From the Mortgage Bankers Association’s Quarterly Data Book:
Last month commercial real estate prices took a bit of a breather, falling just 1% after seeing prices fall 9% from March to April and an additional 8% from April to May. Those are fairly stunning rates of decline. In July, the descent picked up steam again, falling 5.1% compared to June.
Commercial real estate prices…renewed steep declines and low transaction volume in July… The [Moody's/REAL Commercial Property Price Index] was down 5.1% from June after having declined by only 1% the prior month. It is now 30.8% below what it was a year earlier and 38.7% below the peak measured in October of 2007.
Overall market transaction volume continued the pattern of calendar 2009. “The market has averaged about 375 sales per month for the seven months in 2009,” said Moody”s Managing Director Nick Levidy. “Over the same time period in 2008, sales were averaging nearly 1,100 a month.”
So much for improving second derivatives, at least on the CRE side.
For residential, you can see the market appears to have stabilized this summer. But that’s thanks to government support. Eventually support will go away and residential prices will likely turn back down.
As always, I want to include a caveat with the chart above. Comparing these two indices is difficult due to the number of data points available. The Case-Shiller index draws on millions of transactions over time. The Moody’s/REAL index has far fewer, just 300 this month.
So it’s tough to say anything definitive about commercial real estate prices using this index.
But the lack of transactions suggests sellers don’t want to hit the bid in the market. Though Felix makes a good point–he’s sitting next to me–that many sellers probably couldn’t hit bids if they wanted to. For particularly overlevered properties, selling at today’s prices implies wiping out equity and forcing a big haircut onto debtholders. It’s not easy getting all interested parties to agree on a short sale…
Earlier this week, I was surprised when I read that Moody’s put the decline in commercial real estate at 16% over the last TWO MONTHS. That’s a stunning rate of decline that has very negative consequences for banks who are still carrying commercial whole loans on their balance sheet at close to 100¢ on the dollar.
(Click chart to enlarge in new window)
Peak to trough the declines are similar: Residential is down 33% from its July ’06 peak while commercial is down 35% from its October ’07 peak.
But note the stunning rate of decline of late for commercial. 28% since September. Residential is off half as much over that time.
To be sure, comparing these two indices isn’t totally fair. As Dan Alpert of Westwood Capital pointed out to me, there are millions of transactions that go into Robert Shiller’s residential index. It’s very granular. On the CRE side there have been very few actual sales that indicate recent pricing. So you have to read Moody’s/REAL with a grain of salt.
Directionally, however, the index is correct. Commercial is collapsing very quickly, even as residential looks to be forming a (temporary?) bottom.
What are the implications? Consider the $1-$1.5 trillion in commercial mortgages being held as whole loans at commercial and savings banks in the U.S.** Because whole loans are “held to maturity,” they are typically carried at full value until the borrower actually defaults. Never mind that the underlying collateral is now worth far less than the mortgage.
But banks aren’t forced to take writedowns until an event of default. To avoid that they can play all sorts of games to make things easier for the borrower. According to Alpert:
Banks and other lenders with loans collateralized by income-producing properties have been offering borrowers nearly any forbearance imaginable: loan extensions, interest rate reductions, delayed principal payments, wavers of covenants and guarantees, and in some instances additonal funding—anything and everything to avoid taking a current loss, as long as there is some cash flow or reserve balance to draw on so as to maintain that the loan is performing against its (often heavily modified) terms.
The bottom line is that banks still have hundreds of billions of losses buried on their balance sheets. Commercial real estate prices aren’t coming back, which means these loans will have to be marked down eventually. The longer banks wait, the more painful the writedowns will be.
Bank shareholders should take note. Assuming the government isn’t going to absorb all these losses, their equity may eventually be wiped out.
*As I was drafting this post I noticed that CR has been working on the exact same data! He has more to add on the subject, be sure to check it out.
**Excludes “multifamily” borrowing. Source: Fed Statistical Supplement December ’08.