Sunday, March 4, 2012

2012 Commercial Real Estate Outlook: Extend & Pretend


The following graph shows the collapse in commercial real estate prices since 2007.  Prices are now down 42% from the peak.


The following chart shows the loan maturity schedule from 2011 through 2018 (when loans are coming due and need to be refinanced).


In 2009, our leaders were looking out at the tsunami of commercial real estate loans ready to rollover in the years ahead.  Between 2010 and 2013, $1.2 trillion in loans were set to mature.  They came up with a plan with a catchy phrase that, so far, has postponed the crisis out into the future.  It is called "Extend and Pretend."

Facing extreme pressure on their balance sheets, regulations were relaxed to allow (and encourage) banks to approach property owners and extend their loan at the current terms.

For example, Bob’s hypothetical loan that was due to refinance in 2008 was given a 5 year extension through 2013.  Everyone’s hope was that over that 5 year period the economy would begin to recover, unemployment would fall, incomes would rise, and Americans would go back to borrowing and spending.

This would create demand for Bob’s vacancy allowing him to fill the building with two new tenants (maybe Nancy’s Nails and Tina’s Tans would return).

The problem?  This has not happened.

The following shows total credit card accounts falling from $500 million at the peak in 2008 down to just $385 million today.  Americans continue to pay down (or default) on credit cards month after month.  The discretionary income from credit cards that was once used to purchase tanning sessions (Tina's Tans) or a pedicure (Nancy's Nails) is now going to paying for food and gasoline – also known as survival.


The next chart shows the total household de-leveraging (consumers paying down/defaulting on debt and not taking on more) process currently taking place.  In June of 2009, Americans had borrowed a total of 114.76% of personal income. At the end of 2011, this number has fallen down to just 101.1% - still extremely high with a long way to fall.  This means Americans will continue to pay down debt instead of borrowing more to consume as they did during the early 2000’s.


The extend and pretend program was created on the hope that consumers would re-leverage, not de-leverage.  Real unemployment has stayed high, with many Americans taking part time jobs or significant pay reductions.  The cost of living in terms of food, gasoline, medical costs, and monthly rent continues to rise, cutting further into discretionary spending.

Office vacancies are at 17.3%, strip mall vacancies are at 11%, and regional mall vacancies are at 9.2%.  All these are at or above 20 year highs.

Banks and property owners have continued to “delay and pray” that the economy will recover and property values will rise.  This has concealed the problem (similar to the shadow inventory in the housing market) making many believe that there is a “shortage" of product available.

Default rates “peaked” in 2009 and have fallen for the past two years.  This is because banks stopped sending default notices.  In many cases banks are not even requiring monthly payments in order to push back the day of reckoning.

Due to this supply being held off the market, prices have begun to stabilize and in some areas even begun to recover.  Investors, starving for any form of yield on their capital, have begun to bid up the prices on the few office and retail buildings that have entered the market (more on that coming).

There is even new construction supply entering the market. 12.3 million square feet of office space and 4.9 million square feet of retail opened in 2011. There is now 46 square feet of retail space for every man, woman, and child in our country.

Banks and building owners continue to race against time.  They are underwater hoping that the economy and building prices recover before they run out of air. They will not. As the economy begins its next leg down, more banks and owners will give up. The built up supply of properties that should have hit the market in 2010, 2011 and 2012 will begin to hit the market in force during 2013 – 2015.

This will occur at a time when our economy and stock market will be in the next leg downward.  Consumers will continue to retract, the cost of living will continue to rise, and our government will find it more difficult to support the entire economy through stimulus.

Investors that have been patiently waiting, like a hungry lion perched in the shadows, will reap the rewards of a market that will soon be at its most vulnerable point. 

This is obviously bad news for Bob, but great news for Mike if he has been patiently waiting out Bob’s refinancing reckoning day

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