Is Commercial Real Estate About to Go Belly-Up?

 |  Includes: BLK, ICF, IYR, VNQ
by: Jim Delaney

“It has become clear to us through this process that the only viable alternative to bankruptcy would be to transfer control and operation of the property, in an orderly manner, to the lenders and their representatives. We make this decision as we feel a battle over the property or a contested bankruptcy process is not in the long-term interest of the property, its residents, our partnership or the city.”

And thus ended what was at its consummation, the largest commercial real estate deal in the U.S., Tishman Speyer’s $5.4BN purchase of Peter Cooper Village and Stuyvesant Town. Tishman Speyer and BlackRock Inc. (NYSE:BLK) also defaulted on $4.4BN of debt in the process from a veritable who’s who of institutional investors.

The commercial real estate market is thought to be high on the list of contenders as the next shoe to drop in an economy reeling from the deleveraging process as the effects of the credit bubble continue to be felt. The strategy of “extend and pretend” might be working for some but the combination of top of the market prices, a legal challenge to a rise in rents and a weak underlying economy proved too much for the PCV/ST deal.

With that said some other prominent people in the real estate business gave their thoughts on the commercial real estate environment recently and provide a range of alternative outlooks to the reality suffered by Tishman Speyer and BlackRock Inc.

David Greenbaum, president of Vornado Office said, “In prior cycles it took five years to get from peak to trough; this time it took five months. But now Wall Street is hiring again. Smaller financial firms are taking up the slack, and I see New York leading the recovery; not lagging as in previous cycles. Tenants are taking this opportunity to trade up to Class-A space.”

A slightly more sober view was expressed by Darcy Stacom, vice chairman of CB Richard Ellis when he said: “We’ll see slow sales for quite some time. Banks are sitting on properties they’ve taken back, waiting for the market to meet them, instead of selling to someone who’ll create jobs by improving the property. Meanwhile, borrowers that are highly leveraged with term on their LIBOR-based loans are fine. Those that are leveraged and don’t have term left on their loans are in trouble.”

If these two represent separate ends of the optimism/pessimism spectrum Bruce Mosler, co-chairman of Cushman & Wakefield sounds like he’s taking a middle of the road approach as he thinks, “So much capital is on the sidelines now, lacking product. A lot of real estate is owned by the banks or in CMBS, and as banks’ balance sheets improve they’ll put the product back on the market. Sometime in the latter half of 2010, we’ll see the investment sales market adjust. Owners who can leave a lot of equity in the property – REITS, foreign buyers, institutions – will dominate the new ownership landscape.”

The CEC Strategy went into last week long 20 out of 21 of the REITs in its universe. With correlation once again moving towards 1.0 across all sectors of the market as a result of China’s credit restriction, Obama bashing the banks and then Congress bashing Bernanke it was not a kind week to any long position, anywhere. Having said that the Strategy’s REIT positions are not really in any worse shape than all the other long positions and with the new high of last Tuesday followed by a perfect storm of news, as well as the fact that risk limits have not been reached the CEC Strategy has not reduced its long REIT exposure.

The technicians are saying the current index levels should provide support and that the 5.2% three day drop has left things oversold. Not being a technician I am only passing on what I’ve heard. For the CEC Strategy is it all about risk management and as painful as it might be in the short term, staying true to the tenets of the Strategy remains most important.

Enjoy the week.