This page has been archived and commenting is disabled.
PIMCO's Perspectives On Commercial Real Estate: "Expect Cap Rates Near Or Above 8%"
As part of its Commercial Real Estate Project, PIMCO has conducted an extensive overview of opportunities in the U.S. CRE market. In this most perplexing of markets, where if one follows REIT stock prices, a V-shaped recovery is all but guaranteed, PIMCO has a notably less optimistic outlook. Based on the framework of its well-documented "new normal" paradigm, the Newport Beach asset manager is far less sanguine about investment opportunities in the market - in evaluating prospects for the most relevant CRE valuation metric, PIMCO sees a gradual return to 8% capitalization rates. "the market can expect long term cap rates near or above 8%. In this case, even if properties with floating rate debt can successfully avoid defaults in the short term, rising longer term rates will create a floor for cap rates and limit recoveries." On the other hand, extrapolating from current CMBS spreads, the prevailing market expectation is for a current and future cap rate up to 150 bps lower. Which means that as securities backed by existing assets see their cash flows dry out, as all valuable assets get extinguished, the repricing in assorted CRE fixed income securities, and their equity counterpartes in the REIT realm, will likely have a very dramatic downward repricing event in the future.
Full PIMCO report
h/t Robert
»
- 7555 reads
- Printer-friendly version
- Send to friend
- advertisements -
PimCo has access to all 5 US indices for CRE, though they apparently didn't use them all in writing this synopsis report: Three of the five US indices are transaction based (RCA, GRA and TBI), one uses appraisals (NPI) and the remaining index utilizes rent data (REXX).
Each has drawbacks, REXX doesn't calculate incentives well, appraisals were 'suspect' for much of the last decade, TBI is much like the Case-Shiller RRE index as it only reports sequential sales of existing CRE assets. The RCA which is the database used in the CPPI mentioned and criticized in the PimCo article,
and the S&P GRA, which measures sales on all assets, which seems ridiculous in this divergent sector.
It's all a wild ass guess for now.
On the East Coast we're working on the following assumption
if the area was financially vibrant at the end of the Reagan-Volcker recession in '82,
and the are was also vibrant in 1999,
and the area was vibrant at the 2006 peak,
then the area will be vibrant again in the coming years.
Everything else, outside of some minor locations, are F***ed.
All the massive geographic expansions with attendant massive increases in CRE footprints, will crumble, there is a good blog post regarding zombie buildings:
http://www.argussoftwareblog.com/argus_software/2010/05/zombie-buildings...
The above blog is good reading, Argus Software is the industry leader in CRE IT.
Infill is another story.
Some points: Even though Stuy-town will sell for 60% under peak price, the brokerage survives.
The early 2010 FDIC auction mentioned in passing, was performed by Prestige Auctions, it had such desirable holdings as Florida swampland, warehouses in the middle of rural Piedmont uplands, and concrete slabs for row houses in areas around US military bases. The auction went so badly that Prestige might exit the FDIC property auction market.
And personally I believe we will see 10 year Treasuries well above 5% in the midterm, pushing CAP rates over 9.5%, in some instances above 11%.
And as mentioned, "the rising tide will not lift all boats", BUT this report was released in June, and Manhattan commercial lease rates went up in June, first good signal seen since the collapse. So I'll leave it on that positive note.
Wasn't Stuyvesant Town supposed to be the urban central-planners' model for "regentrification" and all that nonsense?
The pictures of it are terrifying--it looks like old Soviet Bloc housing:
http://www.newyorkcondoloft.com/wp-content/uploads/2010/03/StuyTown_001.jpg
http://nymag.com/daily/intel/20061116stuytown.jpg
Agreed. Looks no different to me than Cabrini-Green or any other huge public housing project in major urban areas. Don't have to go all the way to Russia to see it.
Stuy-Town was for decades a pretty nice lower-middle class neighborhood, there are hundreds if not thousadn of very successful folk who have roots there. Also, the best bagel store in the New World is 2 blocks away. Best bialy in the world.
I lived in Peter Cooper for years and loved it. Cheap rent , parks, sjpaced buildings and great location. Recent events have screwed it up.
The headline reads.... "Blah, blah, blah limits tenants options or some other such bullishit." Then the passage below. I have just one question - Does the author really think EVERYONE is stoopid enough to believe that? Yeah, there are so many upside-down property owners that tenants are in a bind! Ha! Let me remind all here what happened during RTC - the RTC (this time FDIC) fire-sold bldgs that gave the new owners competitive advantages and they crushed the existing property owners - the ygot every new tenant and stole any tenants with expiring leases at rates the other property owners cuddnt service debt with. IMO, the FDIC is purposefully slowing the foreclosure process - the forced marriages and 85% backstopped losses is a great example.
The phenomenon, dubbed "Zombie Buildings" by Grubb & Ellis researchers, refers to properties that have significant capital constraints and are therefore unable to fund market-level tenant improvement allowances and commissions, which adversely impacts their ability to compete for tenants.
I live in a hard hit town in SW Florida. Huge amount of investment properties, drove up prices ridiculously, lots of speculation. There are so many properties in the foreclosure pipeline that it is actually hard to find rentals. The banks are holding it back as much as possible. The market can't handle a wave of more homes for sale, there's too much on the market already.
QQQball,
I thought the linked article was interesting. However, I understand your comment (based on your experience) that eventually RE prices will have to reflect current values and landlords that have not defaulted will face disaster trying to compete with landlords who bought foreclosed, short-sale or otherwise low priced properties.
Two examples:
A friend in Atlanta is currently losing several residential rental properties. Her cost for the properties was 80-90K. Equivalent properties next door have sold for 20K and a recent short-sale offer for one of her houses was 10K. Landlords that bought anytime in the last 5, even 10, years cannot compete with the rents offered by their competitors.
A relative in a rust belt city bought a duplex that sold two years ago for 70K, for 14K. Even after significant renovation (that will make the rentals even more desirable), the cap rate on this property is (conservatively) 25%. If there is a "rent war" (which shows no sign of happening in this lower-middle class neighborhood near several major, stable employers), there is no way long term owners can compete (unless they have owned the property for many years).
My conclusion: The CRE crisis will spread from the weak hands now facing an inability to re-finance underwater properties to stronge hands that have so far avoided any problems because they are well-capitalized and bought at what at the time were "reasonable" prices. I think we may be going back to 2000 prices (or maybe 1995 price) before this is over.
My upper-end Atlanta home is closing this week at a price slightly below the 2003 purchase prices (5%). However, factoring in improvements, costs of selling, etc. the final tally is 15% loss. I will be overjoyed when it closes.
In line with the article, we are currently looking at renting (or buying) a home in the Rust Belt. However, I would not rent a home without a credit check on the landlord. Anyone considering renting from an individual would be wise to ensure that the landlord is current on the property mortgage and is financially sound. You risk losing moving costs and security deposit if the property owner defaults.
We are currently bidding (unsuccessfully so far) on a high-end foreclosure where the defaulting owner sold all major appliances, kitchen cabinet knobs, closet shelving and even the sump pump prior to eviction. I never thought I would see the day...
That said, I wouldn't go long or short REIT's today because the REITs are supported by market distorting govt policies. However, someday, relatively soon, REIT shorts are going to be a great investment!
8% is awfully conservative. 12-15% is likely more realistic over the longer-term. Remember, these are pre-tax cashflows, *and* buildings do wear out, become obsolete, etc.
So sit back, get some popcorn out, and watch all the REITs implode with the rest of the financial industry that supports these Ponzi schemes.
IMHO, we won't see a bottom to this market until the entire paradigm of financing real estate with debt has been completely and utterly destroyed. Productive businesses, which have mostly been divesting real estate over the past couple of decades, will be the only buyers, and they will be cash buyers. The next number of years will be an opportunity of a lifetime for businesses to acquire the properties they currently lease from their distressed owners.
There is nothing inherently wrong with financing real estate with debt.
There are plenty of people in this country who put down 15 or 20% and locked down a nice low fixed interest rate with responsible payments instead of an adjustable hoping to grab that extra .5% at the bottom. They'll see their houses lose paper value from the peak, but if they bought it to live in and aren't trying to flip it, even that doesn't matter much in the long run.
There are likewise plenty of small business owners, and mid/large businesses, who took a responsible and conservative approach. Again, they'll lose paper value, but if they're living within their means they're still paying very low interest historically, and will have no problems.
The 0%, variable rate, welfare-checks-as-income model is what needs to go, along with the thug politicians pushing the "right" for non-creditworthy people to be guaranteed a loan they won't pay off at insanely low rates. Tar and feather Bawney Fwank, unwind Fannie and Freddie, and let lenders adjust their standards to reflect the fact that they're the only ones who'll eat losses on bad loans.
But debt always will give you a feedback loop of rising (or falling) equity, as debt increases or decreases. That is what is wrong with financing real estate, as opposed to paying for it entirely with cash (at cash prices of course).
We know that the past few decades have been characterized by an over-use of financing, and essentially, the Ponzi-fication of the real estate market. The next few decades are likely to be characterized by the opposite, to wit: not only will RE be an all-cash purchase, but one will be expected to put aside a substantial amount of cash reserves to make a RE purchase.
The use of financing also makes real estate far more expensive because a banker has his 'hand' in the transaction, and is collecting a spread. Take financing out of real estate, and it will be more affordable for all.
Pitz - I personally am by nature a bit averse to debt (though I don't mind borrowing burgers), and am sympathetic with your stance, but leverage in CRE is here to stay, IMO.
+1
This should be good to moon-shot IYR another 5% in a single trading day. What the fuck? Why not push the REITs to 250X? It's completely bogus anyway so what harm does doubling up again do?
Before I read this article I thought to myself, Scooby, Tyler won't be announcing any bullish news here this evening.
To my surprise I WAS RIGHT! Bearish repricing event. Let's get short bear cubs.
It's a raging opportunity for you to get out there and snap up some primo CRE with all the readily available bank loans. Maybe you can snap up a Subway or a Bojangles.
So I called the floor and said:
"account 8392839 selling 100,000 Reit cars".
floor says:
"account 8392839 seller 100,000 Reit cars".
"hold".
"sold 50,000 Reit cars at 35.75 ticket 1217".
"sold 50,000 Reit cars at 36.25 ticket 1219".
Fast forward 1 month. The Reit sold is now trading at 46.50ish. So I call: 888.qui.zero (888.784.9376)
and ask for Tyler because I have a bone to pick. The receptionist lady says "which one"?
Scoobs - how do you get the slobber off the phone receiver?
Phone condoms.
http://www.nytimes.com/2010/07/12/business/global/12refinance.html?pagew...
Rut Ro Raggy!!!
I echo what is said above about there nothing being wrong with purchasing CRE with debt. If you want proof that you are wrong about debt disappearing, consider that the first "new" lenders/investors to enter the market during the downturn were Debt Funds backed by private equity money. Using leverage always improves returns - therefore it will stay.
A big problem was the short term nature of the debt with no amortization - forced equity creation. It leaves a borrower too exposed to greater economic, macro-CRE market, and specifically price cycles. Even if you consider the problem of cash flows dropping so much no one could meet debt service payments, that should still lead to an orderly foreclosure and disposition of an asset...but again the initial over-leverage and lack natural de-leveraging (via amortization) meant no orderly disposition could occur. Compound this with the stupid practice of special servicers buying the B-piece and the sheer magnitude of the situation and welcome to the CMBS debacle.
The reason this will be a lost decade, and not a relatively orderly solution (like the RTC days), is because their is not a release valve like there was with CMBS assisting in the S&L crisis resolution. The only players that are in a position to work this out are the PE firms/vulture funds and they don't have the lobbying power that the community/regional banking industry or wall street have. If your up for re-election are you going to allow mark-to-market gimmickry to help your struggling local bank or will you force them to fail so the PE firms can step in like we need?
I think the most telling point of the analysis was the $1.9bn in trades in 2009 that made up all the indices while StuyTown itself was a $5.4bn purchase.
Really this is a great post from an expert and thank you very much for sharing this valuable information with us.................
windows vps | cheap vps | cheap hosting | forex vps