Emerging Trends' Crystal Ball

Doug Marshall
Market Assessment
Published October 30, 2008

Emerging Trends in Real Estate is a 30-year old annual publication, focusing on the real estate and land use industry. It is co-authored by ULI (the Urban Land Institute) and PricewaterhouseCoopers LLP. It surveys experts from all sectors of commercial real estate and comes back with a report on where they believe the industry stands and is heading.

Brace yourself. The future has (unfortunately) become clearer.

According to the 2009 report issued recently, experts don’t expect the US economy to hit bottom until 2009, and they feel it will “flounder” throughout 2010 as well. In general, interviewees believe that financial institutions will continue to be pressured into moving bad loans off balance sheets.

Investors will likely wait until sellers realize that the market has adversely changed requiring them to lower their asking prices or wait until the market slowly comes back. Once the adjustments have made, both by lenders and sellers, those investors with cash or can afford low leverage transactions will be “king.”

In a situation like this, when bad debt is rampant and investors are burdened with upside down properties, serious retrenching is taking place. Absolute avoidance of risk seems to have taken priority with both lenders and those they serve. Commercial real estate is seeing a tremendous shift to a “back-to-basics attitude toward property management, underwriting, and deal structure”.

However, if you own an 8-plex apartment house near a bus stop, you’re still probably going to make money. That’s one of the few shining lights left in commercial real estate, says the report.

While the situation is dire, to be sure, there is hope for the future in the creation of more stable real estate markets. However, Emerging Trends has indicated several things that have to happen before we can see that recovery:

1. Private real estate markets need to correct – lenders must force distressed owners to become motivated sellers.
2. Debt capital needs to flow – the CMBS market must recreate itself and lenders will need to learn to adjust to the new, more conservative regulatory environment.
3. Regulators need to restore confidence in the securities market – systemic overhaul of the capital markets will slowly increase debt flows.
4. The economy needs to improve – unfortunately a waiting game for most CRE players.

The report predicts that the property sectors most promising in the months ahead will be apartments, with distribution/warehouse coming in second. Downtown office space is expected to outperform suburban markets.

But retail development will likely be at the bottom end of the real estate investment spectrum, with vacancies expected to climb due to the economic downturn.

Source:
www.marketwatch.com, Commercial Real Estate Market to Hit Bottom in 2009…, October 21, 2008.

Update On The Fed Rate Cut

Doug Marshall
Market Assessment
Published October 14, 2008

Last week the U.S. central bank, in a coordinated monetary policy move along with other major central banks worldwide, lowered the federal funds rate by 0.5% to 1.5%.

The purpose of this decision was to help calm the credit markets by taking another step towards stabilizing the global financial system.

The federal funds rate is the interest rate that banks charge each other for overnight loans. This decision will have an almost immediate impact on credit card rates, automobile loans, and business loans.

The rate cut is meant to give the economy a slight lift during a tough time, by reducing interest rates and making it less expensive for consumers and businesses to spend money.

But what effect will the rate cut have on commercial real estate loans? The day before the rate cut the 10 year treasury rate was trading around 3.50%. Today it is trading at 4.01%, an increase of 51 basis points.

Why would lowering the federal funds rate by 50 basis points increase the 10 year treasury rate by about the same amount?

The reason is that the 10 year treasury rate is not set by the Fed but rather by the market. And who owns most of our treasury bills? Foreign investors do.

The cut in the fed funds rates has left many foreign investors worried about the Fed’s ability to contain inflation, which has led them to begin pulling their investments out of US dollar- denominated assets.

So, as foreigners reduce their investment in US treasuries it reduces the demand for US treasuries. The law of supply and demand dictates that if the supply is staying essentially the same and demand is weakening then the price is going to come down, pushing up the yield rate.

So in effect the rate cut by the Fed is actually having the opposite effect that many hoped it would. It’s actually causing long term interest rates, which are more important to the economy and particularly the real estate industry, to rise.

Go figure!

Sources:
Matt Heaton, Active Rain Real Estate Network, Update on the FED rate cut
Reuters.com, October 8, 2008 Fed funds rate at 1.5 percent, matching target rate

The Four G's of Investment in a Hard Asset Economy

Doug Marshall
Market Assessment/Review
Published October 1, 2008

Last Friday I had the opportunity to attend the 3rd Annual CCIM/CID Conference in Bend, Oregon. The guest speaker was Dr. John Baen, professor of Real Estate at the University of North Texas. For three intense hours, Dr. Baen had the audience on the edge of their seats as he explained in layman’s terms what was happening in the capital markets.

His explanation of the current crisis was fascinating, but instead of simply focusing on the problem he also talked about the solution. In every economy, he said, there are opportunities for the savvy investor.

The crux of his talk could be summarized this way: we are at the beginning of a new hard asset cycle, where cash is king and where investing in securities, such as money market accounts, stocks, and bonds will be the big losers.

He talked of “the four G’s” – the type of investments that will prosper in a hard asset economy:

· Gold – precious metals will be a hedge against inflationary pressures.
· Ground – not just land but real estate as an asset class. Bare land is an excellent hedge against inflation but produces a smaller return on your investment than income-producing properties.
· Gas – investing in gas and oil is an excellent investment, but only for those with an understanding of this type of investment.
· Grub – meaning food, i.e., commodities and basic staples such as corn, wheat, etc. These will do well in the years ahead.

Dr. Baen then focused most of his time on how we can identify good real estate investments. Here are some of his thoughts:

Interest rates will have to go up substantially in the years ahead. He cited Alan Greenspan’s book, The Age of Turbulence, as a reference. Those who lock in long-term interest rates today will be among the winners.

Not all real estate will prosper equally. In a “down” economy, apartments and rental housing should do well. As the economy continues to soften, office and retail properties will be likely losers.

In the months ahead, lenders will be willing to make deals on properties in default in order to get them off their books. Those investors who are willing to propose very one-sided offers may be pleasantly surprised by lenders eager to make deals.

Bob Nelson, principal of Pacwest Real Estate Investments, also attended the seminar and did a much more thorough job of taking notes than I did. Click here for Bob’s 6 page summary of Dr. Baen’s talk.

Source:
Dr. John Baen, Professor of Real Estate, University of North Texas