Blog on the Run: Reloaded

Friday, September 4, 2009 11:06 am

I’m going to elaborate, and you’re going to be sorry

Filed under: We're so screwed — Lex @ 11:06 am

In Sunday’s edition of Simple Answers to Simple Questions, I said the commercial real-estate market was, to put it kindly, in poor shape. I’m back now with the not-so-simple answer.

To start with, you cannot base an assessment of the CRE market on bank valuations of those properties. That’s because the government is allowing the banks to carry those assets on their books at valuations significantly higher than what they’d actually be worth in the market today. Why? Because a number of large banks would be recognized as insolvent if their assets were correctly valued, and the government really doesn’t want to go there. At least, not right now, despite the likelihood of increasing damage (including but not limited to cost to taxpayers) the longer we wait to start valuing these things at what they’re really worth.

So how do we know what the market is really like? Once again, Zero Hedge to the rescue:

The National Council of Real Estate Investment Fiduciaries (NCREIF) is an association of institutional real estate professionals who share a common interest in their industry.  They are investment managers, plan sponsors, academicians, consultants, appraisers, CPA’s and other service providers who have a significant involvement in pension fund real estate investments. They come together to address vital industry issues and to promote research.  The NCREIF was established to serve the institutional real estate investment community as a non-partisan collector, processor, validator and disseminator of real estate performance information.  Now you know what we are talking about in terms of integrity of the data. … The NCREIF publishes a National Property Index (NPI) on a quarterly basis that gives us some very good insight into what is happening quarter by quarter with the value of institutionally held commercial real estate investments.  And you can be darn sure they are much closer to the truth of what is happening with CRE values than the banks in this country will ever let on.  The NPI covers all “classes” of institutional investment in CRE including, office, retail, hotel, industrial and apartment properties.

We’re currently looking at the most significant period of consecutive quarterly drops in value in what admittedly is the short history of the data (going back to 1978).  Although we do not detail the quantitative numbers in the chart, over the last four quarters (3Q 2008-2Q 2009) the index has recorded a 22.5% contraction in value.

(The accompanying graphic, which you can see if you follow the link, includes this bit of decoration: “We’ve NEVER seen anything like this,” referring to the drop in values.)

And just what does this [imply] about bank holdings of CRE loan paper?  Thanks to the current Administration’s financial sector “don’t ask, don’t tell” policy for bank assets, we’re not going to really know any time soon.  Good thing the US banks can simply move forward reporting record earnings and ignore the current inconvenient truth of declining CRE values, no?  We only see some glimpse of the truth in asset values every Friday when we see that week’s US bank failures.  Did you catch how BB&T wrote down Colonial Bank asset values by 37% after Colonial’s essential failure and melding into BB&T?  The write down never happened until Colonial hit the tarmac nose first, yet asset values had vaporized long ago.

The writer goes on to split out the five major types of CRE: retail, office, industrial, apartment and hotel. For the year ending June 30, their values fell between 14% (retail) and 27.3% (hotel). And actually, all but the tiniest fraction of that drop occurred after last Sept. 30. This has been a precipitous decline.

How precipitous? In just three quarters, values have dropped almost half as far as they dropped during the 24-quarter value decline from 1Q 1990 through 4Q 1996. That’s not a decline; that’s practically free fall.

That drop has led to a big drop in the number of CRE transactions. That, in turn, has led to a tightening of CRE credit markets. And that will lead to even more trouble, because about $300 billion in CRE mortgages are up for renewal or reset this year. Banks — which, remember, are carrying a bunch of CRE on their books already that isn’t worth nearly what they say it is — won’t be in any position to provide the financing because they won’t be able to turn those loans into securities. Worse, they’ll be calling for capital from CRE owners whose properties are under water — worth less than is owed on them.

This is going to get worse before it gets better.

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