When will the commercial real estate market ‘bottom out’ as a result of the global recession was a key question on the minds of participants in the Global Property Market (GPM) held in Toronto on December 2, 2008.
While there may be buying opportunities now for property investors with a war chest of available cash, most investors will wait for clear signs that market re-pricing has occurred, and lending protocols are re-established, to start buying again. For the majority of investors therefore knowing when the market has stabilized is critical.
Jacques Gordon, Global Investment Strategist, LaSalle Investment Management explained that the recovery of global property markets will be ‘a first in, first out’ process where the first countries to experience a decline in property markets will be the first to recover. He said that the U.K. was the first to go down and will be the bell weather market for the recovery followed closely by Australia, Japan, Korea, German and France.
Michael Clarke, Head, Property Distribution, Schroder Property Investment Management Limited in England said that the U.K. market is not going to bottom out until 2010. This opinion has also been validated by recent reports from the Royal Institution of Chartered Surveyors who forecast a 50% peak to trough decline in U.K. property values at the end of 2010 (Financial Times, December 8, 2008).
Jacques Gordon did not provide a firm prediction for renewed stability of the U.S. commercial property market offering a range in dates of 2011 to 2012. He said that 'while the U.K. will be at the front end of the recovery, the U.S. would be the back end.' He also expects property fundamentals in the U.S. ‘to start deteriorating quite quickly.’
Blake Hutcheson, Partner, Head of Global Real Estate, Mount Kellet Capital, formerly President of CB Richard Ellis in Canada, said “Canada is not a hole in a donut” implying that realistically Canadians should expect significant negative impact to its commercial markets. He added, “In the past real estate caused its own problems but in this case it is a problem effecting every industry. It will get worse before it gets better. In two years (2010) we will know better where we are,” he said.
Many at the conference, including Hutcheson, (and as has been widely reported in the media) agreed that while the Canadian market is forecast to decline in the shadow of the U.S. market because it has more stringent lending practices it will not experience as severe re-pricing and stagnation as other country’s markets.
The collapse of the U.S. CMBS market is forecast to significantly impact commercial property markets most notably in the spring of 2009. According to Hutcheson, about US $66 billion of a US $225 billion US CMBS market comes due at that time and property owners will need to locate new lenders.
As a high proportion of remaining U.S. CMBSs come due between now and 2012, until an alternative lending protocol is established, they will prolong the shake up in the U.S. commercial property market. Over time, however, as commercial property is re-priced, and credit markets restructure, the impact of CMBS will diminish.
In both the U.S. and Canada, bank lending is ramping up to take the place of securitized loans for commercial real estate. The banks are expected to have stringent lending requirements that will likely set the tone for credit availability for the foreseeable future.
According to Jeffery Scott, Managing Director, Real Estate Corporate Finance Group, Wachovia Securities, the industry can expect that ‘risk will stay on the corporate balance sheet’. As the cost of risk is renegotiated smaller property transactions – under $50 million – generating smaller loan requirements are likely to be viewed more favorably by lenders than large loans. In other words, said Scott, “Small may be the new big”.
CMBS are a significantly smaller component of the Canadian credit market at Can $25 billion and while it too must be absorbed into a re-established lending paradigm it is not expected to have as severe an impact in Canada as it will the U.S.
With respect to the amount of re-pricing to expect in the commercial property markets, many at the conference said that it is difficult to know in the absence of commercial real estate transactions. Nevertheless, three out of four panelists (Peggy DaSilva, Director Real Estate Opportunity Funds RREEF America LLC, Jeffery Scott, Managing Director, Wachovia Securities and Jeff Barclay, Managing Director, ING Clarion Partners) discussing the United States situation at the Global Property markets anticipate an average 30% to 40% decline in that market. Some markets will experience in excess of 50% declines such as in the Florida apartment market while others, such as Class A office buildings in key markets, may only experience 10% to 20% reductions.
Jeffrey Barclay, Managing Director, ING Clarion Partners, along with other conference participants expect there will be ‘a flight to quality’ that will favour large urban areas over secondary markets. He said, “It is a risk adverse strategy with an implied expectation of lower returns in the range of 7% to 9% instead of 10% to 14%.”
The first signs of a meaningful market recovery will be significant transactions in key markets according to Jacques Gordon. He indicated that some of the first good deals would be office properties in the U.K. and these may serve as benchmark transactions in the global property market recovery.
By way of intriguing stories about recent transactions, Barry Sternlicht, Chairman and CEO, Starwood Capital Group LLC said at the Toronto Real Estate Forum that a Manhattan office building has been sold at 25% of its peak value. He left it to the audience to judge whether this sale is an anomaly or a trend setting transaction suggesting the U.S. market is recovering more quickly than expected.
While investors with deep pockets may find bargains in the current market, the advice from Jacques Gordon was ‘to maintain a defensive position in 2009 and an offensive yet strategic position in 2010 and beyond.”
Andrew Trickett, Senior Vice-President of the Oxford Property Group Inc. also said he thought that “In 2010 greed will overcome fear and property markets will start to return to normal.”