For CRE Assets, It’s ‘Dislocation, Dislocation, Dislocation’

MBA (4/23/2008 ) Murray, Michael
Distressed paper and non-distressed assets are causing dislocations in commercial real estate pricing and valuations with wider gaps between buyers and sellers.

Meghan Gorman, senior research analyst at CBRE/Torto Wheaton Research, Boston, said the LIBOR rate (London InterBank Offered Rate) is spiking while the 10-year Treasury note had its largest weekly decline in four years and CMBS issuance dropped 92 percent in March from last year.

"Dislocations in the debt market continue to persist," Gorman said.

Despite a credit crunch and dislocation in the capital markets, commercial real estate prices increased 2.1 percent in February, offsetting most of the losses posted since October in Moody's/REAL Commercial Property Price Indices (CPPI).

"We interpret the CPPI's increase in February as a continuation of the process of price discovery, which is likely to continue over a protracted period, possibly a few more quarters," said Sally Gordon, vice president at Moody’s Investor Services. "Few foreclosures or other forced sales at market clearing prices have occurred to help tease out the impact of the credit crunch on current property prices."

“While there is some distress at the paper level, it was clear that there was very little distress at the hard asset level,” said Jay Rollins, president of JCR Capital, Denver, following a conference on distressed commercial real estate assets. “There are very little distressed hard assets trading hands.”

Fitch Ratings, New York, reported an increase in delinquencies for commercial mortgage-backed securities in the United States by three basis points (bps) during March, up to 0.33 percent following a similar increase during February. In its loan delinquency index, Fitch noted an uptick in loans not refinancing precisely at their maturity date, as the number of non-performing matured loans increased year over year from 11.6 percent in March compared to 2.9 percent of the index in March 2007.

Many industry analysts focusing on distressed markets said it is still early for condominiums to hit bottom as developers continue to deliver in South Florida, San Diego and other markets.

“These construction loans need to run out of interest reserves and miss their pre-sale closings before they go non-performing,” Rollins said. “Mezzanine debt in many of these deals is wiped out, but action has not yet been taken.”

Moody's expects commercial property prices to fall nearly 15-20 percent before bottoming out, but it said that a longer average holding period for property sales in the past year slows the process and supports the assertion that recent sales are weighted toward "winners" that have realized more appreciation.

Based on Fitch’s report, 44 loans were considered non-performing matured loans, consisting of $213.2 million, with seven non-performing matured loans in 2007 at $37.3 million. More loans are reaching maturity without financing in place, but loans are continuing to payoff near maturity, Fitch added.

“The majority of fixed-rate non-performing matured loans pay in full or extend their terms within 60 days of being transferred to special servicing,” said Susan Merrick, managing director and CMBS group head at Fitch.

Multifamily drove increases in the delinquency index, followed by office, retail, hotel, manufactured housing and mixed-use properties for March—with more delinquencies than at the end of February.

Rollins noted that distressed capital is “out there” seeking unleveraged 20 percent returns from distressed commercial real estate assets, but a wide bid-ask gap in the market leads to “very little trading.”

Moody’s also noted the large gap between buyers and sellers as fewer repeat transactions occurred in February compared to previous months.

The ratings agency said volume could be down based on prices not yet adjusting to market conditions. The increase in February’s CPPI in put the year-over-year price increase at 4.2 percent with a two-year change in price up 12.9 percent for February.

Meanwhile, the industrial, healthcare, self storage and other sectors moved in the opposite direction, their smaller contribution to the universe having a minimal impact on the overall index, Fitch added.

"The return of securitization will take liability commitments off balance sheet and inject liquidity back into the banking system, stabilizing LIBOR, the TED spread and the cost of debt," Gorman said. "Restored confidence in the monoline insurers will result in accurate pricing of the low default probabilities of municipal and triple-A-rated paper."

Rollins said falling LIBOR is helping many properties stay current and make their net operating income extension tests. “Many lenders with hard assets do not have to mark to market,” he said. “Lenders want to extend these loans, which helps performance and avoids write downs."

"When CMBX begins to price CMBS deals based on the fundamentals of the underlying properties as opposed to reflecting the increased risk in the credit default market, structured finance will return as a capital source to commercial real estate,” Gorman said. “As the health of these indicators improves and liquidity returns to the market, we predict that the state of debt flow will drive cap rate compression and the return of stable commercial real estate value.”