This is what makes following commercial real estate so maddening.
Yet in the last few days articles have appeared at Time, MSNBC and Fortune boasting about various aspects of a brewing commercial real estate recovery. John Reeder over at Marketwi.se warns us that this might be a reason to worry given the mainstream media's track record of calling booms or busts at exactly the wrong times.
Time's piece appeared first. It's an interview with Mike Kirby, chairman of Green Street Advisors, that asks if commercial real estate is bouncing back.
This whole premise that commercial real estate is "the next shoe to drop" is overstated. Clearly, we have problems, since there are many mortgages out there that were underwritten using very aggressive assumptions, and those will be difficult to refinance. But the good news is, if you look at our property index, we're back to 2005 pricing. So that means that most properties that were financed in '04 and '05 are not going to be much of a challenge to get refinanced. And, yes, the '06 and '07, which some indices say are still underwater, will also need to be recapitalized. The good news is, there's a very long line of capital sources that have shown up in the last nine months that are ready, willing and able to play that role.
Fortune's piece came next, showing up yesterday afternoon. Its piece looked at how the market has exhibited some vitality lately (something we've noted as well). What's been most remarkable about the CMBS recovery is that many people thought that the old model would have to be modified in some way for CMBS to come back. But that's not been the case. Nor has the intervention of the federal government been as essential to the process as some had thought.
The piece is interesting and traces how the recovery of the CMBS sector has unfolded through a series of fortuitous occurrences, shifts in strategies and the emergence of buyers for bonds that previously may not have been so interested in the sector.
CMBS's were in a complete freeze in 2008 and early 2009. They weren't saved solely by government programs or a concerted "save CMBS" movement. Instead, a game of financial hot potato accomplished the necessary work of turning up the right buyers at the right times. Again, the prices weren't always right -- at one point, the "super-senior," highest-rated tranches were trading at a paltry 50 cents on the dollar -- but they reflected what people were willing to pay and represented a market nonetheless. That's better than RMBS, CDS and CDOs could ask for at the height of the financial crisis.
The green signal that gave the go-ahead for investment activity was the government's decision in March 2009 to open up TALF, the government's toxic-asset buying plan, to CMBS. It soon followed by opening the PPIP plan to investors. Together, these two moves didn't clean up many actual CMBS, but they did provide a go-ahead to many large institutional investors including hedge funds and money managers, who immediately started trading as much CMBS as they could.
The way CMBS investors worked out the market was a kind of compartmentalization. They drew sharp lines. Some investors maintained an interest in highly rated triple-A CMBS tranches, which were and are still considered mostly stable with relatively high yields of around 6%, higher than U.S. Treasury bonds. Others took an interest in the more speculative, more troubled "B-piece," which carries with it lower ratings and greater chances of delinquency, but also provides the opportunity to push a loan into default and take control of the underlying real estate properties.
The CMBS market's recovery, then, can be traced through the underlying shift in who was buying. Trying to judge who the real holders of CMBS are is challenging. Many values have dropped, which have caused banks and insurers to mark down the value of the holdings and therefore provide a skewed view of how much CMBS they might really own.
More recently this year, there has been another trend that has focused interest on legacy CMBS. Another group of buyers has stepped in: real estate investors looking to control the underlying properties by buying into the CMBS, helping to choose the "special servicer" that extends the loan, and influencing the way the loan modifications work.
The biggest play in the future might well be CMBS investors trying to get close to these special servicers.
MSNBC, meanwhile, posted a piece this morning saying that commercial real estate fundamentals have improved--but only in coastal markets. New York, Los Angeles, Seattle and Boston are mentioned. But there's a different picture in the rest of the country where there's less evidence of any kind of positive momentum.
So while fresh hope buds in New York, Boston, L.A. and Seattle, commercial investors and developers in heartland markets are “are getting despondent,” says Alan Guinn, managing director of the Guinn Consultancy Group in Bristol, Tenn. His firm has developed alternative energy projects and consulted on real estate ventures with businesses in Memphis, Las Vegas, San Jose, Charlotte, Atlanta, Nashville, and Cleveland.
Indeed, some commercial real estate “gains” grabbed recent headlines, Guinn acknowledges. But “in most cases” positiveon the commercial front is “due to mergers and acquisitions, or consolidations of businesses,” he adds. “That, in and of itself, however, is not good news” because it shows that “businesses can't financially survive in the morass into which they have been thrust” and “sales have slid to levels where business growth and development simply can't be supported.”
So what to make of all of this?
I think ultimately the lesson is that too often the concept of "commercial real estate" is overly simplified by the mainstream business press.
There are tons of moving parts. There are different kinds of lenders. There are different kinds and qualities of properties. There are different markets. During the boom years there was an awful lot of compression in cap rates and values and financing terms and it seemed as if those differences between markets and property quality had disappeared. For example, the spread in pricing between a class-A building in New York and a class-C building in St. Louis compressed. When getting loans, LTVs were high, interest rates were low and all loans were non-recourse.
But the end of the boom and subsequent recession have reintroduced those differences with a vengeance. And I think what we're going to see is a recovery playing out at different speeds and in different degrees for different parts of the commercial real estate business.
So I don't think we can spin one simple narrative of commercial real estate as a sector rising or falling in unison. It's neither the "next shoe to drop" nor is it "recovering." It's a messy story. Unfortunately, messy stories don't make for clean and neat narratives when writing trend pieces. So the messiness gets glossed over.
We're going to see continued pain in some places alongside recovery in others. It does very much appear, though, that a bottom in values has formed. But I don't think anyone can say for certain what the contours or speed of recovery in values is going to look like. And it's going to play out differently in different markets and in different property sectors.
We are seeing improvement or stability for top properties in top markets. That makes a lot of sense. Class-B or class-C properties--especially ones in secondary or tertiary markets--are going to have a much tougher road. And some, ultimately, will never succeed as they were envisioned. They'll need to be redeveloped or demolished.
On the lending side, life insurance companies were more conservative thanand conduit lenders. And today the loans on their books have the lowest delinquency rates. So they have less problems to deal with going forward as loans mature. And financing is available from various sources, but not on the terms we saw at the frothiest time in the market.
Lastly, I think it's hugely important to remember that the health of commercial real estate as a sector is contingent on the health of the rest of the economy--particularly the jobs situation. Without a jobs recovery there will be no rise in demand for office space, no recovery in business and leisure travel, no sustained recovery in consumer spending and less people doubling up or living at home and moving into their own apartments.
So until that happens, I expect that the mainstream media's read on commercial real estate will continue to swing wildly depending on whatever the latest zeitgeist happens to be.