Is the CRE Shoe Dropping?

By: Andrew Fallon

Recent CRE Headlines – Which Ones Should We Believe?
FDIC Frets Over CRE Loan Losses
3 Signs of the Next Real Estate Collapse
Is a Market Bottom Imminent?
Plan Coming on Commercial Loans
Commercial Real Estate Debt Won’t be the Next Shoe to Drop

So the commercial real estate market will be the next economic catastrophe but the market bottom is near, investors have amassed substantial acquisition capital, and the FDIC is getting ready with a plan. Will CRE be the next shoe to drop? No one is certain how this will play out and varying sources have varying opinions, but something must budge when $1.4 trillion of commercial real estate debt matures over the next three years.

As reported, those likely to budge will be community banks, many of which hold portfolios containing a large percentage of commercial real estate and construction loans. NREI reports that nation-wide, community banks hold roughly 11% of total CRE industry assets. To this point, FDIC Chairman Shelia Bair is encouraging these banks to restructure existing and maturing loans in hopes of avoiding or minimizing larger losses. Unless value returns quickly, community banks might be the next shoe to drop. That will sting, but does it mean that the commercial real estate market is collapsing, and what will the overall impact be on Main Street and the financial system.

Fear and history has everyone thinking about the residential mortgage meltdown and the widespread financial impact, but commercial real estate is a different beast. First, the majority of loans causing concern are construction and development loans, not existing buildings. Secondly, even though CRE property values are down, the underlying assets are/or have potential to be income producing properties, which can be value-add opportunities to capable investors. Lastly, there is a market for distressed commercial real estate (as opposed to second homes). Investors have been amassing cash and REITs have been raising capital to acquire many of these troubled CRE assets. According to a NREI survey, 70% of investors are preparing capital to acquire real estate assets indicating that some investors see great opportunity in commercial real estate despite the doom and gloom reports. Who are you going to believe and what’s your appetite for risk?

McDonalds Earnings Go Up

McDonald's earnings rose 6% in the third quarter, posting earnings of $1.26 billion. Last year, same quarter sales were recorded at $1.19 billion and McDonalds expects this positive trend to continue.

Earnings per share also saw an increase, growing 10% to $1.15 from $1.05 a year earlier.

McDonald's success is a good sign for the net lease industry, as many McDonalds are structured as such.

Calkain Highlighted by Business Journal in Pitango Gelato Sale

Washington Business Journal's Tierney Plumb recently reported on the sale of the Pitango Gelato, located in Logan Circle's Metropole, for $618,000 ($1,123 per square ft.). The sale was brokered by Calkain Companies and represented "the highest square foot price that was attained to date". Assistant Vice President Rick Fernandez represented the seller.

Read the full article here.

Is There Such Thing as a “Recover-less” Recovery?

This is certainly an interesting time for the economy and the world in general. After being rocked by one of the worst financial blows recorded we are seeing a mixed bag of results:

The Stock Market?

Up. Now hovering around 10,000.

Unemployment?

Up. Now at 9.8% but as many analysts point out the real number is closer to 17%. It’s predicted to reach 10.5%.

CMBS Delinquency Rate?

Up. September posted a rate of 3.64% as opposed to .54% a year ago.

Home Foreclosure Rates?

Up. “As of last month, 7.58 percent of U.S. homeowners were at least 30 days late on their mortgages, up from 7.32 percent in July”.

U.S. Debt?

Up. It’s currently over $11 trillion.

There are no doubt numerous other indicators which should be thrown into the tea leaves but aside from the stock market it seems like we are in for a somewhat downtrodden recovery. The recession may be characterized as “over” but do most people really feel that way?

The term “jobless recovery” is thrown around a lot but looking at all these numbers, one wonders if there is also such thing as a “recover-less recovery”. If unemployment continues to rise, people will naturally spend less and more defaults will be observed. Furthermore, due to the large amount of debt accrued over the past few years, one would expect a lot of earnings to be dedicated to debt obligations, not current spending.

When giving out coupons for products businesses are often faced with the prospect of “borrowing from future sales”. They may increase sales numbers this month but next month they will go down. Collectively we did just that over the past decade, borrowing from future prosperity to have it “right now”. Naturally we are now experiencing the subsequent drought. There is nothing to really do; giving out more coupons (stimulus) only puts off the problem till later. That is why the recovery does not really feel like one. The economic growth that was supposed to sustain us today was spent yesterday.

Vacant Commercial Real Estate Reuse

There is an interesting article from Business Week detailing many creative reuses for our vacant commercial real estate. Some of ideas seem more probable than others (some seem crazy). Here is an outline of some of the highlights, organized from least crazy to most.

1. In the Realm of Possibility

Hydroponics in Auto Plants:

Many auto factories have been left vacant from the recession but may serve more agrarian uses. As Business week observes, “The open bay nature of auto plants and showrooms can provide the space for hydroponic and aquaponic greenhouse operations”.

Community (Kitchen) Gardens:

Turn that unsightly vacant lot into a veritable country landscape! Many old properties were demolished to make room for new properties, only to have the recession hit, forcing the projects to be abandoned. Residents are using the land the way our forefathers did, “Philadelphia has already implemented an urban kitchen garden policy and many other U.S. cities could benefit from one.”

2. Getting Out There

Farms In-Between Freeways:

You know those grass, sometimes tree covered medians? Well instead of dreaming about plowing your 4x4 over them when traffic hits, turn your thoughts to farming! “Freeway interchanges can be transformed into self-sufficient, positive contributors to cities…Converting the un-usable green gaps of the interchange to usable farm land is a win-win for everyone.”

Affordable Housing and Malls:

This one is sort of odd because we really don’t get the rationale behind the proposal. Here is the quote in full:

“Public housing has been decimated by the altruistic construction of mixed-income, mixed-use affordable housing projects throughout the country. Unfortunately these projects have, statistically, merely relocated the poor and working poor to inner ring, dying suburbs, with dying retail and little access to the necessary basic services that were centrally located in the original housing ‘projects’. Might it be possible to use dead malls for the basic services needed by these displaced citizens, and program the proximate houses, many in foreclosure, for true affordable housing, providing both access to basic needs as well as the seeds of a sense of belonging and ownership.

Instead of being placed by “dying suburbs and retail”, affordable housing should be placed in neighborhoods populated with foreclosed houses and near abandoned malls?

3. Crazy

Wind Harvesting Super Tower:

How would you feel about your house or apartment located right next to a wind harvesting super tower? “Erect large urban/suburban wind harvesting super tower units that occupy minimal floor space but can cleanly alleviate a percentage of community energy consumption.” At least there won’t be a bird problem, right?

4. Jack Nicholson Crazy

Airships:

This is completely serious, someone did suggest the option you are about to hear. “Repurpose empty lots and/or structures to be used as landing stations for a system of small urban commuter airships. Clean transportation and a notable city feature.” Yes airships. Did you know they make a notable city feature? While we wouldn’t be opposed to having them, it seems like this idea belongs in an alternate reality universe. One without the Hindenburg.

In all seriousness, it is quite an interesting article and worth checking out.

Retail Sales Exceed Expectations for September

Many retailers are quietly having a much better than expected month of September. Stores such as Kohl’s, Target, J.C. Penny, Walgreens, Family Dollar and Limited inc. (the parent company of Victoria’s Secret) all posted sales figures that met or exceeded expectations.

This is great news for the retail sector, which has been hit especially hard by the recession. If all goes well, September could actually post positive same stores sales, rather than ending in the red. If September same stores sales should drop, it will mark the first time this decade that the same month posted declines in consecutive years.

HSBC Agrees to Sale-Leaseback its Fifth Avenue Headquarters

HSBC has entered into a sale-leaseback with its American headquarters in New York for a deal totally $330 million. HSBC is also considering similar sale-leasebacks for its Canary Warf tower and Paris offices on the Champs- Elysees for $1 billion. HSBC plans on leasing the building for one year, and then lease only the first 11 eleven floors (the building is has 29 stories) for the following 10 years. HSBC has commented that this results not from cutting employees but from better utilization of office space.

This deal is not thought to be connected with HSBC’s recent decision to move its CEO’s office to Hong Kong. The buyer is a subsidiary of IDB group, a holding company owned by prominent Israeli billionaire Nochi Danker.

Sale-Leasebacks have become quite popular lately as more firms require an immediate inflow of capital to maintain operations. Another prominent example is a sale-leaseback with the NY Times building. Recently, even governments have been getting in on the act, as Net Lease Insider reports sale-leasebacks are to be undertaken by many U.S. State governments.

Confidence Crisis = Core Investments = Net Lease Properties

By: Andrew Fallon

The word crisis has been used in a variety of ways to describe the economic situation of the past 18-months. The National Housing Crisis. A Global Financial Crisis. Wall Street’s Capital Market Crisis. Banking’s Liquidity Crisis. This past weekend while attending a panel discussion on asset allocation, I heard a new term for the current stage of the crisis – the Confidence Crisis. The crisis terms listed above best describe what led us into the recession and the resulting chain-of-event reactions. The new term, confidence crisis, is important for determining the speed of recovery and how consumers and investors will be allocating their resources and assets. Promising surveys (WBJ) and reports (GlobeSt) have made recent headlines, indicating that investor confidence is mounting as credit rating agencies provide encouraging outlooks for retailers.

These reports are speculative because the confidence crisis stems from fear, lack of trust, and uncertainty, all of which are still very prevalent in today’s environment. As a result, consumers are conserving their discretionary spending, and investors are questioning where their funds can safely go to work for them. There is now more emphasis on wealth preservation and long-term hold strategies. This confidence crisis has highlighted the importance of core investments, which may not be sexy but can act as defensive holders of value.

Enter net lease properties, which attract investors due to the stable and predictable nature of a NNN property’s income stream. Net lease cap rates continue to creep higher, hovering between 7.00 - 8.00% in the NNN market, providing potential value add opportunities for core investment properties. Investment sales transactions are still taking place, although at a much slower pace than in 2007 - 2008. As the confidence crisis unfolds, complex high-risk investment alternatives are likely to be avoided and investors will be allocating more resources to core investments until confidence returns (and let’s hope we remember what this confidence crisis feels like so we can avoid it in the next cycle). In real estate investment terms, what’s more core than a single tenant net lease property?

A Tale of Two Industries: Residential and Commercial Real Estate

Private Residential Spending: Up 4.7% in August from prior month

Private Non-Residential Spending: Down 0.1% in August from prior month

Total Construction Spending: Up 1.1% from July

These numbers indicate that while residential real estate is recovering, commercial real estate lags behind. This could be due to a number of factors, including over supply and tighter credit. Currently the commercial real estate industry is expected to "continue its slump into early 2010".

For more, click here.

Holiday Retail Sales & Outlook:

The fourth quarter is typically a time retailer’s look forward to with such glee that even a child would be hard pressed to match their level of expectancy. This is, after all, the time of presents, candy, costumes, decorations, ornaments and lavish meals. Children know Santa is coming to town and retailers know parents are. In-fact retailers are so anxious to begin this cycle of profits; they are often accused of putting out holiday items too early, the infamous “Christmas creep”. However, last year retail was hit hard by the recession; today the economy looks much the same and retail must adapt.

This will be the second holiday season celebrated under our current recession and the retail sector carries no illusions about that. According to a recent survey released by Hay Group, 72% of retailers predict sales this year will be equal to or less than sales last year and 57% are planning on reducing staff levels this holiday season. In comparison, last year 60% of retailers expected an increase in sales and only 29% decreased staffing levels. While these numbers are obviously negative, they are also prudent, reflecting a necessary change in mindset rather than an unfortunate change in the economy.

Additionally, retail is adopting new promotional strategies to better fit the current economy. 43% of respondents plan on “running more promotions and/or deeper discounts” this holiday season and another 43% plan to run promotions continuously from now till new years. This reflects a shift in focus from last year, when 45% percent of retailers ran most of their promotions on Black Friday (this year only 35% will), giving people more time to save up paychecks before making purchases.

These changes may already be having a positive impact on retails outlook. According to Fitch Ratings:

“Many companies across Fitch’s U.S. retail coverage have been managing inventory positions well. Gross margins have rebounded for those companies in the discretionary categories that were hit particularly hard during the 2008 holiday period. This, combined with strong cash flow management and the resolutions of liquidity issues for several companies, has resulted in an improved overall credit outlook”.

Though this may not be the holiday season of our dreams, it will certainly be a reality we are more equipped to cope with. Through tempering sales predictions, cutting overhead costs and altering promotional activities, retailers are becoming leaner and more efficient. Furthermore, in this current market where nearly 50% of net leases are traded as retail, should credit scores and sales improve, the only thing that may be going down are cap rates.