Worst- and Best-Case Scenarios for Commercial Recovery
Dana Rubinstein Sept. 15, 2009, 7:39 a.m.
What is the congenitally optimistic real estate professional to do when confronted with a Moody’s report titled: “For CMBS, Recovery Appears Through a Glass, Darkly—and Slowly.”
Apparently, so downcast was Moody’s senior vice president Daniel Rubock that he had to resort to poetic language—and, later on, a LeBron James metaphor!—to articulate his predictions. And his conclusion? A rebound in commercial real estate “will not be any time soon.”
“Our reckoning of the best case of when a CRE recovery will emerge (what goes down eventually does come up) is late 2010 or early 2011, though this depends on the macroeconomic arc of recovery,” he wrote.
In a worst-case scenario, recovery will begin in 2012. In a best-case scenario, recovery will begin in late 2010 or early 2011. Though Mr. Rubock warns that even when said recovery “begins,” it may well be an unpleasant beginning, one fraught with “anemic growth” or “volatile acceleration/deceleration.”
“This much is certain: because commercial real estate has not changed its stripes, it will continue to be an economic performance dawdler, typically lagging macro trends by between four and six quarters.”
And the drubbing goes on, believe it or not:
“[Commercial real estate] will stagnate because of increasing unemployment rates, increasing vacancy rates, and increasing capitalization rates. This will lead to decreasing property values and, accordingly, more formidable refinancing challenges, decreasing cash flow and thus increasing term loan defaults, and continued liquidity ordeals for both capital markets and portfolio lenders. REITS, which many times act as a herald for CRE financing, have recently been able to raise surprising amounts of capital and some debt. How long before other (more leveraged) areas of CRE finance follow is an open question.”
As of July, according to Moody’s, the delinquency rate on U.S. CMBS loans was 3 percent. The delinquency rate is expected to hit somewhere between 5 percent and 6 percent by the end of 2009. Meanwhile, vacancy rates are rising and will continue to do so until the end of 2010 or the beginning of 2011.
Correspondingly, property values have taken a dive off a very steep cliff by a good 35.5 percent since late 2007. More value depreciation is anticipated.
When, oh when, will the industry start to convalesce? First, there has to be job growth: “Increased employment means fuller office buildings, more crowded retail stores, more hotel beds slept in, more factories and warehouses humming with activity, and thus, more cash flowing through to all landlords.”
Once that happens, hotels are generally thought to recover first … and office buildings last.
New CMBS issuance will only occur after “values slowly stabilize,” and investors develop a new appetite for CMBS. Which will take a while, and which is, frankly, sobering news for a market that once saw 45 percent of its lending capacity come from commercial-mortgage-backed securities.