Where's The Promise Land?
Slatin: Not yet, I have to say. You know, yes, the numbers were good. But real estate is a lagging indicator. And we're still, in the commercial real estate industry, I'll start with that, is still suffering from fallout in values, in undercut by the terrible over-leveraging of many properties. Look at what's happening in New York Stuyvesant Town, and Peter Cooper Village. This was a property purchased for $5.4 billion. It's now valued at about $2 billion. And there's a lot of leverage under the bridge on that one. And there's enormous overhang of properties that just can't be sold, that are in trouble. The firm I work with, Real Capital Analytics, has tracked $130 billion of real estate, that's commercial real estate, that's either in default, foreclosure or bankruptcy . And only about 17 billion of that has been resolved through a resale or restructuring, and another 12 billion has been claimed back by the lenders, is real estate owned. So there's a huge overhang of assets that need to be cleaned off the balance sheets of lenders. And that's not happening anytime soon, because values, as I said at the outset, have fallen so sharply that just like in the residential market, the investors are suddenly underwater. The value of their asset is lower than the value of their mortgage. And sometimes they have several mortgages, and mortgages have been securitized out and are held by huge numbers of anonymous investors who are unable to sort of decouple their investments. So there's just a lot of issues preventing re-sale of these assets. And without that, it's hard to set market-clearing benchmarks. At the same time, we have, as you know, even though we've now emerged from recession, companies are not hiring. And there's tremendous pressure on rental rates and vacancy. Slatin: Roughly. And that's so far. In other words, and we've tracked most of that this year. You know, there's some $800 billion in loan maturities, over the next few years that we have to deal with. This is the other question, as to when are these, as you know, major and minor banks just aren't handing out money like they used to, and underwriting standards are finally strong. But they're not really enabling borrowers to get what they need. So this is a real concern. In addition, as we know, a lot of the major banks, your Citigroup s and your Goldman Sachs and JP Morgan & Chase have declared their write-downs, have, you know, revealed their losses or much of them anyway. What we have now is throughout the country, many smaller lending institutions--community and regional banks, local banks--have made loans that are harder to unwind and they are depressing their ability. Slatin: And extend and extend. Yeah. I think that that would have been better a while back. I think now it's a little too late for that. I think what that might do, if that happened right now, suddenly, is that would be the next big shoe on the economy. And we don't really need that right now. I mean, we saw that a year ago with Lehman Brothers and Merrill Lynch and Bear Stearns. I think right now the world financial system doesn't need another huge dump immediately of, you know, large amounts of troubled assets. I think working through these assets, there should be some pressure to do that over time. But I don't think that a major housecleaning right now, anymore, is in order. I would have preferred that early on this year and even late last year. Forbes: Now, when a loan comes due, one of the things that saved the REIT industry, as you know, was the ability to sell stock, even though it was underwater. At least everyone knew it was going to get the debt in order, and so therefore, these things could survive. With a bank or holding a loan, and the loan's coming due, do they just extend it, and hope, somehow, the borrower, or the regulators--are the regulators going to allow that to happen? Slatin: I think right now, the regulators are feeling that they don't have much of a choice. The banks also don't want to take back this property. And have to sell. You know, it's expensive for them to do that, on several fronts, just managing it until they resell it, process of selling it and when they sell it, then they have to declare the loss. So with pretend and extend, or extend and pretend, whatever, you're extending a loan for some relatively short duration and hoping that by the time you have to close again and have to deal with it again, the market is improved. We are seeing slight pickups in the volume of sales; pricing on the commercial side is still falling, but it's falling at a slower rate. It's down about 40%, according to the Moody's Real CPPI, which we supply the data for. So, there's no immediate answer. That's for sure. It's just going to take time. It has to work through. There are billions and billions of dollars in opportunistic funds out there, waiting to buy assets. Slatin: Yeah. And they're really pissed off, if I may say, because prices haven't. They want 10, 20 cents on the dollar and they're getting 40, 50, 60 cents on the dollar . And that's just not good enough, you know. These are greedy folks and you know, this is also not 1991 or 1994. So, the truth is that the assets were well-valued at 60, 70 cents on the dollar. And it depends on where you are. Here in New York City, 70 cents on the dollar, 75 cents on the dollar. If you're in, I don't know, Minneapolis, I hate to pick on Minneapolis. Well, St. Paul, that would be, you know, it's probably closer to 40 or 50 cents on the dollar. So, but yes, these guys are waiting and at some point, they have to adjust their expectations. Slatin: That often depends on the case by case basis. We are seeing an increase in the rate of foreclosure. As we mentioned briefly, residential properties, there are still plenty of areas where foreclosures are going to go up, and residential assets and the same is going to be true in commercial assets. We will see banks begin to lose patience, and they'll need money, no matter how they get it. So we'll see an increase in that and an increase in what's known as REO, real estate owned, increase in re-sales, and again, it's just going to take time. But these are fundamentally, for the most part, one of the bright spots in commercial real estate, which is different than housing, is that there has not been tremendous overbuilding in most categories of real estate. Slatin: Oh yeah, over-malled. We're malled over, yeah. So, you know, and that's just going to be with us. Those are harder to turn around. What do you do with an old mall? Well, that's a problem we haven't really figured out yet. So, we can look at housing, too. Housing, we've seen housing prices come down. Again, we saw sales slow down this week. We saw that came out. Sales slowed down. There's still no engine for growth in housing, as you know. It's jobs, jobs, jobs, that create homes, homes, homes. This is really endemic throughout society, because if small business is the engine of growth for the U.S., then small banks and community banks and the money they provide, that's the engine of growth for small business. And without that, there's really no new mechanism yet that we're aware of that's going to provide the means for that kind of growth that we need. Slatin: For now. I don't know if it's over. It's certainly leveled off. What REITs did, which was very smart, and what they've done better than anyone else in real estate investing this year is they've raised capital . How have they raised capital? They went to the public and issued new equity. They've raised around $20 billion in equity. They've sold some assets, prime assets. And they have capital that can actually buy properties. They can invest. That will grow their revenue, even if they're buying distressed assets. They have the wherewithal to do that. They can also pay down their debt, re-equitize themselves, basically. De-leverage, so they've been pretty smart. And also lucky, that the public said, "We like this." Now why does the public like this? They have an income stream. These are well-managed companies. Not all of them, but the well-managed companies with good balance sheets that are even better now that they've raised capital. They have long experience in real estate. And they know how to pick properties that can survive and thrive, even in these tough circumstances. Slatin: No, hotels, I had recommended in one of my columns this year, I recommended Host Hotels , that was selling for about just under $4 a share. It's now up to $9 or $10 a share, because it was just ridiculously cheap. And they're well-positioned going forward, when the economy picks up to some degree, even a little bit in renewed business travel. They have great assets in gateway cities. They have a strong balance sheet, one of the strongest in the industry. So, and it's a good company. I would focus right now on the niche areas. There's one in particular I like, and I've mentioned this in my column, Digital Realty Trust . This is what we used to call Tel-Co hotels, telecommunications switching services, et cetera. There's just an endless need for this kind of space that's technology-intensive. There's not a lot of people running around in these buildings. These are server farms where switching entities, switching machines and companies pay high rent for these and they need them. And just as our demand for the Internet grows, for Internet capability grows, there is no shortage in sight for this kind of facility. And Digital Realty Trust, which is DLR, is the premier provider of this in the public space . Slatin: Absolutely. Apartments are sort of steadfast. They've fallen less far, and come back better than other areas. I particularly like a company called AvalonBay Communities, AVB , which has great properties on the East and West coast, high barrier to entry markets, high quality properties and an experienced management. Their stock has also come back from a low. All these companies have come back from lows. And they're about 50% or more off of those lows. They don't have a lot of growth in the near term, but long-term they do have growth. They have a steady and dependable yield. And I like them. Good balance sheets. AvalonBay, Essex Properties Trust. That's ESS. More properties on the West coast. I like Essex. And that's in the apartment space that I really like. I also mentioned niche areas. A couple other niche areas, one is student housing. A company called American Campus Communities , ACC, based in Austin, Texas, has grown from about 300 million a few years ago in market cap, to a couple billion today. And they really dominate that space, and they provide the kind of housing that you or I wish we could have stayed in when we went to college, trust me. These are like places with swimming pools and beautiful suites. And it's the life of royalty for these kids. Slatin: Yeah, but that's a very good company. And again, excellent management, good balance sheets. Going forward, they have good growth in front of them. A couple other areas. The one office area that's really got growth potential is life sciences, biotech, et cetera. And the leading company in that space is Alexandria Realty Trusts, ARE . They're based in California, San Francisco area. They really run some great biomedical research facilities, storage facilities. Just all kinds of medical office buildings. It's a wonderful company, very well managed, very careful, and they've seen tremendous growth. And they're allied with another important area of growth, and that's, of course, health care. Whether you're talking, and that's either senior housing, health care. There's a mix. These companies get kind of muddy in what they own or what they don't own. But there's good growth in that, as we all know. Health care. You've heard a little bit about health care lately? Haven't you? The point is, you can put your money in, but if you want it back, you're gonna have a haircut, a big one. Sometimes 15, sometimes 18%. If you take it, if you need your money out long before the maturity of your investment. If you say, "I'm putting it in for seven years," or they tell you, "This is a seven-year fund, and we'll give you 7% a year." Well, great, they'll give you 7% yield. That's nice. And that's not to be sneezed at. But if you need that money, you can't just turn around and sell it and get your principal back intact. Of course, that's true in any public investment, if it goes down. But these are not traded. These don't mark to market every day, and every second, the way publicly traded REITs mark to market every second. And so, I find them, they're just not transparent enough for me. Slatin: No, I see them coming back. Well, certainly, the Middle East is not playing with a full deck right now, but Abu Dhabi is still strong. They are clearly in the market. The Chinese, I believe, well, you know, the Chinese sovereign wealth fund, the Chinese Investment Corp, is basically in cahoots, they're in league with our own Treasury Department to put out hundreds of millions of dollars. I forget the total figure, but they've pledged to invest in opportunistic investments in the U.S., with help from the U.S. Treasury. German banks, which are really running open-ended funds, they're making serious investments in the U.S. Slatin: Some German money. Some Middle Eastern money. You'll probably see some Australian money come back into the US. Australia has stabilized. They took some big hits with some of their major listed property trusts, like Centro , McQuary Group, but they are stabilizing. They've seen steady investment this year at home, but their tax record is such that they will have to put some of that money out when it recovers. And you can bet some of it will end up back here. And I think the securitized markets, I don't think, are going to come back soon, although I do believe there will be another instrument or two that someone will come up with. And you know, and the residential mortgage space, you know, we're done with subprime, at least for now, but we are going to see just enormous trouble with people trying to restructure their home mortgages. It's just not working that well. And that's why we're seeing increasing foreclosures. And again, without the job creation and the income growth that people need, there's trouble out there. Now you have these special servicers. And you have mezzanine lenders. You have vulture funds out there, buying up tons of home mortgages. And homes themselves. I knew someone recently who flew to Detroit to look at 300 homes for a weekend. Slatin: They're brave, I think, but you know, that's because there are opportunities there. Prices are way down. That doesn't quite answer your question. But I think the mortgage markets, we're all in for a rough ride on that front, because we just don't know what the banks are capable of. It goes back to our original discussion. What's happening with the banks? They're playing it close to the vest. And they're running scared too. They're under enormous pressure internally.
Source: Commercial Real Estate - Real Capital Analytics in the Press
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