WSJ: Credit Downturn hitting Commercial Real Estate

December 26, 2007

For anyone who thought commercial real estate was going to escape the subprime mortgage meltdown, time to wake up and smell the roses. This article from the WSJ doesn’t have a lot of new info so much as juicy tidbits describing how easy credit blew up a commercial real estate bubble the same way it blew up a residential one.

I don’t think anyone seriously believes commercial real estate isn’t going to get sucked into the abyss. So many aspects of that market, shopping malls for instance, are derivatives of the residential world. And of course, the same credit crunch that has erased easy credit to buy homes has also eliminated credit to buy commercial property. It’s amazing to me that banks lent Harry Macklowe $7.1 billion to buy Equity Office properties that Blackstone flipped. Those buildings were purchased at record cap rates. How much equity did he have to put down? $50 million. Less than 1%. He’s now looking for “an equity partner.”

Reports of commercial property sale prices from earlier this year made it clear that rents weren’t substantial enough to pay back debt service. To believe they’d actually make money after paying such high prices, buyers had to assume two things: substantial growth in rental prices along with continued capital appreciation for the underlying property. Sounds a bit like speculation in the residential real estate world doesn’t it?

The larger focus of the story is about Centro Properties Group, the Australian firm that paid up for up for U.S. strip mall owner New Plan Excel. Centro paid too much and is now struggling to roll over their debt.

Quoting the most interesting part of the article:


….The predicament facing Centro, Mr. Macklowe and numerous others underscores the state of the once-unflappable commercial real-estate market. For the past few months, the sector has been in a state of near-paralysis, as financing has nearly dried up. The number of major properties sold is down by half, and many worry that the market will continue to deteriorate as property sales remain slow, prices continue to drop and deals keep falling apart.

“Where we’re really in a fog is on the capital markets side,” said Michael Giliberto, a managing director of J.P. Morgan Chase & Co., on a conference call last week about the state of the commercial real-estate market.

[Harry Macklowe]

The CMBS market was the engine that drove the commercial real-estate boom. Over the past few years, the issuance of CMBS allowed banks to get rid of the risk on their books, lend with cheaper rates and looser terms and that made it easy for private-equity firms to do huge real-estate deals.

Between 2002 and 2007, CMBS issuance rose to an estimated $225 billion from $52 billion, according to Commercial Mortgage Alert, a trade publication that compiles its own statistics.

Real-estate investors aren’t the only ones feeling the pain. Many big banks issued short-term loans to buyers and planned to sell them off later, much the way they do with loans made to private-equity buyout shops. But the banks have gotten stuck with an estimated $65 billion in fixed- and floating-rate loans on their books, according to J.P. Morgan. Some of the largest issuers have been Lehman Brothers Holdings Inc., Credit Suisse Group and Wachovia Corp.

Lehman has said that about half of the $79 billion in mortgage debt it was holding at year-end is CMBS-related. Wachovia and Credit Suisse declined to comment.


You’ve gotta love that Journal drawing of Macklowe: Scrooge straight out of central casting.

Anyway, securitization lavished easy credit on the commercial real estate world with “CMBSs” just as it did the residential world with “MBSs.”

And of course the private equity world reached dizzying heights due to the financing terms available. Who can recall the days of Leon Black at Apollo Mgmt burdening his companies with new debt so that he could pay himself and his investors dividends? The cash-out refi writ large. Anyone else remember reading arguments from the private equity guys about how they were “adding value” by bringing in new mgmt and helping companies escape SOX 404? Sure fellas, financial engineering using cheap, unlimited credit had NOTHING to do with your success.

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I do not believe this

Posted by fornetti | Report as abusive