March 2008 Commercial Real Estate Trends Podcast
-- Transcript of Capital Synergies Podcast
DARBY: Hello. This is Darby Worley, your host for Capital Synergies Talk Show for Real Estate Investors. Capital Synergies is brought to you by Steelhead Capital, your commercial loan advantage. Today we have with us, again, Mr. Dan Fasulo, Managing Director of Research for Real Capital Analytics. Dan, welcome back to the show.
DAN: Thanks for having me again.
DARBY: So Dan is here to take a look at the recent activity in the investment sales market trends, and to share with us his take on some of the dramatic changes we’ve seen in the commercial real estate sector. Dan, so last time we spoke with you back in December, we talked about the affect of the residential sub-prime on the commercial market. Where do you think we stand today?
DAN: Well, you know, unfortunately, for whatever reason, too many investors clump up residential and commercial in the same bag, and the residential and commercial real estate markets are really two distinct marketplaces, and there’s not much crossover. Where the crossover certainly is, is investor psychology and how that’s impacting decision making on that side. I certainly don’t think…besides maybe in the condo arena, there being a direct connection on the sub-prime part, however...
DARBY: So there isn’t a commercial lending version of the sub-prime products with those high…?
DAN: Well, I think maybe your closest comparison could be the CDO Marketplace for commercial real estate, which many expect to have significant troubles as asset values have dropped. And CDOs usually represent the riskiest part of the loan structure, and many have expected the values for those types of assets to fall dramatically.
DARBY: And just to back up for a second. What does CDO stand for?
DAN: Commercialized Debt Obligation.
DARBY: Okay. You also shared with us some words of caution regarding secondary markets. Are you still feeling the same way about that?
DAN: Well, I mean, nationwide, everyone’s being affected by the liquidity crunch right now, and just the lack of availability of debt capital. But certainly the U.S. hasn’t been affected the same throughout. There’s certainly a bifurcation going on between the more domestic based U.S. markets – which are arguably already in recession – versus the markets that are more linked to the ongoing global economic expansion – like your Manhattan, or San Francisco, and D.C. The primary markets with global exposure have held up better than your more domestic U.S. markets as far as activity and pricing. But we still are seeing declines across the board, unfortunately to report.
DARBY: So now, does the issue continue to be access to credit? Or are there other dynamics in play?
DAN: Well, at first there was certainly a credit crunch, and raised debt costs, and lenders really were putting more restrictions on who they would lend to, where geographically they would lend, but now I think we’re moving into a period where there seems to be more economic uncertainty which is driving decision making at this point. And I say that comfortably because in our recent analytics that we’ve put together, in previous slow-downs we’ve seen, we track all the major buyer capital groups – whether it’s institutional debts, or is it private investors – and previous blips on the down cycle we would always see one sector pull back and another kind of fill the gap. Right now, we’re seeing an across the board slow-down in acquisition activity by all different capital groups, and it really seems to indicate that there is uncertainty right now in the marketplace, and there’s certainly the disconnect between buyers and sellers right now. Sellers... and we’ve seen the situation over the last several months where we’ve seen a tremendous spike in offerings pulled from the market, where sellers would bring their property to market, and they would receive some bids for a particular asset, and they didn’t like, basically, what the market was telling them. They didn’t like their bids and they decided to just pull their property off the market as opposed to going through with the sale, and we’ve seen a tremendous spike in that activity. And that leads us back to the disconnect between buyers and sellers, and you have a situation where property fundamentals – occupancies and rents – have remained relatively strong, but the buyer is coming into a situation saying, “Hey, my debt costs are so much more expensive. I’ve got to put in more equity. You’re going to have to lower your price.” Unfortunately, sellers just haven’t come to the table ready to throw real significant discounts yet.
DARBY: Right. So as a follow-up to the question on the health of secondary markets, is there any hard data yet on how far values or cap rates may have moved?
DAN: Yeah. Well, I think it’s obvious that from the height of the marketplace – probably in the summer of ’07 – we’re certainly down 10 to 15 percent for commercial property values nationwide. Now, it certainly varies on a market-by-market basis. In Manhattan it may be 5 to 10, in certain markets in the Midwest it may be 15 to 20, but there’s no question that we’ve seen asset values fall and cap rates rise recently.
DARBY: Yeah. There’s a big article on – it must be three or four weeks ago – in New York Magazine talking about how historically, real estate in Manhattan has been kind of impervious to market fluctuations, but because there is so much new commercial building going on in terms of condos, that perhaps five years from now it might be – for the first time maybe ever – better to rent in New York than to buy. Do you... what do you think about that?
DAN: That kind of moves over to the residential side a little bit.
DARBY: Right. So that doesn’t affect the guy who’s building the rental building or the condo? That doesn’t qualify as commercial?
DAN: Yeah, I guess on the development side of it, but from my perspective development versus historical norms has been very limited in all the major markets across the U.S. like in Manhattan or D.C. And I think the market is actually tremendously undersupplied with new construction, and that’s what gives me a little comfort going into this slow-down, is that we certainly have not seen the type of over-building on the commercial side that we have seen on the residential side.
DARBY: Okay. So following on with that, is there…would you say then that like the hotel or office industrial/retail space might be better than apartments? Or are other areas there are property tax that stands out as either particularly bad or surprisingly resilient in this market?
DAN: Actually, we’ve been a little surprised that multi-family property – apartments – have held up relatively well versus the other property types in the U.S. and we were sitting down a few months ago and trying to figure out why, and we came to a couple of different conclusions. One was: apartments in the U.S. already went through a significant correction in 2006, so we had a situation where we lost the condo converters, if you recall, and it really drove cap rates back up and shot prices down. So we had that significant correction already in apartments. And then on top of that, the debt markets haven’t dried up on the multi-family side because Fanny Mae and Freddie Mac are still very active lenders there, and really giving some support for the debt markets for apartments where that support is obviously lacking for the other commercial property types right now.
DARBY: Okay. So where do we stand on foreclosure rates for commercial properties?
DAN: I think the latest report was that it’s slight increase, but we’ve been very fortunate not to have any significant commercial default at this point. This goes back to the point we were talking about before, that underlying property fundamentals remain in relatively good shape right now. We’re not seeing any widespread tenant defaults. While there may be decreasing occupancies in certain markets, overall occupancy levels and rent levels still remain at or near their record highs for many markets. So we haven’t seen a situation where that many investors are in danger of a default. Probably the only investors that are really in jeopardy are the investors who purchase property at the top of the marketplace and then finance those investments with short-term financing. They’re obviously in a very difficult position right now because the refinancing markets have pretty much dried up, or if not dried up they’re on completely different terms than when the investor originally made the deal. So... all-in-all, I don’t see any real significant situation where we have tons of commercial defaults unless there is an extended slow-down in the economy.
DARBY: Okay. There are some analysts that would say that for all practical purposes the CMBS market is gone forever. Do you agree with this?
DAN: No, I don’t believe that at all. Not in the slightest. I think it’s a very efficient way of placing debt. It really divides the risks appropriately among those who can take them. I think it’s only…I think when it does reappear, eventually, I think it will reappear in a much more conservative format, probably the way it was when it was a novice product. But I think it’s only a question of when it comes back, not if.
DARBY: Okay. So you don’t think there’s some kind of like hybrid of it that could emerge that would supplement it? Or...?
DAN: No, not at all. I think there’s a lot of unfounded fears right now, a lot of misconceptions, and unfortunately, the same thought process that drove investors to really buy up all this paper originally is really driving the lack of activity now – if you know what I mean. It’s just more investors need to be educated about what CMBS is, and what it could do, and I think it’s a very efficient way of placing debt, and it will be back.
DARBY: Okay. So that leads me into my next question. So given that the forces of capital have changed significantly, what do private investors need to know to be able to adapt and succeed to the new market position?
DAN: Well, there’s no question this is going to be a challenging year for private investors, especially if there’s a necessity to access the debt markets. I think 2008 will be a great year for your private investors to really focus inward on their portfolio – just try to strengthen the core of their assets, improve property fundamentals, et cetera. And I think there will be many opportunities for investors who can use a significant amount of equity in their acquisitions. I think there certainly will be some great deals to be made in 2008, but overall it’s going to remain difficult until the debt markets can return to a period of normalcy. We’ll always come back.
DARBY: Yeah. Good times don’t last, bad times don’t last.
DAN: There’s a lot of drama both ways.
DARBY: Yeah. So looking ahead kind of near term, what do you see on the horizon for the rest of 2008?
DAN: Real Capital Analytics – my firm – has expanded our operations overseas. I tell you, the more we venture out and start really tracking overseas markets, and understanding the fundamentals, and the pricing structures, I seem to get more and more bullish about the prospects for the U.S., especially in many of the major markets where there’s no oversupply. I think 2008 could, if we’re looking back, could wind up to be a very great buying opportunity for commercial property investors here in the U.S.
DARBY: When you say that the major markets, you’re talking Washington, New York, but where…are there others around the country that are...?
DAN: I’m talking an overall. There’s a good deal in every single market. You just have to find it. And there’s bad deals in every market. I think if you’re just trying to play a market, per se, I would be in the primary market for 2008, but on a deal by deal basis, you can find opportunity in every U.S. market right now. I just think that some of our global cities in the U.S. remain relatively undervalued versus our global counterparts that we’re tracking – whether it’s London, or Paris, or Moscow, or Tokyo. I think there’s certainly value, and if you recall after the credit crunch occurred in August, and we had a corresponding fall in the Dollar about the same time versus the Euro and the Pound, and everyone expected this flood of capital – this flood of foreign capital – to come into our market, and it never really came. And it was... from many conversations with overseas investors, it mostly had to do with the economic uncertainty surrounding the U.S. economy as opposed to, “Hey, my currency is worth 5 or 10 percent more. Let’s go buy in the U.S.” But there certainly is a mindset out there developing that on a risk adjusted basis the U.S. is starting to look more and more attractive to overseas investors. There’s certainly some value on the rate side that many are noticing right now. It’s rumored that for the first time some of the Sovereign Wealth Funds might be interested in maybe taking down a rate or two. It’s rumored that Cutter is... their Sovereign Wealth Fund is interested in maybe partnering and taking down McGuire Properties – a major office based in southern California. So I think that there is going to be opportunity in 2008, and investors are just going to have to do the proper homework, and not make any blind bets this year.
DARBY: Yeah. And speaking of proper homework – and I’m going to guess that you’re going to say this is kind of a case-by-case situation – but for people... regarding the management of their portfolio, is there a general word of advice that you would give in terms of buy, sell, hold?
DAN: Well, you answered my question originally. It always depends on the position of the assets, or whatever position the investor is in. But I think this is a great year to really focus inward on one’s portfolio and improve it as much as possible, and bring it to market in a better day when the markets are really back to normal.
DARBY: If an investor feels that they really need to sell relatively soon, should they try and get out before anything gets worse?
DAN: That is not a mindset that we’ve seen much of at all. We certainly have not seen any type of panic selling yet, nor do I expect it unless there’s some sort of severe economic downturn. We’ve seen none of that whatsoever.
DARBY: Okay, great. Well, Dan, if our listeners wanted to get this kind of investment research data on a regular basis, where can they go to learn more about subscribing to your reports from your company Real Capital Analytics?
DAN: They can certainly go to our website at www.RCAnalytics.com. We have a bunch of free reports up there that they can download, and they can certainly find all the information they want on the side.
DARBY: Okay. Say it one more time.
DAN: www.RCAnalytics.com
DARBY: Excellent. All right. Thanks, Dan, this has been a very insightful discussion on commercial real estate, and I’m sure our listeners appreciate you spending time with us today. So guys, if you are an investor looking for expert assistance with financing commercial real estate, be sure to check out the new commercial loan programs offered by Steelhead Capital, your commercial mortgage advantage. Again, that web address is www.SteelheadCapital.com. This has been Darby Worley, your host for Capital Synergies. Dan, thanks again for joining us.
DAN: My pleasure.
DARBY: Hello. This is Darby Worley, your host for Capital Synergies Talk Show for Real Estate Investors. Capital Synergies is brought to you by Steelhead Capital, your commercial loan advantage. Today we have with us, again, Mr. Dan Fasulo, Managing Director of Research for Real Capital Analytics. Dan, welcome back to the show.
DAN: Thanks for having me again.
DARBY: So Dan is here to take a look at the recent activity in the investment sales market trends, and to share with us his take on some of the dramatic changes we’ve seen in the commercial real estate sector. Dan, so last time we spoke with you back in December, we talked about the affect of the residential sub-prime on the commercial market. Where do you think we stand today?
DAN: Well, you know, unfortunately, for whatever reason, too many investors clump up residential and commercial in the same bag, and the residential and commercial real estate markets are really two distinct marketplaces, and there’s not much crossover. Where the crossover certainly is, is investor psychology and how that’s impacting decision making on that side. I certainly don’t think…besides maybe in the condo arena, there being a direct connection on the sub-prime part, however...
DARBY: So there isn’t a commercial lending version of the sub-prime products with those high…?
DAN: Well, I think maybe your closest comparison could be the CDO Marketplace for commercial real estate, which many expect to have significant troubles as asset values have dropped. And CDOs usually represent the riskiest part of the loan structure, and many have expected the values for those types of assets to fall dramatically.
DARBY: And just to back up for a second. What does CDO stand for?
DAN: Commercialized Debt Obligation.
DARBY: Okay. You also shared with us some words of caution regarding secondary markets. Are you still feeling the same way about that?
DAN: Well, I mean, nationwide, everyone’s being affected by the liquidity crunch right now, and just the lack of availability of debt capital. But certainly the U.S. hasn’t been affected the same throughout. There’s certainly a bifurcation going on between the more domestic based U.S. markets – which are arguably already in recession – versus the markets that are more linked to the ongoing global economic expansion – like your Manhattan, or San Francisco, and D.C. The primary markets with global exposure have held up better than your more domestic U.S. markets as far as activity and pricing. But we still are seeing declines across the board, unfortunately to report.
DARBY: So now, does the issue continue to be access to credit? Or are there other dynamics in play?
DAN: Well, at first there was certainly a credit crunch, and raised debt costs, and lenders really were putting more restrictions on who they would lend to, where geographically they would lend, but now I think we’re moving into a period where there seems to be more economic uncertainty which is driving decision making at this point. And I say that comfortably because in our recent analytics that we’ve put together, in previous slow-downs we’ve seen, we track all the major buyer capital groups – whether it’s institutional debts, or is it private investors – and previous blips on the down cycle we would always see one sector pull back and another kind of fill the gap. Right now, we’re seeing an across the board slow-down in acquisition activity by all different capital groups, and it really seems to indicate that there is uncertainty right now in the marketplace, and there’s certainly the disconnect between buyers and sellers right now. Sellers... and we’ve seen the situation over the last several months where we’ve seen a tremendous spike in offerings pulled from the market, where sellers would bring their property to market, and they would receive some bids for a particular asset, and they didn’t like, basically, what the market was telling them. They didn’t like their bids and they decided to just pull their property off the market as opposed to going through with the sale, and we’ve seen a tremendous spike in that activity. And that leads us back to the disconnect between buyers and sellers, and you have a situation where property fundamentals – occupancies and rents – have remained relatively strong, but the buyer is coming into a situation saying, “Hey, my debt costs are so much more expensive. I’ve got to put in more equity. You’re going to have to lower your price.” Unfortunately, sellers just haven’t come to the table ready to throw real significant discounts yet.
DARBY: Right. So as a follow-up to the question on the health of secondary markets, is there any hard data yet on how far values or cap rates may have moved?
DAN: Yeah. Well, I think it’s obvious that from the height of the marketplace – probably in the summer of ’07 – we’re certainly down 10 to 15 percent for commercial property values nationwide. Now, it certainly varies on a market-by-market basis. In Manhattan it may be 5 to 10, in certain markets in the Midwest it may be 15 to 20, but there’s no question that we’ve seen asset values fall and cap rates rise recently.
DARBY: Yeah. There’s a big article on – it must be three or four weeks ago – in New York Magazine talking about how historically, real estate in Manhattan has been kind of impervious to market fluctuations, but because there is so much new commercial building going on in terms of condos, that perhaps five years from now it might be – for the first time maybe ever – better to rent in New York than to buy. Do you... what do you think about that?
DAN: That kind of moves over to the residential side a little bit.
DARBY: Right. So that doesn’t affect the guy who’s building the rental building or the condo? That doesn’t qualify as commercial?
DAN: Yeah, I guess on the development side of it, but from my perspective development versus historical norms has been very limited in all the major markets across the U.S. like in Manhattan or D.C. And I think the market is actually tremendously undersupplied with new construction, and that’s what gives me a little comfort going into this slow-down, is that we certainly have not seen the type of over-building on the commercial side that we have seen on the residential side.
DARBY: Okay. So following on with that, is there…would you say then that like the hotel or office industrial/retail space might be better than apartments? Or are other areas there are property tax that stands out as either particularly bad or surprisingly resilient in this market?
DAN: Actually, we’ve been a little surprised that multi-family property – apartments – have held up relatively well versus the other property types in the U.S. and we were sitting down a few months ago and trying to figure out why, and we came to a couple of different conclusions. One was: apartments in the U.S. already went through a significant correction in 2006, so we had a situation where we lost the condo converters, if you recall, and it really drove cap rates back up and shot prices down. So we had that significant correction already in apartments. And then on top of that, the debt markets haven’t dried up on the multi-family side because Fanny Mae and Freddie Mac are still very active lenders there, and really giving some support for the debt markets for apartments where that support is obviously lacking for the other commercial property types right now.
DARBY: Okay. So where do we stand on foreclosure rates for commercial properties?
DAN: I think the latest report was that it’s slight increase, but we’ve been very fortunate not to have any significant commercial default at this point. This goes back to the point we were talking about before, that underlying property fundamentals remain in relatively good shape right now. We’re not seeing any widespread tenant defaults. While there may be decreasing occupancies in certain markets, overall occupancy levels and rent levels still remain at or near their record highs for many markets. So we haven’t seen a situation where that many investors are in danger of a default. Probably the only investors that are really in jeopardy are the investors who purchase property at the top of the marketplace and then finance those investments with short-term financing. They’re obviously in a very difficult position right now because the refinancing markets have pretty much dried up, or if not dried up they’re on completely different terms than when the investor originally made the deal. So... all-in-all, I don’t see any real significant situation where we have tons of commercial defaults unless there is an extended slow-down in the economy.
DARBY: Okay. There are some analysts that would say that for all practical purposes the CMBS market is gone forever. Do you agree with this?
DAN: No, I don’t believe that at all. Not in the slightest. I think it’s a very efficient way of placing debt. It really divides the risks appropriately among those who can take them. I think it’s only…I think when it does reappear, eventually, I think it will reappear in a much more conservative format, probably the way it was when it was a novice product. But I think it’s only a question of when it comes back, not if.
DARBY: Okay. So you don’t think there’s some kind of like hybrid of it that could emerge that would supplement it? Or...?
DAN: No, not at all. I think there’s a lot of unfounded fears right now, a lot of misconceptions, and unfortunately, the same thought process that drove investors to really buy up all this paper originally is really driving the lack of activity now – if you know what I mean. It’s just more investors need to be educated about what CMBS is, and what it could do, and I think it’s a very efficient way of placing debt, and it will be back.
DARBY: Okay. So that leads me into my next question. So given that the forces of capital have changed significantly, what do private investors need to know to be able to adapt and succeed to the new market position?
DAN: Well, there’s no question this is going to be a challenging year for private investors, especially if there’s a necessity to access the debt markets. I think 2008 will be a great year for your private investors to really focus inward on their portfolio – just try to strengthen the core of their assets, improve property fundamentals, et cetera. And I think there will be many opportunities for investors who can use a significant amount of equity in their acquisitions. I think there certainly will be some great deals to be made in 2008, but overall it’s going to remain difficult until the debt markets can return to a period of normalcy. We’ll always come back.
DARBY: Yeah. Good times don’t last, bad times don’t last.
DAN: There’s a lot of drama both ways.
DARBY: Yeah. So looking ahead kind of near term, what do you see on the horizon for the rest of 2008?
DAN: Real Capital Analytics – my firm – has expanded our operations overseas. I tell you, the more we venture out and start really tracking overseas markets, and understanding the fundamentals, and the pricing structures, I seem to get more and more bullish about the prospects for the U.S., especially in many of the major markets where there’s no oversupply. I think 2008 could, if we’re looking back, could wind up to be a very great buying opportunity for commercial property investors here in the U.S.
DARBY: When you say that the major markets, you’re talking Washington, New York, but where…are there others around the country that are...?
DAN: I’m talking an overall. There’s a good deal in every single market. You just have to find it. And there’s bad deals in every market. I think if you’re just trying to play a market, per se, I would be in the primary market for 2008, but on a deal by deal basis, you can find opportunity in every U.S. market right now. I just think that some of our global cities in the U.S. remain relatively undervalued versus our global counterparts that we’re tracking – whether it’s London, or Paris, or Moscow, or Tokyo. I think there’s certainly value, and if you recall after the credit crunch occurred in August, and we had a corresponding fall in the Dollar about the same time versus the Euro and the Pound, and everyone expected this flood of capital – this flood of foreign capital – to come into our market, and it never really came. And it was... from many conversations with overseas investors, it mostly had to do with the economic uncertainty surrounding the U.S. economy as opposed to, “Hey, my currency is worth 5 or 10 percent more. Let’s go buy in the U.S.” But there certainly is a mindset out there developing that on a risk adjusted basis the U.S. is starting to look more and more attractive to overseas investors. There’s certainly some value on the rate side that many are noticing right now. It’s rumored that for the first time some of the Sovereign Wealth Funds might be interested in maybe taking down a rate or two. It’s rumored that Cutter is... their Sovereign Wealth Fund is interested in maybe partnering and taking down McGuire Properties – a major office based in southern California. So I think that there is going to be opportunity in 2008, and investors are just going to have to do the proper homework, and not make any blind bets this year.
DARBY: Yeah. And speaking of proper homework – and I’m going to guess that you’re going to say this is kind of a case-by-case situation – but for people... regarding the management of their portfolio, is there a general word of advice that you would give in terms of buy, sell, hold?
DAN: Well, you answered my question originally. It always depends on the position of the assets, or whatever position the investor is in. But I think this is a great year to really focus inward on one’s portfolio and improve it as much as possible, and bring it to market in a better day when the markets are really back to normal.
DARBY: If an investor feels that they really need to sell relatively soon, should they try and get out before anything gets worse?
DAN: That is not a mindset that we’ve seen much of at all. We certainly have not seen any type of panic selling yet, nor do I expect it unless there’s some sort of severe economic downturn. We’ve seen none of that whatsoever.
DARBY: Okay, great. Well, Dan, if our listeners wanted to get this kind of investment research data on a regular basis, where can they go to learn more about subscribing to your reports from your company Real Capital Analytics?
DAN: They can certainly go to our website at www.RCAnalytics.com. We have a bunch of free reports up there that they can download, and they can certainly find all the information they want on the side.
DARBY: Okay. Say it one more time.
DAN: www.RCAnalytics.com
DARBY: Excellent. All right. Thanks, Dan, this has been a very insightful discussion on commercial real estate, and I’m sure our listeners appreciate you spending time with us today. So guys, if you are an investor looking for expert assistance with financing commercial real estate, be sure to check out the new commercial loan programs offered by Steelhead Capital, your commercial mortgage advantage. Again, that web address is www.SteelheadCapital.com. This has been Darby Worley, your host for Capital Synergies. Dan, thanks again for joining us.
DAN: My pleasure.
