Vultures Circling Commercial Real Estate May Be a Good Sign

When the vultures start flocking, is that a good sign for the economy? It may seem perverse but there’s probably some truth there. That’s why I take a little bit of hope out of this article in The Deal:

When it comes to investing, especially in real estate, the conventional wisdom is the best time to get in is at the bottom. And with interest-only financing coming due in the next few years and an oversupply of commercial office buildings, now seems to be that nadir or close to it. That’s why office landlord Vornado Realty Trust is looking to raise $1 billion in private equity funds, The Wall Street Journal reports to invest in distressed properties that will likely hit the auction block in the next few years.

The article points out that Vornado is not alone. PE real estate firms have announced $253 billion of fund raising plans for 2009 with $92.5 billion targeted for distressed real estate. These guys naturally smell bargains but they probably also give an early signal about the commercial real estate market.

Recall the S&L collapse and the commercial real estate collapse that was part and parcel of the debacle. Most people tend to focus on the, say, 1991 to 1993 time frame when the RTC began to dispose of their assets. That becomes the time frame that defines the crisis. In reality, the slide began around 1987 and only when government gave up on trying to nurse the banks and commercial real estate back to health and bit the bullett did things start to improve. The RTC sales actually marked the end of the crisis and beginning of the recovery.

Any move towards capitulation, recognition of losses and recirculating the assets back into the private sector would be a positive. It’s going to take down some banks but that shouldn’t surprise anyone at this point in time. The faster we move through the cycle the better. The question is, will the government allow it to happen. The jury’s still out on that one.

If you’re looking for a way to profit from this disaster, you could do a lot worse than invest in failed commercial real estate. Historically, distressed commercial properties have yielded pretty fat returns to those that picked them up at the right price. If you know what you’re doing then starting to poke around to find your own deals is not a bad strategy. If you don’t, then take a look at the players like Vornado (VNO). There aren’t any guarantees in life but vulture CRE has about as good a track record as you can find.

Comments

[Mark54:]

Too many people think CRE similar residential real estate. Commercial properties are underwritten to different standards and are largely based off cash flow. There are no NINJA loans, no liar loans and financials are regularly updated. This is more attractive to large investors than residential due to the transparency and investment size. (No large investor wants to monitor and dispose of a pool of $250,000 properties). Bottom line is that CRE has the benefit of the natural institutional investor base where residential is dependent on the psychology and resources of individuals.

Jul 08 08:44 PM

[Tom Lindmark:]

Agreed on the point that CRE is more attractive to large investors in that you have transparency and ease of management. However, many of the loans now in trouble were underwritten not to existing cash flows but to proforma projections. CRE dropped its standards too much and effectively created its own version of liar loans. That's a big part of the problem and one of the reasons valuations have plunged so dramatically.


On Jul 08 08:44 PM Mark54 wrote:

> Too many people think CRE similar residential real estate. Commercial
> properties are underwritten to different standards and are largely
> based off cash flow. There are no NINJA loans, no liar loans and
> financials are regularly updated. This is more attractive to large
> investors than residential due to the transparency and investment
> size. (No large investor wants to monitor and dispose of a pool
> of $250,000 properties). Bottom line is that CRE has the benefit
> of the natural institutional investor base where residential is dependent
> on the psychology and resources of individuals.

Jul 08 09:20 PM

[Roger Knights:]

"There aren’t any guarantees in life but vulture CRE has about as good a track record as you can find."

Maybe not this time around, if we're entering a New Normal. Maybe only ultra-bargains, at next years' prices, will pay off.

Jul 08 09:43 PM

[The Caring ...:]

thanks for the article

Jul 08 10:50 PM

[REITBull:]

Tom,

Do you happen to know how many loans were underwritten with pro-forma cash flows? I was curious if anyone might have this number as a % of loans. I can see it being used for construction/rehab loans or properties that were in the process of lease-up. But I wonder if pro-forma underwriting was really that prevalent in the large scheme of things.


On Jul 08 09:20 PM Tom Lindmark wrote:

> Agreed on the point that CRE is more attractive to large investors
> in that you have transparency and ease of management. However, many
> of the loans now in trouble were underwritten not to existing cash
> flows but to proforma projections. CRE dropped its standards too
> much and effectively created its own version of liar loans. That's
> a big part of the problem and one of the reasons valuations have
> plunged so dramatically.

Jul 09 12:18 PM

[Tom Lindmark:]

I don't have that information and I doubt it's available without a lot of granular research. You would have to go back to individual loan files and build from there.

I can tell you that I was in the business of financing commercial real estate at this point in time and from around 2003 or 2004 on, the percentage of deals that relied on proforma NOI growth to justify the deals steadily increased. The industry split with some lenders going all in on the concept and others saying no way, no how. Certainly, the securitization market was much more open to the concept. Eventually, the banks came around as that was the only way to keep generating loan volume.

I can assure you that it became prevalent in purchase transactions.


On Jul 09 12:18 PM REITBull wrote:

> Tom,
>
> Do you happen to know how many loans were underwritten with pro-forma
> cash flows? I was curious if anyone might have this number as a %
> of loans. I can see it being used for construction/rehab loans or
> properties that were in the process of lease-up. But I wonder if
> pro-forma underwriting was really that prevalent in the large scheme
> of things.

Jul 09 12:41 PM

[REITBull:]

Thanks. I appreciate the feedback.

Jul 09 01:14 PM

[Mark54:]

This appeared in a JP CMBS weekly publication a few weeks ago... May be a little off topic but amusing

Revisiting the phases of grief

*Shock, disbelief, & unreality...
Downgrades? But there haven't been any losses and the deal w as issued only 17 months ago.

*Denial ...
What? Triple-A spreads are WHERE? That's impossible!

*Bargaining...
I will never buy proforma underwriting again if spreads rally enough for me to sell some of my overweight position.

*Guilt...
If only I had sold into that last rally .

*Anger....
It's all the CMBX's fault. This would never have happened if it weren't created.

*Depression...
This feels like it's never going to improve.

*Resignation...
May be triple-A spreads can hit S+1500

*Acceptance...
At least I'm partially hedged

Jul 09 01:23 PM