Headlines – Week of December 26, 2010
January 3, 2011
2011 – The Year of the New Normal
According to many economists, 2011 is the first full year of the New Normal, an entrenched period of slow economic growth, high unemployment, and volatility.
So what will the “New Normal” look like for commercial real estate? Some believe it will return to the ‘Old Normal’ … before the bubbles of the early 2000s, when nonrecourse commercial real estate loans were a rarity and home owners didn’t spend the equity in their homes at the mall.
Many reports seem to indicate that brokers in major markets are seeing multiple bids on Class A, top-tier properties even if the transaction numbers are still a fraction of those in 2007 or 2008. Lenders are taking calls again—if not yet making many commercial real estate loans. Cap rates for some Class A properties are nearing pre-credit crisis level.
And what about jobs, the real catalyst for economic recovery? According toCBRE Econometric Advisors in Boston, the good news is that the pace of new job creation should pick up to about 100,000 jobs a month in the near future. They predict the increase will begin in mid-2011 and last a year or so before leveling off. In the longer term, job growth will “settle down to about 50,000 a month, much slower than the 2003–2007 recovery, but still the fastest growth of any developed economy.
Another positive factor — the record high corporate profits and funds available for investment. As of the second quarter of 2010, U.S. companies saw the internal funds available for investment increase by $61.1 billion, according to the U.S. Bureau of Economic Analysis. The addition of $30 billion in federal funds for small-business lending in fall 2010 could also boost business confidence and thus hiring.
Office rents have also repriced, but instead of moving up to better space, some tenants are moving away from top-of-the-line space as companies don’t want to be perceived as overspending This shift away from ostentatiousness to value is all part of the New Normal lifestyle.
A prevailing sense of economic uncertainty is making commercial real estate more attractive to investors. Most of what investors are buying falls into two diverse pools—Class A core assets in major markets or severely distressed properties.
The quest for the best has increased the deal volume through August 2010 to $54 billion. That’s half of the deals done over the same period in 2008 but up 45 percent from 2009’s lows, according to Real Capital Analytics.
At the other end of the investment spectrum, distressed buyers are still active. Vultures with patience are being rewarded with more product to choose from and price drops of about 20 percent last year compared to 2007 highs. Lenders have taken on too many extend-and-pretends and are moving some off their books.
However, regulatory pressure that discourages lenders from foreclosing and selling repriced assets to entrepreneurial investors is keeping the market from clearing. Lenders have learned that they aren’t the best owners of commercial real estate and are less eager to seize assets
This regulatory pressure from the FDIC not allowing commercial real estate loans exceed 300 percent of the bank’s equity has kept most lenders from making new loans.
Five Predictions for Residential Real Estate in 2011
According to the analysts at Freddie Mac, key macroeconomic drivers of the economy – such as income growth, unemployment rate, and inflation – will affect the performance of the housing and mortgage markets in 2011. With fiscal policy supporting aggregate demand for goods and services and an accommodative monetary policy providing low interest rates and ample liquidity to capital markets, the economic recovery should accelerate gradually over the year, with the second half of 2011 exhibiting more growth and job creation than the early part of the year.
These forces will support a gradual recovery in the housing and mortgage markets. Here are five features that will likely characterize the 2011 housing and mortgage markets:
- Low mortgage rates. With Fed observers expecting the central bank to keep the federal funds rate at its current target range of 0 percent to 0.25 percent for most (or all) of 2011, relatively low mortgage rates will be a feature of the 2011 mortgage market. Thirty-year fixed-rate loans are likely to remain below 5 percent throughout the year, and initial rates of 5/1 hybrid adjustable-rate mortgages will likely remain below 4 percent in 2011.
- Prices have hit bottom. House prices are likely to begin a gradual, but sustained recovery in the second half of 2011.
- Housing will remain affordable. With affordability high, many first-time buyers will be attracted to the housing market in the New Year, likely translating into more home sales in 2011 than in 2010.
- Refinances will dwindle. Many eligible borrowers have already refinanced and the federal Making Home Affordable refinance program is expiring on June 30. While fixed-rate loans are likely to remain low, they will move up gradually, making it even less likely that refinances will be attractive to most home owners.
- Delinquency rates will decline. Based on the last several business cycles, the share of loans that are 90 or more days delinquent or in foreclosure proceedings — known as the “seriously delinquent rate” — generally crests within a year of the start of the recovery in payroll employment, and this economic recovery appears to fit within that pattern. Payrolls began to rise last January, and by the spring the seriously delinquent rate had begun to fall.
Top Ten Issues Affecting Commercial RecoveryHere are the top five issues facing commercial real estate in 2011, according to consultant Deloitte LLP.
- The market remains uncertain. The recovery isn’t following previous trends. While there is some indication that the worst may be over, some markets continue to decline.
- Impact of “amend and extend.” Some banks are recognizing that they will never recover full value on some properties and are willing to work with borrowers. This has made it more difficult to tell when the business has hit bottom.
- High maturities remain a challenge. The high level of maturing debt over the next several years remains a significant barrier to recovery. In addition to commercial mortgage-backed securities (CMBS), loan delinquencies and commercial real estate loan defaults, there is also an increase in strategic defaults as more commercial borrowers make a pragmatic business decision to exit profit-draining investments in order to divert money to performing projects or shareholders.
- The number of deals is increasing. A good sign.
- The economy is recovering very slowly. This increases opportunities in distressed properties, but the overall market isn’t in a hurry to pick up.
- Fundamentals moderating, but recovery may be slow. Absent a strong boost from the economy, the performance of commercial real estate fundamentals has remained weak for an extended period. However, while trends vary by property type, some key industry metrics indicate that sharp declines experienced during the height of the downturn are in the process of stabilizing.
- REIT rebound continues. Commercial real estate fundamentals may be in the early stages of a slow recovery, but another key element of the market — Real Estate Investment Trusts (REITs) — has already demonstrated a strong rebound. Return on investment for REITs has outperformed the competition recently, and firms are taking advantage of the spotlight by raising funds, which could eventually lead to increased acquisition activity for the segment.
- Capital markets — lending stabilizes; demand subdued. As commercial real estate struggles to deleverage, key lending sources have demonstrated flexibility in the treatment of existing debt, but have remained somewhat strict in terms of new loan origination. New lending is expected to remain subdued in the near term; however, stabilization is evident and alternative sources such as CMBS are showing signs of renewal.
- Regulations directly and indirectly impact CRE. In 2008 and 2009, government intervention in the form of stimulus programs, including the Troubled Asset Relief Program (TARP) and the Term Asset- Backed Loan Facility (TALF), indirectly impacted commercial real estate by injecting liquidity into the financial system and helping prevent the financial crisis from intensifying further. In 2010 and 2011, newly introduced financial and health care regulations should also impact commercial real estate both directly and indirectly, perhaps leading to increased demand for commercial space, as well as decreased access to capital.
- Positive signs for global CRE. Global commercial real estate has shown signs of improvement, following a pause in the industry’s globalization as a result of the financial and economic downturn that originated in the United States. In non-U.S. markets, investment trends began to demonstrate a return to growth in the first half of 2010, but a rebound to robust, pre-crisis levels is challenged by some of the same lending and distress-related issues that have been prevalent in the United States. As the global market begins to recover, the Asia Pacific region is expected to be a catalyst for growth, both as a destination and a source of investment into the U.S. market.
Posted by Scott R. Lodde