Outlook: Goverment Programs to Restart Commercial Real Estate Credit Flows Beginning to Show Promise

Marcus & Millichap recently released our August 2009 Commercial Investment Real Estate Outlook, regarding Goverment Programs and their ability to restart commercial real estate credit flows. Below is an Executive Summary of the content, the full report is available by clicking here.

Executive Summary

Having weathered the recession with resilience throughout most of 2008, commercial real estate is now facing a dual challenge of rising vacancies and exceptionally tight debt financing. Both are largely the result of the escalation of the recession into a global financial crisis last fall.

Tangible results from government initiatives to stimulate the economy and loosen lending are modest at best; however, it is clear that government action helped to avert the worst-case scenario. Interbank lending has stabilized; investor and consumer confidence levels have moved off of recent lows; home sales are rising, albeit largely as a result of foreclosures; and aggressive cost-cutting is resulting in better-than-expected corporate profits. The U.S. economy and the availability of debt capital have a long way to go before returning to "normal," and many challenges remain. It appears, though, that conditions are improving and moving in the right direction.

Status of Government Programs: Pages 3-5

Term Asset-Backed Securities Loan Facility (TALF)

• TALF was expanded in May to include highly rated commercial mortgage-backed securities (CMBS). Spreads on AAA-rated CMBS have since narrowed dramatically.
• At its first subscription date in July, the legacy CMBS component of TALF received requests for $670 million in loans. All but one of the bonds submitted were accepted as collateral for TALF loans.
• Two REITs are expected to soon test the new CMBS component of TALF, with each projected to borrow up to $600 million against assets in their portfolios. A substantial amount of the capital raised will likely be utilized to pay down maturing debt.
• As a result of the lengthy ramp-up time for this program, TALF has been extended through March 31, 2010, for existing CMBS and through June 30, 2010, for newly issued CMBS.

Public-Private Investment Program (PPIP)

• PPIP was initially proposed to remove up to $1 trillion of legacy loans and securities from banks’ balance sheets but has been scaled back to roughly $40 billion in legacy securities only. The Treasury cited improving financial markets as the reason for the change.
• The Treasury recently released its list of prequalified fund managers to participate in PPIP. Each fund manager is required to raise $500 million in private capital. The government has committed $30 billion to PPIP, which will be used to match private equity capital raised and to provide financing.

Commercial Real Estate Market Conditions: Pages 6-7

• Commercial real estate sales volume during the first half of 2009 was down 75 percent from the same period last year and was 90 percent below peak levels recorded in the first half of 2007. The drastic reduction reflects a buyer/seller price expectations gap, as well as the tightening availability of financing. Buyer interest has been rising as more properties become available at realistic prices.
• Beyond hampering sales velocity, tight credit markets add another layer of complexity and challenge to commercial property owners, who have an estimated $550 billion of commercial mortgage debt slated to mature in the next two years. In many cases, lenders are focusing on minimizing further losses by modifying loan terms.

Emerging Opportunities in Commercial Real Estate: Pages 8-9

• As sellers become increasingly motivated due to maturing debt or general capital needs, a wide array of commercial properties will likely hit the market. To prepare for this opportunity, investors are defining strategies today to ensure they can move quickly when attractive assets become available. Pricing differentiation will persist, driven by property quality and location.
• In recent months, more buyers have re-engaged their pursuit of opportunities, and more owners have begun to accept market realities when pricing their properties. With ample capital waiting on the sidelines for the right time and/or opportunity to arise, the transaction market would likely be posting improvement already if financing was more readily available.
• Investors waiting to redeploy capital into commercial real estate until economic growth resumes or a central clearinghouse for distressed properties is established, similar to the Resolution Trust Corporation (RTC) in the early 1990s, run the risk of missing solid acquisition opportunities.
• The complexity of financial sector challenges has prompted an unprecedented amount of government stimulus and intervention, all of which require time to trickle through the system. Once credit markets are restored and economic growth resumes, investors will face significantly more competition from other prospective buyers when desirable acquisition opportunities arise.

Long-Term Outlook for Commercial Real Estate: Page 10

• Aside from retail, there was minimal overbuilding in recent years, and construction starts will remain limited through at least 2010. As a result, commercial property owners should have an opportunity to lease existing vacant space ahead of the next construction cycle.
• Payrolls were relatively lean heading into the downturn, and employers will need to rehire workers when a recovery takes shape. Consequently, the commercial real estate market could experience a relatively swift recovery compared to previous downturns.
• Demographic shifts and solid population growth in the coming years are expected to lend support to commercial real estate fundamentals. In addition to bolstering apartment demand, the growing population will require more services, reinforcing demand for other types of commercial space.