Aftermath of commercial real estate downturn won't be easy, analysts say
By STEVE BROWN
While the worst of the commercial real estate downturn may be in the rearview mirror, industry analysts say cleaning up the mess left behind won't be easy.
"We may be seeing the peak of the cycle," said Greg Leisch, chief executive of the Delta Associates real estate research firm. "For the first time in the cycle, we've seen a decline in construction loan delinquencies.
"And commercial mortgage-backed securities delinquencies have stopped their upward spiral as well," he said. "We've got a rebound in property values, only after two years of a downturn in values."
Leisch, who spoke at a RealShare Distressed Assets conference Thursday morning in Dallas, said the timeline of the commercial property market shakeout is likely to be more compressed than in previous downturns.
"This is quite a contrast to last time in the 1990s, when we had seven years of negative property trends for a total decline of 39 percent," Leisch said. "This time, we had two years and a total decline of 33 percent.
"The failure rate this cycle is well below the savings and loan crisis of the late '80s and early '90s."
The quicker turnaround in commercial property is due in part to more lenient attitudes among banking regulators and lenders, he said.
And investors have stayed with the commercial property market.
"Our institutional investors have really hung with us in this cycle," Leisch said. "The institutions have actually increased their allocations to real estate in this downturn, in contrast to how they abandoned our industry in the debacle of the 1990s."
That may be because they have no better alternatives, he said.
"If you look at the 10-year returns, real estate has held up better than stocks or bonds," Leisch said.
Plenty of worries
There are still plenty of worries for the commercial property sector. Increases in interest rates would be fatal for many deals.
And during the next five years, almost $1.5 trillion in commercial property loans will come due and must be refinanced, Leisch said.
"Of course there is the wild card of the economy, and how the anemic job growth will affect the occupancy rates of all that vacant office space, industrial space and retail space," he said.
Plus, untangling bad debt deals – many of them financed with mortgage-backed securities – will be harder this go-round, longtime market analysts say.
"We are in a mess, and it's complicated," said Michael Buckley, who heads the University of Texas at Arlington's real estate repositioning and turnaround strategy program. "Lawyers are salivating over the fees that will be generated from solving this mess."
Some bright spots
Jeffrey Lenobel, a real estate lawyer with the New York firm of Schulte Roth & Zabel LLP, said he's already encountering legal dust-ups over troubled debt.
"We are seeing more fights between lenders and lenders than lenders and borrowers," Lenobel said. "We've never seen that before."
Because of the multiple debt holders involved in many commercial property deals, sorting out a solution can be more difficult. "We've been struggling with these lender-lender battles," he said.
But during the last six months, Lenobel said he's also noticed an uptick in new commercial property development and investment.
Unlike a year ago, when virtually all debt was frozen, viable commercial projects can now attract financing.
"There is not as much dumb money as there was a couple of years ago," said Thomas Melody, executive managing director with Jones Lang LaSalle.
Property conditions vary widely around the country, Melody said.
"You have certain markets where we think the values have elevated to where they were in 2007, like Washington, D.C.," he said. "And we have markets where it is 50 percent of perceived value a couple of years ago."
Trey Morsbach, senior managing director for investment broker Holliday Fenoglio Fowler LP, said there's plenty of money available "if the story is right."
He said that over the last six months there's been a strong return of capital.
"We are looking at some of the lowest capital costs in history for commercial real estate," Morsbach said. "We are seeing an extraordinary amount of capital flow and debt and equity is coming back."
