A little light bed-time reading for everyone…the Congressional Oversight Panel has issued a 190 page report detailing the risks posed by CRE loans. Full document is below and the COP web site is here.
February 18, 2010
December 9, 2009
Geithner talks about expanding TALF to benefit CRE
I received an e-mail from Treasury this morning which contains a letter which Secretary Geithner has or is sending to Hill leadership on the administrations’s exit strategy for TARP. Most importantly for the CRE world, it holds out some hope that TALF (Term Asset Backed Securities Loan Facility) “may” be increased:
…”we may increase our commitment to the Term Asset-Backed Securities Loan Facility (TALF), which is improving securitization markets that facilitate consumer and small business loans, as well as commercial mortgage loans. We expect that increasing our commitment to TALF would not result in additional cost to taxpayers.”
We’ll see what they actually do, but this is definitely welcome news for those facing loan maturities in the next year or two and it might even help to stop or slow the free fall in commercial real estate pricing.
Letter below…
October 22, 2009
National League of Cities survey reflects challenging fiscal conditions
The National League of Cities reports that the economy is having a very negative effect on cities’ fiscal conditions. And primarily due to the lagging effect of property taxes (with reassessments occurring every few years in many jurisdictions) cities will continue to feel the impact of the recession well after the it has ended. Left unaddressed, though, in the discussion of property taxes is that while valuations will be declining, cities will be forced to largely make up for this over time by increasing the mill rate (property tax rate) in order to (mostly) balance their budgets.
Key findings of the report include:
- 9 in 10 city finance officers report that cities are less able to meet fiscal needs in 2009
- Expenditure growth is outpacing revenue growth
- Property tax revenue growth will be slowing
- Sale tax revenues are down due to the recession
- Rising costs of pensions, healthcare, and wages form a large part of expenditure increases
- Reserves will be drawn down significantly during the recession to plug budget gaps
Full report:
August 19, 2009
Moody’s/REAL CPPI August reports shows pace of price declines slowed
The latest Moody’s/REAL CPPI index, reflecting data through June, showed that the pace of CRE price declines slowed and volume of sales increased. This is in keeping with what is happening across single family housing recently and is in line with recent economic indicators. Most everything still seems to be trending negatively, but not as sharply as before. The Real CPPI aggregate index measured a moderate 1% price drop in June and measured a 50% increase in transaction volume (but only 87 sales due to the low prior tally). The aggregate index shows CRE prices overall are now 27% lower than one year ago, 34% lower than two years ago, and 35.5% lower than at the peak of the index in October 2007. Prices are now approaching levels not seen since 2003; the majority of owners who purchased properties after that point now have no equity left in their deal.
June 25, 2009
The debate about appraisals
WSJ has an article this morning summarizing the debate about home appraisals which has recently erupted. New rules adopted under pressure from NY’s AG Andrew Cuomo have the realtors up in arms with Lawrence Yun, the organization’s chief economist, lamenting “poor appraisals” and “faulty valuations” causing deals to fall through. The rules require greater independence for appraisers, who contrary to their long standing professional standards, have been subject to pressure from parties involved in sale and loan transactions. Now “appraisal management companies” are responsible for independently picking appraisers and managing the process.
WSJ article: http://blogs.wsj.com/developments/2009/06/24/whats-with-all-the-moaning-about-home-appraisals/
On the commercial side there are similar concerns which have arisen. Many institutional investors and managers have recently adopted valuation policies and guidelines which include greater independence in valuations. Some have employed appraisal management companies and many are reappraising their entire portfolios in order to “mark everything to market” on a more timely basis to better reflect reality.
Trouble is, on the commercial side, volume is off 80-90%. It’s tough to perform an appraisal with such limited comparable sales data, and appraisers are loath to rely on the “cost method” and the “income capitalization approach” is fraught with peril these days as well. Who is to say what is a proper discount or cap rate in light of the volatility and uncertainty in the marketplace? How far does an appraiser have to stretch geographically these days with limited transactions and what about all those “adjustments” made to the comparable sales to make them comparable to the subject property?
The reality today is that there are really three potential values for a commercial real estate asset to think about:
1) Fire sale today: Given the lack of transactions and limited appetite for risk, owners will generally sell today only if they have to, i.e., the property is in trouble, has tripped loan covenants, etc., or the owner is in distress. This is the low end of value and represents a market clearing price today.
2) Market stabilized value: By market stabilized here I am referring to the stabilization/normalization of the investment sales market. We may never reach the peak activity seen in 2006-2007, but a return to 1/4 or 1/3 that volume could be viewed as a normalized market which would improve pricing for owners/sellers. The capitalization rate for this value is likely 200-300 basis points below that of the “fire sale” cap rate available today. But one cannot sell at this price today; think of this as the medium to long term “intrinsic value”. Owners might think about projecting out when this value may be achievable and then discounting that value back at an appropriate rate to determine the value today.
3) Orderly dissolution value: This is the value of a property assuming temporary impairments such as owner distress have been resolved but the market has not yet fully stabilized. Think of orderly dissolution as a value somewhere between the fire sale and the market stabilized value. This seems to be something like what the Financial Accounting Standards Board was getting at with FASB 157. See the rule here: http://www.fasb.org/summary/stsum157.shtml
All of this discussion points out that an appraisal is an educated guess. The most solid real value at any given point in time is what an unrelated party will pay for an asset today. Until the property is marketed and sold, the appraisal and valuation process is just an educated guess, and today that guess is more uncertain than ever for residential and commercial real estate.
May 29, 2009
Where are cap rates headed?
Cap rates (for non CRE practitioners think inverse P/E ratio) have been trending up over the last year and half or so, meaning values are declining. There was a time in 2006-2007 when “everything was a 6% cap” (at most!). Quite a few seasoned real estate practitioners were scratching their heads wondering how this came to be and when it would end. With the onset of the credit crisis in the late summer/fall of 2007 it became clear that the 6% cap era may be threatened. As the recession has worn on, cap rates, as measured by the National Council of Real Estate Investment Fiduciaries and Real Capital Analytics, have generally risen by 75-100 basis points. Now everyone is talking about the return of 8% and even 9% cap rates, which were the norm only a few years ago. For perspective, the long term average for institutional quality real estate investment has been about 8.25%. The consensus seems to be that we are headed back to that level, but we are clearly not there yet.
The lack of recent transactions may be holding the cap rate uptick somewhat in check. Aside from investment property supply/demand and investor sentiment/expectations, the primary driver of capitalization rates is the cost of debt, i.e., interest rate levels (and other debt terms which have a material effect on leveraged returns such as loan to value ratios). The expectation is that interest rates will rise, and cap rates will follow. Interest rates are up a bit, but we have yet to see a significant increase in borrowing costs. This is probably the primary reason that cap rates have not gone up as much as everyone thinks they have or will (yet, anyway).
It’s worth noting that if a property’s cap rate started at 6% at purchase and now stands at 7%, that’s a 17% drop in value based purely on cap rate movement and not considering any potentially lower net operating income, which has been common with the recessionary environment we are in.
