic about ratings reform, and again (just like 1988-89) underestimated the power of the banking lobby. They don’t really want to see CMBS come back anytime soon because now they need performing loans instead of origination fees to survive. Also, Congress just doesn’t have the bandwidth to deal with such an arcane issue in the midst of health care reform, record deficits, more industry bailouts and the threat of elections coming around in a year from now. But they will get to it, and you’ll know we’ve hit bottom when indictments fly around S&P and Moody’s. When ratings can be trusted again, then capital will flow back into CMBS. No one knows when that will happen, but I’m betting it will. Too much is at stake, and there are some awfully smart folks with very deep pockets that will make sure of it. (See p.s. below)

However, as mentioned above, don’t think the vulture funds are going to sit idly by and wait until everything is “safe” again. Their business model thrives on chaos and confusion, the more the better. As Ross said in the article, they will evaluate the fundamentals and strike when it makes sense to do so, buying debt and properties at steep discounts to the inflated values of the peak of the market.

The key to spotting the values for us little guys is watching prices relative to replacement cost. When the discount to cost exceeds 30% there is ample room for patient capital to profit, but only if one other factor is in place… demand. That’s where understanding the simple fact that there is no such thing as national real estate is so critical. Market analysis has always been king in this business, but it got swept aside during the rip and flip frenzy of the last five years.

Those times are over now, and sustainable holding strategies are called for, which means deals have to be structured for worst-case break even. Now is the time for careful analysis of basic property fundamentals, market identification and segmentation, identifying demand generators and proper capital structures.

This is not rocket surgery… it doesn’t take a genius to figure out that buying properties 30%-50% below cost in areas with the right demographic components is the way to get really, really rich in this business.

In the meantime, I’m thinking of running some ads… “The crash is coming, better get out now! Call me!”

ray

p.s. This little tidbit ran in the Wall Street Journal last week…

“Talk about truth in labeling. The J.P. Morgan Chase group that structures and sells financial products such as CDOs, or collateralized debt obligations, has a new name. Perhaps seeking to jettison unhappy memories, the “structured credit sales and marketing” group is now known as the “cross-asset origination & structuring” group. That’s CAOS for short.”

You can’t make this stuff up folks…

import · November 9, 2009, 6:00pm

Re: - Posted by George

Posted by George on November 09, 2009 at 19:00:58:

Besides all the loans that have to be refinanced in the next couple of years as Ray alluded to, in order for commercial real estate to stabilize or improve, the national economy has to improve. That remains a very iffy proposition. The economy right now is totally running on government stimulus. TARP, trillions in Fed intervention, 2009 stimulus. Without government intervention, we’d already be in Great Depression II. The key to a recovery not only of the larger economy but also commercial real estate in particular is the consumer spending again. With consumer debt remaining at record levels, foreclosures remaining very high for the foresseable future, and unemployment still rising, I don’t see the consumer coming back anytime soon. I believe that Ross and Soros are understating the severity of the problem, not overstating it. Be careful, very careful going forward with any kind of deal right now and keep the risk level low.

import · November 19, 2009, 3:05am

Re: “Huge Commercial Real Estate Crash” - Posted by Bob Smith

Posted by Bob Smith on November 19, 2009 at 04:05:31:

How are you valuing the land? At zero? That’s what “30% discount to
replacement cost” appears to literally mean (buying the whole enchilada
for a price that’s a 30% discount to the cost of merely replacing the
improvements), but I’m not sure if that’s what you intended to say.