The Coming Depression in Commercial Real Estate

The Wall Street Journal has made available a report by Deutsche Bank on the outlook for commercial real estate. The presentation is an eye-opener, as it presents a lot of data on the weakening commercial real estate market. The report's key conclusions are as follows:

• Prices may drop 35-45% in 2009, exceeding price declines of early 1990s
• "Demand shock" has caused downturn, not excess supply (this was different in early 1990s)
• Delinquencies could rise to 6% in 2010, matching peak delinquency rate of early 1990s
• Maturity default rather than term default is top risk, as refinancings will require more equity

George Soros has been quoted as saying that commercial real estate prices have not yet dropped but are likely to do so in the foreseeable future:

It is inevitable, it is written, everybody knows it, there are already some transactions which reflect and anticipate it, so we know, they will drop at least 30 percent.

As the recession in commercial real estate deepens, it will be interesting to see whether the valuations of companies such as Vornado Realty Trust (NYSE: VNO), Boston Properties (NYSE: BXP) and Brookfield Properties (NYSE: BPO) deteriorate further. At some point, investors with a penchant for long-term value may find these companies worth a closer look.

The following are selected supporting slides from the Deutsche Bank presentation (click to enlarge):

Disclosure: No positions.

Comments

[Bull Run:]

I've seen this exact thing before, (regional) 1st the housing collapse, then 1 1/2 yrs later the commercial property collapse, and if your a real estate investor this is the market you should be waiting for.. apartment buildings. strip malls, and hotels. Forget buying houses, wait for the commercial market.

Apr 27 09:49 AM

[Jeffrey Ber...:]

All of this is widely known and the street has had negative positions in REITs reflecting this. The surprise is that REIT stocks in some cases are already reflecting cap rates lower than where CRE is headed. If they are able to refinance and/or raise equity and don't default on their long-term debt at maturity some of these stocks are going to run hard.

Apr 27 11:45 AM

[Gregman2:]

Nice article. "Maturity default rather than term default is top risk, as refinancings will require more equity." Perhaps this is the key...rising debt-to-equity ratios mean that many are undercapitalized, and this will require a fall-out to clean house.

Apr 27 12:01 PM

[Bull Run:]

Gregman2; yes that's true, but what is becoming more true is that Cash flow debt ratios are severly being hurt. Rents have dropped, vacancy rates are higher, and non payment of rents are higher, along with many fixed operating costs have not fallen, but have risen, for commercial property owners.

Apr 27 01:14 PM

[johnthebear:]

It will be interesting to see on May 4th if "off balance sheet items" are required to be shown on the balance sheets of the 19 largest banks?

If that happens as I expect it will, almost all of the biggest banks will require extra capital to survive.

This means that lending capacity to aid REIT's short term cash needs will not be available. Look for more huge stock sales of REIT's so that dividends can be paid.

Look for IYR to take a big hit, even at this low level.

off-balance sheet items Definition | Business Dictionaries from AllBusiness.com

The Murky World of Off-Balance-Sheet Items (Part 3) -- Seeking Alpha

PEU Report: Off Balance Sheet Items: Big for Banks

Does anyone have a clue of what "OFF BALANCE SHEET" items means? Bloomberg reports that the range is from $700-900 Billion dollars!!!

I remember ENRON had a lot of "off balance sheet items that the public did not know existed, which led to it's dramatic death.

The stress test is supposed to require these items to be revealed to the public and they expect most of the 19 banks to need more capital!

Looks like a busy week ahead trying to unlock this story.

Apr 27 11:23 PM