May 27, 2009 

CRE= Commercial Real Estate


Miscellaneous CRE notes

Office Vacancy Rates:

1985 - 1991 19%
1992 18%
2000 8%
2002 17%
2007 12%
2008 16%
2010 (estimated) 18%

Cap Rates for CRE:

Year 12 Month Rolling Cap Rate Mean Cap Rate
2004 7.5% 7.5%
2005 7.4% 7.3%
2006 7.1% 6.8%
2007 6.5% 6.6%
2008 6.7% 7.4%

CRE Mortgage Delinquency Rates

1991 13%
1992 11.5%
2000 2%
2002 2%
2007 2%
2008 4%
2009 7%


CMBS Notes  5/3/09

There has not been a single CMBS issuance reported since July 1, 2007 through 3/31/08. This has been attributed to increased credit tightness (see our BAM thesis), deterioration in commercial real estate (see our BAM thesis), decreased rents, increased vacancies, decreased property values, increased cap rates and requirement to be more conservative in calculation of cap rates. Delinquencies will start to rise, especially when extensions are due. I think properties with claim to lower stated LTV will be susceptible, as a lender would rather take that back, than one of a mortgage that is under-water. Yet, industry insiders have felt that lower loan to values will have greater refinancings, citing the lenders having more comfort with the collateral. All that said, there are expectations that market will open up again, just with wider spreads, greater restrictions, recourses, etc. CRE CMBS delinquencies are increasing. I read a report that showed delinquencies rose from 0.40% in 3Q08 to 1.12% in 1Q09. Later vintage loans are also experiencing unexpectedly higher default rates. These were allegedly issued with greater standards, and hence the surprise of default rate. Interest Only loans have almost disappeared (I think this will obviously affect BAM cash flow).

Sam Zell on CRE

We all drank too much Kool-Aid. Between 2003 and 2007, 50% of all commercial real estate traded. It ended up being over-leveraged. All cash buyers like Calpers played the leverage game instead of buying for cash. Very few who bought from 2003 to 2007 are above water. You can call it credit crunch, sellerís strike, buyerís strike, either way you have more debt than you have value. We wonít see new equity players until the banks foreclose. Itís going to be a couple to three years before the ownership structure changes. Prices are down 25% to 30% on whatís sold. The reality is there ainít much trading. One of the great lessons of Confucius is bankruptcy courts donít respect maturities. Thatís your General Growth (Properties) story. Sales occur when there are prospects. Tell me where the prospects are? Iím happy to buy a hotel when you can tell me the President will stop tinkling (fool profanity filters did not let in Zell's actual quoted comment) on conventions. If owners have no equity, owners have no incentive to do anything. Whoís going to put up tenant improvement money? Publicly held REITs have gone down 65%, arguably too far. Thatís real daily pricing. You have a lot of loans at floating rate, you donít miss payments at 1-2%.Ē


Barron's cover article on CRE

"Kirby adds that REIT executives -- many of them aggressive types who turned family businesses into big public companies -- must change their mindsets. "Real-estate guys can't help themselves. Instead of asking, 'How much debt should I have,' they ask, 'How much debt can I get?' " Kirby argues that the trusts need little or no debt."

"A good chunk of REITs' debt is maturing during the next few years. It may be tough to refinance all of it, owing to lower property values and the cost of new borrowing, which is apt to be higher than the 5% to 6% annual rates of the boom years. Traditional lenders such as life insurers want 7.5% to 8% for secured loans. Unsecured debt can cost 9% or more -- if it is available."

"Real-estate pros focus on a financial measure called the capitalization, or cap, rate -- calculated by dividing annual net operating income by total equity and debt. For REITs, this rate currently averages about 9%. Cap rates hit a low of 5% to 6% in 2007, with some deals, like Tishman Speyer's $22 billion leveraged buyout that year of high-end apartment REIT Archstone-Smith, done at a 4% cap rate. The cap rate is like a bond yield. The higher it is, the better the return to the investor."

"Shulman, who is now an academic, says one of the big issues for Vornado is the future of Wall Street, because Vornado gets 30% of its operating income from Manhattan office buildings. Prime midtown Manhattan rents, which topped $100 per square foot in 2007 and early 2008, are in the $70 to $75 range now, according to the real-estate advisory firm Newmark Knight Frank. The Midtown vacancy rate hit 14.2% in the first quarter, the highest in 15 years"

"Formerly hot office-building owners Brookfield Properties (BPO) and SL Green Realty (SLG) have a lot of debt and are exposed to the weakening Manhattan market."

"The possibility of dilutive common-share offerings is a risk with both SL Green and Brookfield, which owns the lower-Manhattan complex that houses Barron's editorial offices.

There was 65% dilution when highly leveraged ProLogis, an owner of industrial warehouses, recently had a $1.1 billion equity offering. And shopping-center owner Kimco Realty sold $750 million of stock that diluted existing shareholders by 40%."

Some CRE CC notes I took this month.

I find the bottom one on Brookfield most interesting. The whole world is in pain on CRE, yet BPO finds Class A in Toronto at 5% cap rate and $723SF.

Boston Properties 4/30/09

Interesting call. They think the loss acceleration might be losing its velocity.

"Overall, the credit markets remain difficult to access, but are open for companies like ours.

The secured mortgage markets are actively providing term sheets for high quality properties, with 50 to 60% leveraged fixed rate debt for 5 to 10 years, at 7.5 to 8.5% range.

Floating rate bank debt can be found for terms of three to five years at LIBOR plus 300 to 450 basis points that can be swapped to a fixed rate of 5 to 7%. And the government is actively working with the industry on TALC2.0 amend other government programs to try to reopen the securitized market at low leverage levels which might be supplemented with higher coupon junior debt to raise proceeds to 60%.

The secured markets are seeking to finance the highest quality assets with low tenant leasing risk and moderate leverage."

"But just sort of give you a perspective, we signed the lease at -- you know, in the high rise at Citigroup center at $140 a square foot in November of 2008. And I don't think we would be able to get $90 a square foot today."

CB Richard Ellis 4/30/09

"Most significant macrofactors directly impacting our business include weak global economic performance, deleveraging of a global financial system, continuing job losses, corporate bankruptcies, corporate consolidation driven by distressed company sales, capital spending reductions, declining absorption, increasing vacancy rates and declining rental rates. Weakening of fundamentals across most businesses and finally, of course, tough lending conditions. Since the second quarter of 2008, these factors and corresponding impact on commercial real estate have negatively impacted our revenues across most of our lines of business and across all geographies."

"Our assets under management are down 18% from a first quarter 2008 peak of $43.7 billion, driven by the decline in commercial real estate values."

"We do believe that on the yield side, certainly in the U.K. , yields have probably stopped expanding. Values are still declining because rental rates are coming down. In the state, we're getting close to that. I think you're getting about to where yields are going to get to on the top end. Values, of course, still should be coming down because leasing rates are coming down."

"That's what people do. So, they've got four years left on their lease. They're in midtown, Manhattan. They're 100,000 square feet. They're probably going back down saying listen, I'll rewrite the less lease for ten years, 15 years but the rent I'm paying now at $68 a foot, I'll offering $45 or $50. Those types of conversations are very prevalent in the market place right now. That's the trend you would expect to see in this market."

"I love it. The last two years, we were about to hit the worst downcycle in history. I've been nothing but criticized for being negative. I tell you guys, looks we're not going to mince words with you guys. We saw this downturn coming. It was a train wreck. Thank goodness, we took that view because we got it awhile ago. It has been really a magnificent effort by our people to get cost out of business. So, if I sound a bit more positive today, I would say it is based on ......"

" we're certainly not at bottom in leasing yet. And the leasing market is under a lot of stress and it will be stressed for awhile. The Capital Markets, I think we're getting there. I think we're beginning to bounce near -- bounce is the wrong word. I believe we're bouncing along the bottom. I don't think it is going to get hugely worse. Almost impossible to imagine it could. I think there is a reasonable opportunity for it to improve in 2009. I hope I'm not wrong on that."

Mack-Cali Realty Corporation 4/30/09

"We operate in a relatively conservative fashion. We have always been a very modestly levered company from all perspectives -- debt to market cap, debt to undepreciated book, and coverage ratios where we post 3.1 or so interest coverage and 2.7 plus or minus on fixed rate coverage. So that is how we operate, that is our mantra. But there are no specific hard and fast internal guidelines beyond being cautious, careful, with a view towards always understanding that there is a degree of uncertainty in the market place."

"with respect to secured financings the leverage is quite limited. You are looking at potentially 50% or less loan to value and value is a big unknown determinant in this unclear environment that we are in. And generally speaking these transactions take a long time to complete. So I would say we are delighted with what we had done and we think that plus or minus the interest rate is market."

SL Green 4/28/09

"In any typical market, I'd be pleased with these results. However, in the worst market that I've experienced in 20 years, I believe these results to be very compelling. With that said, we do recognize the significant challenges that lie ahead and the deteriorating market fundamentals that we expect to experience throughout the remainder of 2009, which will make it more and more difficult to achieve our objectives. Vacancy in midtown Manhattan now stands at approximately 10% -- that's direct and sublet -- and is expected to rise to as much as 12% or beyond in 2010. Concession packages have been widening out as predicted, and most of the current leasing activity is renewal in nature, not new or expansion deals. While the deteriorating fundamentals are disappointing, nobody who has been on our prior calls should be surprised by any of this as we explicitly and clearly stated our belief that we would see a combination of rental declines, increases in concessions, occupancy slippage, and emphasis on renewal leasing. Although we can't change or influence market fundamentals, we can accurately predict those trends and adapt our business plan accordingly. In our specific circumstance, we sold almost all of our B building, which will be hardest hit in this downturn; renewed and extended early expiring leases in 2006, 2007, and 2008 to act as a buffers again 2009 and 2010 scheduled lease expirations; redeveloped many of our assets to make them more competitive in a down market; and generally acquired buildings with low embedded in place rents which enabled to us grow NOI even in very difficult market conditions.

For our glass is half full listeners, the market news is not all that negative. There are several examples of space that was being included in future availability statistics that have or will be eliminated. First, as I mentioned previously, a portion of Merrill Lynch's investment banking division has been moved up to One Bryant to absorb unused BofA space in that new project."

"The capital markets in New York continued to be gridlocked throughout the first and beginning of the second quarters. There was one transaction of note signed and closed in the first quarter -- Deutsche Bank's sale of the office condominium interest in 1540 Broadway. Deutsche provided the buyer with financing on roughly market terms in all but the size of the loan, where in a third party market sale, it likely would have taken several lenders and a club to reach $227 million aggregate proceed level provided to the buyer in that instance, CB Richard Ellis Investors. Otherwise, we were encouraged by the terms of this sale, with the buyer going in at a sub 6% tap rate and expecting a stabilized cash on cost return around 7.5% to 8% based on our underwriting, and reportedly modeling a sale in seven to 10 years at a 6.5% to 7% exit cap rate. If that kind of underwriting held up, and the financing market returned to some level of normalcy, we believe New York City pricing would reset to a level that would surpass most people's very draconian expectations of the market at this time. Keep in mind this was an office condominium interest which requires substantial lease-up capital selling at an end price of $387 per square foot, as the retail portion of the property was condoed when Equity Office purchased the office component several years ago."

Farley of BPO (et al) recently discussed.....

1. Brookfield claims to be constitutionally conservative in the way they e manage their business. They claim to rarely take debt that is greater than 60% loan to value. They claim to be focused on preserving capital. This is based on a 96% USA occupancy rate, and 99% in CN.

2. Thinks that TD Canada Trust Tower would now trade at a cap rate below 5% and $723 SF (not sure if he was talking CDN or USD.) This was considered "too rich" by Cadillac Fairview Corp. Kimco thought cap rates will accelerate quickly in Canada. Kimco thinks some cap rates have already reached 8 in Canada.

3. Thinks macro-deleveraging process will last longer than April 2010.


Real Estate Storm Brewing - Richard  LeFrak, The LeFrak Organization, March 27, 2009

Here are my notes of the video:

Real estate storm brewing. category 5 hurricane coming. Aggressive underwriting 2005 - 2008. too much optimism in projections. deteriorating market conditions. Real estate market is collapsing. Distaste for real estate capital. He is more concerned today than ever before, because of economic conditions. failure of demand in system. Higher vacancies in office market. (see WSJ as 1 World Financial Center is offering nearly 300K SF available.) CRE is lagging indicator, last to get in trouble, last to get out. As investor he says "his hands are in his pockets." You can keep fingers crossed. Look at employment picture, and if improvement could help.

Unlike BPO properties has stated, I don't think LeFrak sees "business as usual."

Excellent CRE presentation by DB and some quotes that were pertinent to me.


"Price declines of 35-45% (or more) expected, exceeding those of early 1990s"

"Rent declines and vacancy rates may approach those of the early 1990s"

"Conduit collateral performance deteriorating at historically fast pace"

"Large percentage of CMBS loans made in 2005-2008 will not qualify for refinancing without substantial equity injections"

"Aggregate delinquency rate ready to surpass the peak of the previous recession"

"Since October, monthly delinquency rate increases have accelerated sharply to the 17-25bp range, a pace of deterioration that is without precedence"

"Deterioration far more severe in 2006, 2007 and 2008 vintages"

"Historically, larger loans exhibited performance that was far superior to that of smaller loans. This is unlikely to be the case going forward, as underwriting weakened most for larger loans"

"Given the deterioration in employment rates in general, and office employment rates in particular, we expect office to be one of the hardest hit property segments. At 103bp, total office delinquency rates remain low."

"Many of the riskiest pro forma loans from 2005-2007 were structured as 5Y IO loans"

"Declining property prices pose a significant threat to loans needing to refinance over the next decade. CRE prices peaked in October 2007 after appreciating of 30% since 2005 and 90% from 2001."

"The 1540 Broadway experienceÖ Represents almost 63% price decline over past 24 months"

I have written extensively about 1540 Broadway See March 12, 2009 entry at this link

"Required ROE for levered CRE investors suggests price declines of 45% or more"

see excellent tables on pdf pages 31, 40 and 49

"Cap rates increasing to 7% imply a 14% price decline, increasing to 8% a 25% price decline, increasing to 9% a 33% decline and increasing to 10% a 40% decline. We expect price declines of 35-45%, and possibly more."

"The number of conduit loans passing their maturity date without refinancing is growing rapidly"

"For loans maturing through 2012, even lenient underwriting requirements imply the majority (56.8%) of loans will not qualify. Out of $154.5 billion of maturing loans, $87.7 billion do not qualify. Office and multifamily are most severely impacted segments."

"In our view, much of these losses are unavoidable, even in a mass extension environment."

"Some argue that CRE markets are likely recover quickly as the economy begins to recover, which will resolve much of the refinancing problem. We disagree Ė even if rents and vacancy rates improve, the vast majority of the price declines reflected changes in underwriting regimes, not depressed cash flows."