Felix Salmon

The commercial real estate boomlet

By Felix Salmon
April 7, 2010

We saw yesterday that indiviuals across America seem to have learned nothing from the housing bust — and now Dana Rubinstein has a great piece in the NYO showing that exactly the same is true in the world of commercial real estate as well. That’s certainly what Newmark Knight Frank president Jimmy Kuhn thinks:

“There already seems to be a lot of capital out there that thinks that just because it cost $1,000 a foot a few years ago that $500 a foot is cheap,” said Mr. Kuhn, referring to office building prices, which, during the heady boom years, routinely exceeded $1,000 a square foot, even, and most egregiously, for a comparatively modest office building in Soho. “There are a lot of people starting again to underwrite office buildings with aggressive projections for growth in rents.”

In a sense, this is just a natural arbitrage: if risky junk bonds have been soaring in value, then risky real-estate loans have to be getting more attractive too: this is arguably a capital-markets phenomenon as much as it is a case of real-estate investors having the memory of a goldfish.

But it’s a lot easier to protect your downside in junk bonds: you can always buy some CDS, while the market in credit protection on commercial real estate loans is thin to nonexistent.

The biggest worry of all, of course, is not that these loans go bad but that they end up being highly profitable. That will then confirm in the lenders’ minds that they were right, and that they should double up their bets. And so the cycle begins anew. But we’re not there yet. There’s still an enormous amount of oversupply in the NYC office market, and I have no idea where these projected rent increases are meant to come from, especially when the Port Authority and Larry Silverstein are willing to pounce on any uptick in demand by building enormous new towers at the World Trade Center site. My expectation is that we’re much more likely to see a lot more of these loans going bad than we are to see them vindicated.

4 comments so far | RSS Comments RSS

I’m not sure why you’re talking about “risky real-estate loans”, or even what “these loans” is supposed to refer to. This is an article about equity investors, not lenders. They’re paying too much, but that has nothing to do with loans going bad, and the likely loss of some of their equity capital shouldn’t have any systemic effects. Lenders are currently not doing much more than 60-65% loan to value, and are underwriting income conservatively for the purposes of establishing that value, so any new debt financing put in place in any of these purchase transactions (the SL Green deal replaced an existing loan with equity, and will presumably be refinanced after the close out the current owner) should be relatively protected. It may be that lenders yet go crazy, but we’re not there at the moment.

Posted by mrblandings | Report as abusive

In many US cities, commercial property development is heavily subsidized out of the local tax base, taking such ventures – sometimes entirely – out of the realm of real-world economics. No matter how many vacancies abound, there will always be a defined per sq ft threshold below which commercial leases will never go, not until these subsidies are scrapped. Meanwhile…

I can attest from personal observation that aquarium fish actually have longer memories than urban legend allows, longer than commercial property developers whose sense of self generally mirrors that of the countless post-WWII Austrians memorializing themselves as having been in The Resistance.

Posted by HBC | Report as abusive

17% vacancy rate is getting worse

Posted by Storyburn_com | Report as abusive

Seems relevant to me. Today’s conservative underwriting is tomorrow’s catastrophic failure of common sense. Many negative-amortizing residential loans were written at a 75% loan to value. Then California home prices fell 40% in a year.

Posted by PBeller | Report as abusive

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