Not even Joe DiMaggio could have hit this change up. Just one year ago, the United States financial system stood on the brink of failure. GDP had declined by 6.25%, the most severe contraction since 1982. In November 2008, non-farm payrolls were cut by 533,000, the most severe contraction since 1974. But just a few months later, right after the ink had dried on largest corporate bankruptcy filing in American history (Lehman Brothers), U.S. GDP managed to grow at a 5.7% annual rate — the the fastest expansion in 6 years.
It’s a remarkable turnaround, but the problems in commercial real estate persist. CMBS defaults at the end of 2009 registered a five-fold increase over 2008. In two of the hardest hit sectors, hotels and apartments, almost 10% of all CMBS loans were delinquent at the end of 2009. Fitch says overall CMBS default rates could reach 12 percent by 2012.
Indeed, even God is losing money on commercial real estate. Lenders are foreclosing on Stuyvesant Town and Peter Cooper Village, which was acquired in 2006 for $5.4 billion. Stuyvesant Town is a huge property, so it’s not surprising that the acquisition set the mark for the highest price ever paid for a multi-family residential asset. What is surprising is that just four years later, the value of the property is estimated to have declined by 70%. The investor group included the Church of England, and the foreclosure completely wiped out its $250 million investment.
Since divine intervention appears to be out of the question, investors are understandably nervous about the $1.5 trillion in commercial real estate debt maturing over the next three years. Nevertheless, despite the carnage yet to come, the decline in commercial real estate prices is unlikely to cause a rain delay in the nascent economic recovery.
This is primarily because the U.S. commercial real estate market is much smaller in comparison to other important markets. Based on flow of funds data from the Federal Reserve at the peak of the market in 2007, the corporate bond market was worth $3.5 trillion; U.S. government securities $5.1 trillion, single family securitizations stood at $6.8 trillion and all single family mortgages amounted to $11.2 trillion. Meanwhile, the commercial real estate market was worth about $6.8 trillion in total, with only $3.3 trillion of that comprised of debt.
Just as important, the problems in commercial real estate have been well-telegraphed, while the full extent of the problems in single family were not clear until we were well into the crisis. Not only have the problems been well telegraphed, and well documented, but Jamie Dimon (CEO of Chase) is already declaring a bottom. “Commercial real estate is a train wreck, but it’s already happened,” Dimon said during a speech at a J.P. Morgan health-care conference in San Francisco last month.
While commercial real estate debt maturities are clearly still a problem, sophisticated investors from all over the world have lined up piles of dough for America’s distressed real estate play. Combine that with banks and special servicers that are determined not to sell into a weak environment, and the result is 30 or more bids for distressed commercial property sales in major markets, with some bids coming from as far away as Germany and South Korea.
I personally was involved in the recent bank sale of a non-performing loan for 60 acres of entitled but otherwise empty desert outside of Phoenix, and that sale attracted 26 bids. If entitled single family residential land in Arizona isn’t the absolute belly of the beast I don’t know what is, yet most of the bids for that flaccid loan were all cash.
What we’re witnessing is the market’s sometimes noisy process of converting debt to equity. That process is working, greased by baksheesh from all over the world. So why all the unrelenting gloom and doom with regard to commercial real estate and the economy? It’s pretty simple really: in this era of populist schadenfreude, people love to read about it.