Friday, July 4, 2008

Commercial Real Estate Dives


I do not see any evidence that the worst is behind us. The residential real estate bubble fueled by historically low interest rates, unscrupulous mortgage lenders and Wall Street's great securitization bubble is wreaking havoc on all asset classes. As expected, commercial real estate prices are diving in the United States. The typical lag between residential real estate prices and commercial real estate prices is anywhere between eight to twelve months, so we can expect prices to head lower over the next few years.

This afternoon I read Michael Stoler's article in the New York Sun, Real Estate Investors May Resort to Prayer. Mr. Stoler quotes Larry Silverstein, president of Silverstein Properties:

"The capital markets' dislocation in real estate is the worst I have seen in my 55 years in real estate."

And these comments from Joseph Harber, chief operating officer for the New York metro region at Cushman & Wakefield and Edward Lombardo, a vice president at Pacific National Bank:

"Foreign investors, mostly from the Middle East, China, Ireland, Sweden, and Germany, accounted for 40% of the purchasers of property during the first half of the year."

"No one has any confidence in the investment banks, commercial banks, rating agencies, the U.S. dollar, the Federal Reserve, measurements of inflation, or the national government. The losses generated during a period of irrational expectations are still not completely known. Even if the current estimates are accurate, no one believes them. The word 'credit' is based on belief, confidence, faith, and trust, which are all in short supply today."

The article also cites the latest edition of the Price Waterhouse Coopers' Korpacz Real Estate Investor Survey which showed that a plunge of as much as 81% in sales of some types of commercial property, an increase in average overall capitalization rates for many markets, a slip in the rental market, and a decrease in the initial-year market rent change rates accounted for much of the downturn in the quarter:

"The report stated that sales since the third quarter of 2007 have been stagnant as a result of a lack of debt financing caused by the credit markets and by uncertainty about how far property prices will fall. Investors are said to be growing increasingly concerned about how much a stalled economy could affect property fundamentals."

I hope I am getting my points across to all of you who read my blog regularly that the worst is not behind us but lies straight ahead. We are on a collision course with what I believe to be the worst deflationary spiral we will ever experience in post-WWII period. This is not like the 1970s; in many ways it will be much worse. All those Wall Street claptraps proclaiming the end of the credit crisis are peddling incompetent and dangerous advice.

Importantly, today I have demonstrated that the "subprime crisis" has spread into other parts of the capital markets, including venture capital, private equity, and now commercial real estate. Pension fund trustees need to review their exposures to private markets, allocating to top distressed debt funds, as well as review their asset mix to prepare for the serious financial headwinds ahead.

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