Discounts? Yes, but a Fire Sale? No

Commercial Real-Estate Debt Hasn't Tanked Because So Many Are Seeking Bargains
By LINGLING WEI and JENNIFER S. FORSYTH May 9, 2008; The Wall Street Journal

The massive market for debt tied to commercial real estate is beginning to thaw as investors flush with cash are starting to buy up billions of dollars in mortgages and securities that had been stuck on the books of banks.

But that doesn't mean banks are lending -- capital-starved real-estate owners and developers have yet to see relief. As a result, the market for office buildings, shopping malls and apartments remains largely shut down.

At the same time, investors are buying up mortgages and securities at discounts ranging from 5% to 20%, which is much less than the big discounts that vulture investors got in the wake of the last major real-estate collapse in the early 1990s.

"Banks are not moving their inventory at fire-sale prices," said Noble Carpenter, head of loan sales at Jones Lang LaSalle, a Chicago real-estate brokerage and management firm.

Part of the reason is that default rates on commercial real estate remain low by historical standards. But there is also a glut of capital that was raised to buy distressed debt. As a result, many funds may not be able to achieve the low- to mid-teens returns they're targeting -- especially if they can't borrow money to magnify their returns, according to market participants.

Banks' commercial-debt problems began last summer when the credit crunch prevented them from packaging and selling some $200 billion in loans on properties such as skyscrapers and shopping malls as commercial-mortgage-backed securities, or CMBSs. Since then, bargain-hunting investors have been willing to buy at fire-sale prices, but banks haven't been willing to unload at that level.

Now, lenders are increasingly selling that debt, both as whole loans and as CMBSs. Buyers also are coming forward because of growing trading volume of CMBSs in the secondary market, reducing the spread between the securities and U.S. Treasurys.

In the past four weeks, banks have gone to market with four CMBS issues, with a total balance of $4.9 billion, according to data provider Commercial Real Estate Direct. That is a dramatic improvement from early this year, when weeks went by without a deal, but it still pales next to the same period last year, when the issuance totaled $78.7 billion.

"It's anticipated that, industrywide, inventory will be way down by the end of the second quarter," said Steve Kantor, co-head of global securities and of alternative investments at Credit Suisse Group.

Among the notable reductions: Lehman Brothers Holdings Inc., which had $36.1 billion in commercial mortgages and CMBSs when its fiscal first quarter ended Feb. 29, sold roughly $5 billion of the debt just in the following two weeks. Credit Suisse sold roughly $5.5 billion of commercial property loans and CMBSs in the first quarter, which helped cut its inventory by 25% as of March 31. Wachovia Corp., another big lender, sold $4.2 billion of debt in the quarter, reducing its exposure -- after the effect of offsetting transactions, or hedges -- to $3 billion as of March 31, down from $7.6 billion at year end.

Yet the discounts these lenders are offering are anything but generous. During the real-estate collapse of the early 1990s, some commercial debt sold for pennies on the dollar. Back then, though, the default rate was more than 20% and distressed funds didn't start buying huge blocks of assets, primarily from the government's Resolution Trust Corp., until more than a year into the crisis.

Today there are already at least 55 active or planned commercial real-estate debt funds seeking to raise $33.8 billion, according to Real Estate Alert, a trade publication. And many have begun to do deals.

Guggenheim Partners LLC's $1.25 billion real-estate debt fund, raised in December, has so far closed on or committed to more than $2 billion of investments. Edward L. Shugrue III, manager of real-estate debt funds for the firm, said the fund recently purchased $100 million of investment-grade CMBSs backed by office buildings formerly owned by Equity Office Properties -- at discounts ranging from 10% to 15% -- from a liquidating investment vehicle affiliated with a foreign bank.

Fund managers believe they will still be able to hit their return objectives because most of the real estate underlying the loans is healthy. (The national default rate on commercial mortgages is a slim 0.4%.) Eventually, they hope, that will drive up the value of the debt. But the risk is that a serious economic downturn could drive up delinquency rates.
"We only take on risk we know how to manage," said Bradford Wildauer, a partner who heads the debt investing business for Apollo Real Estate Advisors. The debt fund that the firm closed a year ago, with $625 million in equity capital, has so far committed to about $900 million of investments.

The Art of the Office Move in 2008

Hans Hansson April 22, 2008

The year 2008 will be a year of uncertainty in the office market nationwide. The speculative buying of commercial real estate over the last several years has pushed office market rental increases in double digits in many urban markets. Now with a possible slow down in the economy, landlords are feeling uneasy as to whether they can achieve their projected rental rates while tenants that need office space this year are entering a market where vacancy rates are low and therefore alternatives are harder to come by in these same markets.

Unlike the dot com market and its eventual bust this current office market will not see a fast raise of office space availability due to large failures of business. Although a recession could create some vacancies, the reality is that current low vacancies in a number of our markets are based more on the lack of building of office space going back over twenty years in some markets.

Some markets such as San Francisco have started building new office space for the first time since the mid 1980's. With over three million square feet of projected office space being built in the city this could open up real opportunities for lower rental rates in the future for office tenants if this new space cannot be absorbed quickly.

So what is an office tenant to do in 2008? First, an office tenant in a tight office market needs to be able to react quickly if they find a space that works for them. Competition particularly for smaller spaces does exist and if tenants are not able to present an offer, with all the necessary financials required for a landlord to make an informed decision, they could get beat out of that space.

Second, tenants have been accepting that the perfect space may not exist in today's market. If for instance views of the bay are required you may not find it. Don't make the mistake of not pulling the trigger on a space that could work because it is not 100 percent ideal. You need to be willing to accept less.

Third, be prepared to open your checkbook to cover overages in tenant improvements and security deposits that may be higher than the one month you put up for the last year. Tenant improvement costs continue to skyrocket and landlord allowances are not covering full build outs today. If the market does soften new owners of buildings may have trouble funding these shortfalls in tenant improvements, so be prepared to have to finance these improvements outside of the lease rate. Also, because of higher tenant improvements a number of buildings are requiring more than a month's security deposits. Get ready for that as well.

Finally ask your broker to investigate buildings that have not changed hands in the last three years. This is where you might find the best deals. Established owners, particularly those that survived the last boom and bust dot com market, understand that locking in good tenants at a fair market rate rather then a speculative one will provide stability for their asset vs. the new owner that has to find ways to get their building to perform to their original pro forma.

Cross-Border Capital Reshaping Marketplace as Sales Slow

Real Capital Analytics - March/April issue of Global Capital Trends

Globally, $86 billion of significant property sales were reported through February, representing a 50% drop in volume from a year ago.

Investment in Asia and South America doubled in the first two months of the year .

China and Germany may be the biggest net exporters of goods but they have become the largest importers of property capital.

Global buyers are much more likely to originate from the US, Australia, UAE, Israel, Germany and Canada.

Office properties, particularly those located in Europe have been the favored target for global buyers.

Over $88 billion of full-service hotels changed hands in 2007, 70% of the $125 billion global hotel market.

Spain is feeling the "Pain" too!!

Seeing the bright side of property crash
By Mark Mulligan, Financial TimesPublished: April 16, 2008, 00:17
While hardly a day passes without at least one developer, builder or property agent filing for creditor protection, Spain's property sector is trying to put a brave face on its current woes.
Despite a backdrop of oversupply and tight credit conditions that have driven down prices and sales, not all exhibitors at the current Sima international real estate exhibition in Madrid have lost their sense of humour.
At one large stand, a wrestling ring draws visitors as a caped Captain Avantis promotes a rental plan with buying option by defeating the "Evil Mortgage Man" in a staged bout.
At Zapata Real Estate nearby, discounts on new flats are offered under a jovial poster urging people to "put a happy face on the bad times".
'For potential first-time or holiday-home buyers at least, seeing the bright side of Spain's property crash is becoming easier.
A glut of new homes and apartments - particularly along the Mediterranean coast - is driving down prices after 10 years of soaring inflation. Some estimates see average residential prices nationwide falling by six per cent this year.
The International Monetary Fund, meanwhile, estimates that the market is up to 20 per cent overvalued. Buyers have already noted discounts of this magnitude at slow-selling villa and apartment developments in overstocked regions such as Valencia and Murcia.
However, these are exceptional cases, says Fernando Lopez, sales manager at Bancaja Habitat, a Valencia-based developer. A surge in land prices in recent years, fuelled by speculation, municipal kickbacks and a subsequent crackdown on re-zoning and corruption, has already squeezed developers' margins, he says.
"Obviously, prices are coming down. But if buyers are waiting around for across-the-board reductions of 20 or 30 per cent, they're going to be disappointed."
Like many Sima participants, Bancaja Habitat is using this year's trade fair to push badly performing residential developments. Taking a cue from fashion retailers, it is offering discounts of 10 to 20 per cent on "last year's stock" - about 400 properties that the company had hoped to sell on completion at least six months ago.
Grupo Prasa, another coastal developer, also hopes to clear lingering stock during the fair, which ends this weekend. Its lure is a three per cent discount. "The target is to sell 1,000 units during the show," says Miguel Mora, Prasa's marketing chief.
A few years ago, such a target would have lacked ambition, as speculators and long-term investors snapped up Spanish property off-plan.
But surging prices and a series of corruption scandals have eroded Spain's relative appeal against cheaper areas such as Bulgaria and north Africa. Meanwhile, banks, starved of wholesale funds, have reined in lending, exacerbating the crisis.
Scores of Spanish developers, builders and property agents with cash-flow problems have been unable to renegotiate debts, setting off a wave of consolidation and insolvency filings. Figures show 119 companies in the sector filed for creditor protection in the past three months, compared with 48 in the first quarter of 2007.
Large gaps in the Sima layout, where exhibitor numbers are down more than 25 per cent on last year, provide a grim illustration of the market's collapse.
"Last year everyone knew a slowdown was coming, so they came out in force," says Lopez of Bancaja Habitat. "But nobody saw the credit crunch coming . . . For consumers with access to credit, this is a buyer's market."
Trend: US companies focus on European investors
US companies are looking increasingly to European investors to help to finance projects or buy residential stock in tourism and retirement resorts, say organisers. The growing interest from non-European developers and selling agents is partly due to the strength of the euro against the dollar.
"However bad things get in Europe, the US is still looking ridiculously cheap," says Darren Styles, chief executive of Brooklands Group, a media company devoted to buying overseas property.
At the luxury end of the market, where most investors are impervious to financial crises, Europeans are looking to the US or Latin America for dollar-denominated bargains and higher yields.

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