Coming Soon: Commercial Real Estate Crash

Thursday, December 20, 2007 | 12:53 PM

Run-don't-walk to read Jesse Eisinger's article, Wall Street's Next Crisis:

"In their own way, however, commercial-real-estate loans were no less foolish than those made to home buyers with speckled credit . . . The implosion is going to be a refreshingly simple and familiar story.

In 1995, $15.7 billion worth of commercial-mortgage-backed securities were issued. Through the third quarter of 2007, $196.9 billion was issued, according to Commercial Mortgage Alert, a trade publication. That amount means 2007 will be a record year, even though issuance collapsed in the fourth quarter as investors panicked over the credit crunch. Right now, there is about $730 billion in commercial-mortgage-backed securities outstanding. "Not only have we been in a rising tide, but the loans are very different in underwriting standards than even five or 10 years ago," says Alan Todd, head of commercial-mortgage-backed-securities research at J.P. Morgan. "We haven't been through a cycle yet" with these new structures, he adds ominously."


Wall Street's Next Crisis
Jesse Eisinger 
Portfolio, January 2008 Issue

Thursday, December 20, 2007 | 12:53 PM | Permalink | Comments (33) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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Media headlines overhype the potential of commercial real estate (CRE) prices crashing. Real estate prices tend to be stickier and do not go through wild swings (like stock indices). Not only are stocks more volatile, but stocks have generally taken losses before real estate returns fell.

Commercial real estate value is a function of cash flow. CRE provide investors with actual cash flow stream.

Drivers of commercial real estate returns are different from residential RE and are also unique to its sector.

Homebuilders went overboard, and this is reflected by the large inventory of homes in the market.
CRE inventory is low, and developers have been so far disciplined not to oversupply the current market.
Low lumber prices also made it easier to build new single-family homes, while surging steel prices have had the opposite affect on supply of multiple-story buildings.

Demand drivers:
CRE investors favored markets with attractive fundamentals.
Strong job and population growth with limited new development made good office prospect.
Growing international trade and growing port and logistics locations favored industrial space.

Home prices relative to income show that the ratio is currently much higher than the historical average, indicating housing prices are highly overvalued. However, commercial RE fundamentals remain intact, supported by actual cash flow and a relatively contained inventory.

US CMBS delinquencies (heading into 2007) fell below 1%. Media headlines are misleading… especially when they claim “Delinquencies for CMBS May Double.” Even if CMBS doubles… doubling 1% is only 2%, which is nothing close to subprime delinquencies and hardly suggests commercial real estate is imploding. Those cheerleading that commercial real estate is imploding are typically from those who are in a short position. REITs are currently trading well below NAV, suggesting these shorters will need to cover fast if things don’t implode.

The current credit crisis will impact commercial real estate activity, including M&A and buyouts, stock repurchase programs to drive stock prices, among others. Commercial real estate could implode only if the economy goes down the drain, which would drag down everything anyway.

Overall, institutional investors have recognized the benefits of adding commercial RE in their portfolios and realizing the better risk-adjusted returns. Commercial real estate has become more sophisticated and transparent, which answers to the requirements demanded by seasoned investors.


BR: Valid points, Sam.

Thanks for making the other side of the argument . . .

Posted by: Sam Park | Dec 20, 2007 1:06:12 PM

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