The Mortgage Bankers Association has released their quarterly survey of commercial/multi-family loan originations, and it shows continued dramatic deterioration in all CRE lending sectors, including an 80% plunge in bank lending.

Earlier this week, I wrote that commercial real estate transaction volume had declined to practically zero, so it’s no surprise that loan originations would show a concurrent decline, but that decline was precipitous: Q1 loan originations declined to the lowest quarterly level in the 7-year period covered by the survey.

The report is unclear as to which tail is wagging this dog, however. Is the decline in loan volume the result of “suicide-tight” underwriting, or simply a lack of buyers transacting on new deals? Anecdotally, there is a lot of equity sitting patiently on the sidelines at the moment, so it’s likely the latter. In addition to the 80% decline in bank lending, insurance company loan activity declined by 66% and GSE lending dropped by 26%. It was so bad, I decided to paint a picture. the things I do for you

There were some intriguing data in the survey though (read the full report here). One interesting finding is that while all loan activity decreased, industrial loan activity this quarter decreased the least vs. the year ago period, even less than multi-family. In fact, industrial loan activity from Q4 to Q1 actually increased by 67%. With loan capital still flowing into that sector, well capitalized industrial REITs are still relatively healthy.

Indeed, industrial REIT yields are among the lowest in the sector. This should enable industrial REITs to recover more quickly. Unfortunately, that is small comfort to those who lost their shirts betting on the likes of Pro-Logis (PLD). It’s also a sign of hope around increased economic activity, and probably of inflation as well…

Not surprising is that Fannie Mae and Freddie Mac continue to be practically the only game town for apartment lending, which declined by 61% in the quarter from one year ago. Hotel loans were down a whopping 88%, followed by healthcare (down 80%), retail (down 76%) and office lending (down 66%). Aside from the good news for industrial REITs, the only other obvious silver lining is that the rate of decrease in activity has slowed. So things aren’t getting much worse, but it’s still awfully hard to see anything even remotely shaped like a “V” on the horizon.

commercial real estate
commercial real estate loans
reit investments
reit stocks
reits
reit news

REIT earnings season got into full swing last week, but there’s a lot more on investor’s minds these days that last quarter’s earnings. Transaction volume has continued to plunge, and CMBS loans placed in special servicing have continued to rise like a poodle in a jetpack.

This can mean only one thing, and in the words David Hamamoto, CEO of Northstar Realty Finance (NRF), it is that there is a growing backlog of motivated sellers who “will begin to transact later this year and who will establish market pricing as deals are completed.” That people will need to sell is not in dispute, but exactly what “market pricing” will be is the $64,000 question.

Globally, commercial real estate sales plummeted more than 70 percent in the first quarter from the end of 2008, according to Real Capital Analytics. In the United States, first quarter sales were not only anemic, they may also be a form of karmic justice to CRE brokers who are now fond of saying that distressed buyers simply “overleveraged”. Really?

Even apartments, which still enjoy the availability of buyer financing from Fannie Mae and Freddie Mac, saw transaction volume fall 62 percent in 2008, and another 86 percent in the first quarter of 2009 alone. With an average of only 50 apartment sales taking place each month across the entire country, it’s simply no wonder that pricing is unclear.

What is clear, however, is that prices are dropping. And as prices drop, “overleveraged” buyers, or those who were basically convinced to overpay for their assets, are unable to refinance their loans. CMBS loans placed in “special servicing”, which indicates that the borrower is in some form of distress, were dramatically up and to the right at the end of 2008:

That trend accelerated in the first quarter of 2009. CMBS loans in special servicing jumped another 48 percent (as measured by outstanding loan balance), according to Fitch. “Imminent default” was cited as the reason for 73 percent of the special-servicing transfers. Since the end of 2007, the percentage of CMBS loans in special servicing has grown from 0.54 percent to almost 3 percent or outstanding loans.

Nationally, default and delinquency rates for CMBS rose to 1.76%, or $10.7 billion, in the first quarter, up 62 basis points from the previous quarter and more than triple the rate of delinquencies recorded in Q1 2008 (these figures do not include loans associated with the bankruptcy of General Growth Properties). According to REIS Inc., the CMBS default rate could reach 6% by year’s end.

The lack of transaction volume and the increasing levels of distress perfectly illustrate the current market quandary: lenders are unwilling to foreclose on properties that cover debt service, albeit barely, and sellers are unwilling to sell properties at what they believe to be artificially low prices driven by unsustainably low availability of debt capital.

This face-off will not last. Banks must clear their balance sheets at the same time that capitalization rates are rising and NOI is dropping. Rising cap rates mean that a buyer of an office building at a 6 cap in a strong market like Washington D.C. is staring at a 30% decline in value, peak to trough, assuming NOI has remained the same (which is almost certainly not the case). Buyers in tertiary markets are in even worse shape.

However, just as the excess of ready and available credit led to unsustainably high asset values in 2005-2007, so will the dearth of ready and available credit lead to unsustainably low asset values in 2010. Not surprisingly, some investors smell opportunity, and they are betting with real money. Publicly traded REITs raised $10.6 billion in equity in the first quarter, including $6.51 billion in April alone. This is a tidal wave of cash, and the Bloomberg REIT stock index rose by 30%. Nobody ever rings a bell at the bottom of a market, and $10.6 billion says why bother to listen for it now?

commercial real estate
reit investments
reit stocks
reits
reit news

2005 is coming, and nobody can stop it. Like a giant flock of boomerangs, the mortgages originated during the boom years of 2005-2007 are returning home, and the bankers are already struggling to keep up with all the arrivals.

Approximately 80% of new 2008 loans were originated simply to refinance existing maturing mortgages, compared with just 35% from 2000 through 2007. This trend will only increase as record numbers of 2005-2007 vintage commercial mortgages begin to mature in 2010.

In 2009 alone, Foresite Analytics estimates that $250 billion of commercial and multifamily mortgages will mature. This is an all-time high for the real estate debt industry, but the record won’t last long. Over the next two years, $594 billion of commercial real estate loans will mature as aggressively underwritten 2006 and 2007 vintage loans come due. That is on top of $220 billion of multifamily mortgages scheduled to mature:

Many equity investors are likely to get wiped out in the tempest that will ensue when these loans mature, and I wrote about the math behind this certainty in The Coming Bust in Commercial Real Estate: Why Developers Are Desperate For the Dole. That post illustrated how a building worth $100 million at the peak is only worth $74 million now, but a 36% decline in value may be the best one could hope for these days. Yesterday, Bloomberg reported that lenders believe the value of the Hancock Tower in Boston may have declined by 50%

The commercial real estate market is now in a full-fledged tail spin. According to Real Capital Analytics, U.S. commercial real estate prices are falling at a similar rate to residential, down about 17 percent year-over-year. The reason is that $1.8 trillion of loans were originated in the U.S. between 2000 and 2007, with the most rapid growth taking place in 2005, 2006 and 2007. Roughly half of that debt was originated during 2004 and 2008, some of the worst years in terms of deterioration in underwriting standards. That debt is starting to come due right now, and there may not be enough new lending capacity to absorb it all.

Many lenders are playing a game of hide the weenie by automatically granting one-year extensions on maturing loans in the hopes that debt markets will miraculously recover in 12 months. This has been almost standard procedure in the CMBS market, where maturing loans are being extended and placed into special servicing at ever increasing rates:

Source: Costar
These loan extensions are only adding to the pressure in 2010, and 2011 is shaping up to be a potentially seminal year in the world of commercial real estate. “If values have rebounded sufficiently by then, the market could avoid widespread defaults. But if the market is still depressed, a significant amount of these maturities could go into default,” said Foresight partner Matthew Anderson.

The delinquency rate among CMBS loans, which hit 1.8 percent in March, could rise to 3.5 percent by the end of the year, and 6 percent by 2010. This is bad news for lenders, but even worse news for property owners who overbought at the peak. In addition to that pesky refinancing issue, most are already wrestling with the recession and rising vacancy rates, lower demand and decreasing rents.

But the significantly lower commercial lending volumes are much, much worse than decreasing rents. Combined with rising cap rates and tougher underwriting standards, many property owners will be left out in the cold when it comes time to refinance. If the value of the Hancock Tower in Boston has fallen by 50%, which seems likely, Broadway Partners and Lehman Brothers, the equity investor and mezzanine lender, respectively, are now completely wiped out. So much for location, location, location.

Disclosures: None
mortgage reits
commercial mortgages,
commercial+real+estate,
commercial real estate loans

Both Bloomberg and the Wall Street Journal published stories on Monday warning of increasing trouble in the land of commercial real estate. It’s going to be pretty bad, there’s no doubt about it. But why is it bad and who is it really going to hurt? The Bloomberg headline claimed defaults could triple, but how much you care about that depends on where you sit in the food chain.

REIS, a consulting firm boasting a peripatetic chief economist with the best enunciation I have ever heard, evidently supplied data to Bloomberg showing that commercial loan defaults will rise dramatically if property-level net operating incomes (“NOI”) drop by even 5%. That’s a rosy forecast, given what’s going on with the economy. For the time being however, let’s assume they’re correct because there is really no dispute that NOI will weaken in this environment.

All things being equal, when NOI drops, the value of the underlying property also drops. Let’s say you own a property with $6 million in NOI. And let’s also say the “market” capitalization rate for that property is 6%, which is about where cap rates were, broadly speaking, during the boom. That means you have a property worth $100 million ($6MM in NOI/.06). However, if your NOI drops 5% to $5.7MM, your property is now worth only $95 million ($5.7MM/.06).

Could this really be what persuaded a bunch of New York City real estate tycoons to beg for a meeting, hats in hand, with a Senator from Brooklyn? Unfortunately, it wasn’t, because the above example assumes all else is equal, which is not the case. What if you threw in a few more wildcards, like the collapse of the CMBS market and rising cap rates? Then you’d have a story, and blessed be the prophets, it’s all right here on REIT Wrecks!

So what’s going on with the CMBS market? The short answer is nothing, really, and that’s a big part of the problem. During the boom years, CMBS grew to become a $225 billion source of capital to the commercial real estate market. Some were optimistically predicting that it would crash through $300 billion in annual issuance by 2008. What actually happened couldn’t have been more different, but it did crash.

The CMBS market actually collapsed, and commercial real estate lending volumes continue to contract. In fact, those 2008 deals you see on the chart, all $12.1 billion of them, were largely the result of lenders desperately trying to unload the loans they made in 2007. One of the last of those deals, J.P. Morgan Chase Commercial Mortgage Securities Trust 2008-C2, closed in May of 2008 and 20% of its commercial real estate loans defaulted within just 6 months.

Clearly, huge demand for CMBS led to a decrease in underwriting standards, including (among other things), a relaxing of traditional loan-to-value criteria. Moody’s estimated that the gap between the Moodys LTV and underwritten LTVs reached record in the first quarter of 2007 (nearly 45%). The Moody’s estimate of actual LTV also reached a record of 106.5%.

These poorly underwritten loans are still out there and in a few of short years, many of them will start to mature. Unfortunately, no lender will touch them now because they are practically radioactive. At the same time that a huge source of capital has disappeared from the market, borrowing costs have soared, making whatever capital there is out there relatively expensive. You can enlarge the chart a bit by clicking on it. Nevertheless, the lines going up and to the right tell the story: money is more much more expensive.

This is happening at the same time that cap rates, which were compressed down around that 6% mark, are now correcting. Cap rates averaged 8.3% between 1986 and 2008, but they fell below 6% in the first quarter of 2007.

This is a toxic mix for those New York City real estate tycoons, and the reason they made the trip to see Chuck Schumer from Brooklyn is simple: they are all about to lose a TON of money.

If NOI decreases by 5%, that’s a few less dinners at the Palace Hotel. However, if that happens at the same time that cap rates revert to historic averages and borrowing standards suddenly tighten, they can forget about dinner at the Palace because they’ll all be sleeping outside on the sidewalk.

Here is that $6 million in NOI at a 6% cap rate during the boom years. Everything looks great, and we’ve got our $100 million:

Ok, but what happens now that things have changed? If you still want your 15.6% Levered IRR (and that’s a big if), what would that deal look like today? Cap rates are definitely headed north, most likely back to their 8.3% average, and loan to values are definitely headed south, probably close to 50% for office and retail (Pro Logis recently did project level industrial debt at 50% LTV).

Adjusting for the new reality, that $100 million deal is $36 million in the hole. If NOI drops by 5%, the problem gets a whole lot worse. This is the wall against which many equity investors and developers have backed themselves into, particularly those with near-term debt maturities.

While REIS was emphasizing NOI growth, or lack thereof, in the Bloomberg story, the canary in the coal mine for the Wall Street Journal was Foresight Analytics warning about near-term debt maturities. The Journal’s story emphasised 2009 maturities that could have trouble getting refinanced. However, while there will definitely be demand for refinancing next year, it will start to get really interesting in 2010. About $180 billion in 2005-2007 CMBS loans will start to mature then, and a little more than half of those are variable rate deals. These are the Alt-A’s of the commercial world, and they were underwritten for a completely different solar system.

The good news is that if you’re a lender in the above example with a well-underwritten 70% LTV loan, things aren’t looking nearly so bad. You’re only down about 10%, and you get the asset to play with, while the developer/owner is completely wiped out. This could lead to the ultimate irony for all those that have been burned on Mortgage REITs: those loan defaults aren’t looking so bad after all! Thanks to Piping Rock Partners for compiling and assembling the data in this post

Disclosures: None at the time of publication
apartment reits, commercial real estate, commercial real estate debt, commercial real estate mortgages,reits
commercial real estate loans

The good news is that the end is near, and I’m not talking about the rapture. Mercifully (unmercifully?), Moody’s said Friday that commercial real estate is going to get a whole lot worse before it gets better, but that it WILL get better. Unfortunately, that won’t be until 2010, at the earliest.

For now, Moody’s says that the deepening recession and the reduced availability of financing have heightened the risks for the US commercial real estate sector no kidding. The ratings agency cites the retail sector as most exposed to very tight-fisted U.S. consumers, but the gloomy picture they paint is the product of a very broad, thick brush: they say virtually no asset class will escape unscathed.

The hotel sector is clearly in the middle of the storm, as is retail, but demand for office space is also declining in many markets and industrial properties have been adversely affected by slowing trade and retail sales. Even multifamily (apartment) properties face trouble. It’s true that everybody needs a place to live, but Moody’s says there will be fewer “everybodys”.

Reduced household formation, a fancy euphemism used to describe the impacts of children moving back in with parents, other parents moving in with their kids, friends sleeping in closets, and in some cases, dogs and cats relinquishing the kennel to their masters, all combined with growing unemployment and the increasing supply of rentals in the “shadow market” of foreclosed homes, will create stress even at this level in Maslow’s hierarchy. For a little more dark humor on this topic, check out Public Storage: Sold on Craigs List!

Loan defaults will increase as well, but they’ve been at historical lows for so long this was inevitable. Moody’s expects the aggregate default rate on CMBS loans (0.75% as of November 2008) to revert to its long-term historical average of 1.5% to 2.0% in 2009, and most likely to surpass this level before the market begins to form a bottom in 2010 and 2011. They also expect commercial property values, which have declined about 10% from the peak reached in October 2007, to decline an additional 10 to 20% over the next 18 to 24 months.

Other than that, I’m assuming they would also like to wish everybody a happy and prosperous holiday season.

Click here for the full Moody’s press release on commercial real estate.

Disclosures: None at the time of publication
apartment reits, commercial real estate, reits, mortgage reits, reit

The BBB-5 CMBX is above 3250, do you know where your money is? These are record levels for the index, and they are seemingly indicative of even greater trouble in the CMBS market. If one were to use the stock price of many Mortgage REITs however, it would seem that the soaring Markit index is actually behind the times for a change:

Part of the reason for the distress in the index and also the basement-dwelling stock prices of many Mortgage REITs is that two very large loans that were securitized into CMBS, including one loan secured by two Westin hotels, appear to be nearing imminent default. Of course, this distress is also due to the forced selling of anything that hasn’t already been seized by the county sheriff.

The $209 million Westin loan is backed by two hotels located in Tucson, Arizona, and Hilton Head, South Carolina. The slowing economy has hurt hotel operators as consumers and businesses have cut back on travel. The second loan nearing default is a $125 million loan for The Promenade Shops at Dos Lagos, which is located in Corona, California. Southern California has been dealt a particularly heavy blow by the worst housing crisis since the Great Depression.

Credit Suisse analysts reported that the Weston loan is split between two JPMorgan-issued CMBS deals. J.P. Morgan Chase Commercial Mortgage Securities Trust 2008-C2, the more recent of the two deals, is heavily exposed. That trust’s portion of the defaulting Westin loan represents 8.9% of the total collateral pool. Unfortunately, the bad loan on the Promenade Shops is also the largest loan in the same pool, representing fully 10.7% of the collateral. This means two of the top-ten largest loans in the pool, representing almost 20% of the collateral, are about to default. Investors in all but the most senior tranches of this issue are now facing huge losses as remaining cash flows are diverted to those who occupy higher ground (see the post “What is Securitization” for more detail on how subordination impacts Mortgage REITs).

It is not surprising that hotel and retail loans would come under pressure, particularly a retail loan made in Southern California, which was practically the belly of the beast. Hotel occupancies and retail sales have been especially hard hit as consumers and businesses snapped wallets shut when the credit crisis started making what Ross Perot could only have described as that “giant sucking sound”.

The real interesting aspect of these latest defaults is that everyone involved should have known better. Yet the pressure to produce, rate and sell still seems to have trumped the mirrors in front of our faces.

All of the mortgage loans in the pool were originated between June 27, 2007 and April 30, 2008, and the securitization closed on May 8, 2008, well after the Bear Stearns collapse and Ralph Cioffi scapegoat perp walk was led away in handcuffs.

Nevertheless, the Westin loans were interest-only for 36 months and had underwritten debt service ratios (DSCR) at closing of less than 1.25%. This would have been considered risky even in 2006. The loan agreements on the Promenade Shops were interest-only for 60 months and had underwritten DSCR of just 1.10%. The Promenade loan also allowed additional subordinated debt provided that the combined LTV did not exceed 85% and the combined DSCR did not fall below 1.00%. This is the equivalent of allowing someone to rent an apartment that will consume 100% of their monthly take-home pay (assuming a landlord would let anyone do such a thing). More than 75% of the loans in the pool were interest-only or partial-interest only. Other large loans in the pool include the Las Vegas headquarters of Station Casinos good luck and several other large retail and hospitality properties.

One would have thought, given the media and political spotlights around shoddy underwriting and hopelessly conflicted ratings agencies, that underwriting standards would have improved and that CMBS investors would be taking a much harder look at the bonds being furiously shoveled in their direction.

So is it really any wonder that Mortgage REIT stocks are in the tank when two of the top-ten largest loans in a May 2008 CMBS deal, representing almost 20% of the collateral, have gone up in smoke in just six short months?

Click here for an updated Mortgage REIT list, including current yields.

Disclosure: None at the time of this writing