30th October Commercial Real Estate Outlook
30th October 2009
Commercial Real Estate Outlook
Commercial property has been a very popular asset class over the last decade. Investors who were spooked by the equity market dot-com crash were encouraged to invest in commercial property. Investors were encouraged to speculate on a form of “carry trade”- borrow at historic low interest rates and lease the property to take advantage of high rental yields and capital growth (a return on their principle). Add globalisation and the ability to move money globally for very little cost to the mix and this strategy presented very attractive opportunities.
Thoughts from the trading floor
The run up to the collapse of Lehman Brothers saw cheap financing dry up and the implosion of credit markets. This event went hand-in-hand with the collapse of the residential real estate markets. Commercial Real Estate (CRE) was seen as a form of “diversification” by many major real estate investors. The well publicised collapse of the residential property market has masked the time bomb that is the commercial property market. The commercial property market has many parallels to the residential property market, including the mass securitisation of property loans (CMBS). With rising delinquency rates, there is potential for the securitised CMBS market to collapse like the residential MBS market. In recent times, there has been chatter from commercial real estate investors and banks that we may have another round of large losses due to this. The potential for losses have been estimated to around $200-300 billion for US banks, and European banks are heavily exposed also. With soaring delinquency rates across Europe and Asia, the potential for this market to cause havoc world-wide remains very strong. Certain financial players such as major Wall Street investment banks and boutique firms such as Blackstone Capital have heavy exposure to both CRE and CMBS.
Bull View
The bulls will look hope that the recession is starting to come to an end, which would help stem delinquency rates, through a pickup in business activity. Business growth and a recovery in business expansion should help the market recover. This will also allow investors and banks to ride the pain of holding their CMBS positions.
Bear View
The bears will cite the collapse of the residential property market, and draw strong parallels with the commercial market. If economies suffer a prolonged period of contraction, and delinquency rates continue to rise, we may see panic in the CMBS markets. This will be a disastrous event, and could lead to another bout of strong credit contraction. With interest rates already at historic lows, there remains little in the central banks’ armoury to deal with this.
Futex View
We will continue to monitor the situation closely. Hints of a prolonged economic contraction will signal danger, and a collapse of the commercial property and CMBS markets may lead us into a period of economic depression- as a worst case scenario. Commercial property recovery takes many years, maybe decades (take the Japanese example- commercial property prices are still at 45% to their early 1990s peak). In this event we are particularly bearish of Blackstone Capital, as they have major holding of CRE, especially as they went on a buying binge just prior to the Lehman Brothers collapse. We site HSBC, who exited major real estate positions just prior to the global collapse and stated their fears to the market, to be particularly savvy in CRE markets. Recently we have seen them sell their major holdings and re-iterate their fears.
Tags: Blackstone, collpase, commercial real estate, CRE
