December 15, 2008    Further Commercial Real Estate (CRE) Notes.


I have compiled as well as heard from numerous industry sources the following:

Spreads will be going over 400 - 500+ bps, and loans will be based on cap rates of at least 8.5% to 9.0% or greater.

CRE loans are competing with A rated or better loans, which are fetching >8%.

Life insurance companies, previously huge funding sources for CRE borrowers are not eager to loan, and that is not expected to change any time soon.   Vornado discussed the other day, that they were hunkering down and preserving cash because of their credit market expectations.

Loans that were given in 1999 and prior that are starting to mature.  These  are no longer qualifying in today's credit  markets.   If loans are going to be rewritten expect to see lenders requiring additional equity from borrowers just to rewrite existing portfolio loans. In most cases it is projected to be 10% or less of the loan amount in additional equity.

I have been hearing quite a bit that previous eager lenders are telling clients with $1B of loans maturing, that no matter what borrower wants, financial institution or life insurance company will not re-lend. Lenders want the loans paid off. The trend of extensions will turn to a trend of foreclosures, according to these sources (which I have found as typically reliable). Financial institutions and life insurance companies will do their best for liquidity at all costs.

Things are bad right now, no changes expected and if you need money to borrow, you might have some difficulty. Especially when the need is > $250M, no matter what the LTV is.

I think the common understanding amongst NYC CRE professionals is that most properties purchased in 2005 - 2006 (even 2003 - 2004) have materially had their value reduced. Lack of transactions have not given one the ability to really determine value.

This would be a possible exercise.  Maybe one way to interpret value is to do the following.

Take a Class A NYC or DC building. Reduce rents by 15%. Increase vacancies to 10% (assuming current vacancies are less than 5%). Increase debt service by required 15 year principal and interest amortizations.   Keep in mind that the trend of recent  past debt service was often interest only. Assume an interest rate of 8.5%. Use a cap rate of 10%. This is just an exercise and possibly could be one generic method of trying to interpret value in today's Commercial Real Estate market.

One other method you could use is replacement cost.  According to Vornado last week,  this has come down substantially over the last 6 months. Vornado feels replacement cost, not long ago at $1,200 SF is now in the range of $700 SF.