I like Heidi Moore. She’s a very good writer and even better tweeter (IMO). So I was keenly interested to see her article on commercial real estate and commercial mortgage backed securities. It didn’t disappoint. It’s a good read.
But I couldn’t resist playing devil’s advocate. Because I think some folks are still wearing rose tinted glasses regarding CRE. Consider what Richard Lefrak said in the piece:
Richard LeFrak, chairman of the LeFrak Organization, said at the Milken Institute Global Conference in April, “The failure that we were all anticipating in the commercial real estate market, it kind of didn’t happen. We blinked, it went away.”
In the immortal words of Ace Ventura, Pet Detective: “RRRReeeeaaaallllyyyy.” Then why would Fitch come out and say this in their latest CMBS loss study?
The average loss severity rate for U.S. commercial mortgaged-backed securities (CMBS) loans resolved with losses in 2009 was 57%, an increase of 33%, compared to the 43% rate in 2008. The higher losses can be attributed to declines in property values, adverse selection of loans resolved, and the tremendous number of loans in special servicing as of year-end 2009. Although more loans were resolved in 2009 than in previous years, the volume of specially serviced loans at year-end 2009 was at an all-time high, with 4,435 loans totaling $74 billion.
Not depressed enough? Try this (also from the same report):
Fitch Ratings expects loss severities to continue to outpace the cumulative historical average of 37.2% through 2011.
So in my mind, we’ve already seen a CRE crash. I guess people were afraid it was going to be worse. Go figure. At any rate, the whole report can be found here:
The way forward that people are thinking of is interesting, and I think it’s largely correct. The path is downward for CRE and CMBS, but it’s really a question of how far and how fast. On one hand, there’s a crash:
Some predict foreclosures, loan defaults and a national crisis of disastrous proportions. In that corner is Elizabeth Warren’s Congressional Oversight Panel, which flatly predicted this year that commercial real estate loans are heading for a crash that will bring down small banks, destroy small-business lending and create “a downward spiral of economic contraction,” in her ominous words.
So that’s one camp. It’s a scary scenario, to be sure. But in my mind, there’s another that’s much, much worse:
On the other side, investors in commercial properties and buyers of commercial mortgage-backed securities believe that the commercial real estate market will continue to suffer until it hits a bottom, but it will never crash in the way that the residential market collapsed. They believe that commercial real estate will be an example of how a market can take the hits and keep on ticking, that not every spot of trouble results in a crisis, that an industry can actually, somehow, stop a crisis if it acts early enough and has enough support.
Right. And I’m sure the same was said about Japanese real estate, circa 1990. If you take a look at this chart from Richard Koo, you’ll see how *that* turned out for the Japanese:
The rest of Koo’s presentation can be found here:
The reason I worry more about the secnod outcome and the Japanese experience is simple: the time value of money. The keyword being time. Time is the one commodity out there that’s more valuable than money. So whenever you are given the choice of realizing losses sooner rather than later, it’s best to do it sooner. But it’s also more difficult to do because of the pain that’s usually involved. You can get money back, but you can’t get time back. That’s what worries more about the long, slow bleed.
So call me crazy, but I have a feeling being underweight real estate going forward won’t cause me to lose too much sleep.
And I need my beauty rest…