The commercial real estate ("CRE") market is beginning to look attractive relative to other real estate investments. During 2004-2008, the U.S. CRE market, driven by record levels of capital inflows, increased by 50%. In the subsequent collapse prices have fallen 42% nationwide from their peak, according to the CPII index. Capital has been slow to return to many parts of the real estate market. MBS issuance reached only $40 billion in 2010 and is expected to increase, but remain at low levels. Investors, in a flight to quality and in search of yield, have poured capital into core CRE, which has caused prices to return to near record levels. However, less capital is available for assets with high vacancy rates, over-leveraged balance sheets, and bankruptcy situations. An abundance of income producing, distressed assets are available at favorable prices for investors with the ability to turn around poor performing assets.
The current supply-demand trends in CRE provide an opportunity to earn attractive returns. Below is a list of factors that contribute to the current opportunities that exist within CRE:
· The CRE market appears to be in the very early stages of a recovery and now faces favorable supply and demand trends. Absorption rates have been positive for three consecutive quarters, which has lead to a better vacancy picture nationwide. Vacancies appear to be slowing, and in some areas improving after increasing 35% since 2008. Commercial vacancies across the U.S. are currently estimated at 16.4% which is well below the long-term U.S. average of 14.6%. New CRE supply is near an all-time low, because rents in most areas do not justify new construction. New construction represented only 1.2% of the total CRE stock in the first quarter of 2011. Increasing demand and favorable supply trends is producing a rebound in NOI, thus increasing valuations.
· Roughly $250 billion of CRE mortgage debt is currently distressed; an upcoming wave of maturities should push the amount of distressed mortgage debt higher. An estimated $2.5 trillion of commercial mortgage debt will mature over the next seven years. Lower NOI and CRE valuations will make refinancing difficult for CRE that was originally financed at historically high valuations and with significant leverage. On a weighted average basis, 34% of all CMBS loans originated during 2003-2007 are on a watch list or are delinquent. Some private equity real estate funds, such as Blackstone Real Estate, are positioned to provide the necessary capital for restructuring, recapitalization, and refinancing. Distressed property sales increased from $5 billion in 3Q 2010 to $12 billion in 4Q 2010. Lenders have been generous with distressed properties often extending loan maturities or providing some other form of restructuring, but as property values have appreciated many lenders have begun looking to remove CRE from their books.
· Limited debt capital is available to fund over-leveraged, distressed assets. Only $11 billion in CMBS was issued in 2010, down from its peak of $230 billion in 2007. CMBS is an important source of debt capital and is necessary to support a sustained recovery. Early this year the CMBS market showed signs of improvement; in the first quarter of 2011, approximately $10 billion of new CMBS issuance was in the pipeline and analysts expect total issuance for 2011 to top $35 billion. However, new CMBS issuance has recently slowed as the market has become more volatile. REIT and Private equity capital has returned to the CRE market as well, but the majority of funds have focused on core properties. REITS raised $26.24 billion in 2010 and $23.72 through the second quarter of 2011. A significant portion of this capital was used to shore up balance sheets, but REITs have also increased acquisitions. A total of 439 private equity firms are attempting to raise $160 billion for new real estate funds compared to approximately $40 billion in 2010. Capital inflows will provide some support to valuations despite unfavorable global economic conditions.
· Core real estate prices have enjoyed a strong rebound; for example, the vacancy rate in New York City's prime office market is approximately 4%. Distressed properties have not participated in the rebound, which has created favorable valuations. Stabilized core CRE often attracts several buyers; however, far fewer investors have the capital and experience to purchase distressed assets, which often requires complicated capital intensive workouts. The lack of buyers for distressed assets has created an opportunity to earn outsized risk premiums. A strong core market is good for opportunistic real estate funds because once the distressed properties have been stabilized they can be sold to core buyers for large premiums.
Despite the favorable trends in CRE, substantial risk still exists. General economic conditions, interest rates, and changes in supply and demand pose risks to CRE. Economic growth and employment are of particular importance to CRE due to the reliance on office property demand, retail spending, and hotel demand. Investors are also dependent on the availability of mortgage funds to finance the portfolio. Lack of financing and/or rising interest rates can negatively impact returns.
Comparatively, private equity opportunistic CRE looks more attractive than REITs. REITs have rebounded strongly from the great recession, gaining approximately 130% since their 2008 lows. The rebound in REIT prices is worrisome; many REITs now trade at a premium to NAV. Core real estate prices have been pushed up by REIT and private equity buyers. Core properties are selling for capitalization rates that historically have not produced outsized returns.
No comments:
Post a Comment