Posted on Wednesday, February 24, 2010
The February 10, 2010 Congressional Oversight Panel report on Commercial Real Estate Losses and Risk to Financial Stability includes some noteworthy updates and new information and brings to mind some other factors that should be kept in mind but may not be obvious when considering the state of this market. Here are a few personal thoughts and Report highlights;
Between 2010 and 2014, $1.4 trillion in CRE loans mature.
CRE value has fallen over 40% since 2007. Half are underwater now.
Vacancies are at 8% for multi-family to 18% for office. Rents falling 40% for office and 33% for retail.
Biggest loses are predicted for 2011 and later. $200 to $300 billion for banks alone
Last year’s stress test was only thru 2010 and only for the 19 biggest banks. Small and mid-size are most at risk.
TARP ends October 3, 2010 but is winding down. 59 of 708 banks have repaid.
Mortgages on multi-family are 26.5% of CRE
Since the 4 CRE valuation methods are revenue dependant: cap rate, discounted cash flow, comparable sales, and replacement cost, values are far more dependant on revenue generated than residential values.
Retail depends on business occupying the space and is the most location sensitive. Hotels depend on occupancy, have shorter occupancy terms (which also means rates have to be more competitive), and tend to be more highly leveraged. Offices are classified by A to C class, have leases for . 3 to 10 yrs so tend to be more stable, but have high leasing costs:down time, re fits, brokers. Industrial also tends to be more stable. Multi-family is classified high rise, low rise. Garden. Since this property type has more tenants and shorter leases (6 month to 2 yrs) and there are low barriers to entry, pricing tends to be competitive. Sometimes multi family is also government subsidized as is the case with Section 8 assisted or affordable housing. There are an estimated 17 mill multi family housing units in the US, most 1 or 2 bedroom. The South has the most, followed by the West, Northeast and Northwest.
In 2007 median renter income was $25,500 compared to overall National median income $47,000. Average renter age is 39. Half of all units have only 1 occupant. 22% have at least 1 kid.
Because owners expect to pay CRE costs from income. Tend to be professionals. Deal with different tax treatment (for example with CRE depreciation), many are owned by multi investors removed from the asset itself, strategic defaults in CRE are more likely than in residential. .
Construction loans, generally classified as ACD (acquisition, development and construction) C&D (construction and development). Typically have adjustable interest rates, carry interest reserves, provide for a limited amount of time to complete construction (short term), and are recourse loans. This in comparison to Permanent loans following completion of construction which are typically 50 to 80% LTV, 3 to 10 year term with a final balloon payment, but often amortized over . 30 years. Permanent commercial loans may often be non recourse, and therefore involve tighter underwriting and a prepayment penalty. All meaning that the rate a default will vary between construction and permanent CRE loans simply because fo the loan terms. In theory lenders factor this into their credit risk (risk of default due to inability to pay, etc) and term risk (risk of default due to inability to refinance at end of loan term) calculations…but who could’ve known?
Commercial lags residential: residential subprime borrowers needed to refinance 1 to 3 yrs after their orginal loan. In commercial tenants are hit first, it then takes then time to default and the landlord-borrower to then default on his loan. Stores may have low sales for months before closing and not paying rent. Unemployment is lagging indicator that greatly influences commercial demand.
The last time we saw this in CRE was 1980 to 91 when bank losses exceeded $157 billion and thousands of banks failed as CRE values dropped 30 to 50% in under 2 years.