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Record Commercial Real Estate Deterioration In June As CMBS Investors Pray For 50% Recoveries
In continuing with the trivial approach of actually caring bout fundamentals instead of merely generous (and endless) Fed liquidity, we peruse the most recent RealPoint June 2010 CMBS Delinquency report. The result: total delinquent unpaid balance for CMBS increased by $3.1 billion to $60.5 billion, 111% higher than the $28.6 billion from a year ago, after deteriorations in 30, 90+ Day, Foreclosure and REO inventory. This represents a record 7.7% of total outstanding CMBS exposure. Even worse, total Special Servicing exposure by unpaid balance has taken another major leg for the worse, jumping to $88.6 billion, or 11.3%, up 0.7% from the month before. And even as cumulative losses show no sign of abating, average loss severity on CMBS continues being sky high: June average losses came to 49.1%, a slight decline from the 53.6% in May, but well higher from the 39.6% a year earlier. Amusingly, several properties reported loss % of 100%, and in some cases the loss came as high as 132.4% (presumably this accounts for unpaid accrued interest, and is not indicative of creditors actually owning another 32.4% at liquidation to the debtor in addition to the total loss, which would be quite hilarious to watch all those preaching the V-shaped recovery explain away. Of course containerboard prices are higher so all must be well in the world). Putting all this together leads RealPoint to reevaluate their year end forecast substantially lower: "With the combined potential for large-loan delinquency in the coming months and the recently experienced average growth month-over-month, Realpoint projects the delinquent unpaid CMBS balance to continue along its current trend and potentially grow to between $80 and $90 billion by year-end 2010. Based on an updated trend analysis, we now project the delinquency percentage to potentially grow to 11% to 12% under more heavily stressed scenarios through the year-end 2010." In other words, the debt backed by CRE is getting increasingly more worthless, even as REIT equity valuation go for fresh all time highs, valuations are substantiated by nothing than antigravity and futile prayers that cap rates will hit 6% before they first hit 10%.
We dare all the V-shapists to point out where precisely on the chart above is one supposed to look for this ephemeral economic improvement.
And an even scarier dynamic is currently occurring in the Special Servicing space, where after a slight decline in the rate of deterioration, June once again saw a surge in this forward looking indicator.
RealPoint has this to share on the role of special servicing:
Special servicing exposure continues to rise dramatically on a monthly basis, having increased for the 26th straight month through June 2010. The unpaid balance for specially serviced CMBS under review in June 2010 increased on a net basis by $5.23 billion, up to a trailing 12-month high of $88.6 billion from $83.38 billion in May 2010 and $81.38 billion in April 2010. Special servicers will play a key role in the level of delinquency reached in the next 12-24 months as large loan modifications, lender financing (through discounted assumptions and modifications prior to foreclosure), maturity extensions and approved forbearance have the potential toslow down or mitigate delinquency growth and delay losses. In addition, while vacancies across most if not all property types are near historic highs, optimism has recently surfaced regarding asking rents and vacancy across distressed loans. Some experts believe that increased interest for vacant retail space and pent-up demand may fuel a recovery for the sector.
We hope for the sake of all those value investors who have bought into the GGP resurrection story, that they are right, although if one actually goes by such things as fundamentals, which value investors presumably track as well, things are not looking good:
- Special servicing exposure increased for the 26th straight month to approximately $88.6 billion across 4,830 loans in June 2010, up from $83.38 billion across 4,755 loans in May 2010 and $81.38 billion across 4,689 loans in April 2010.
- For the 31st straight month, the total unpaid principal balance for specially-serviced CMBS when compared to 12 months prior increased, by a high $48.07 billion since June 2009. Such exposure is up over 119% in the trailing-12 months.
- Conversely, for historical reference, special servicing exposure was below $4 billion for 11 straight months through October 2007.
- Exposure by property type is now heavily weighted towards office collateral at 24%, followed by retail at 22% and multifamily at 21%.
- Unpaid principal balance noted as current but specially-serviced decreased to a low of $1.44 billion in July 2007, but has since increased to $30.9 billion (up slightly from $29.73 billion a month prior).
- Within the 3.9% of CMBS current but specially-serviced, we found 257 loans at $27.28 billion with an unpaid principal balance at or over $20 million, compared with 266 loans at $26.04 billion with an unpaid principal balance at or over $20 million a month prior.
- Unpaid principal balance was at or above $50 million for 128 current but specially-serviced loans in June 2010, and was at or over $100 million for 68 loans. The largest of such loans included the current but specially-serviced EOP Portfolio loan at $4.93 billion in the GSM207EO transaction, the $1 billion CNL Hotels and Resorts loan in COM06CN2, and the $775 million Beacon Seattle & DC Portfolio Roll-Up loan in MSC07I14.
The neverending deterioration has forced RealPoint to reduce its already bleak outlook for future delinquency trends, noting the following dynamics:
- Balloon default risk remains an issue form both highly seasoned CMBS transactions as loans are unable to payoff as scheduled. In many cases, collateral properties that have otherwise generated adequate / stable cash flow results are not able to refinance their balloon payment at maturity, due mostly to a lack of refinance proceeds availability. This continues to add loans to those with distressed collateral performance in today’s credit climate.
- Five-year and seven-year balloon maturity risk is growing for more recent vintage pools from 2003 through 2005 where little or no amortization has taken place due to interest-only payment requirements, while collateral values have also declined. Within this area of concern, large floating rate loan refinance and balloon default risk continues to grow, as many of such large loans are secured by un-stabilized or transitional properties reaching their final maturity extensions (if they have not done so already), or fail to meet debt service or cash flow covenants necessary to exercise in-place extension options.
- Declined commercial real estate values and diminished equity in collateral properties continues to prompt more struggling borrowers with marginal collateral performance to claim imminent default and ask for debt relief.
- The aggressive pro-forma underwriting on loans originated from 2005 through 2008 vintage transactions, comingled with extinguished debt service / interest reserves required at-issuance, has led to an increasing number of loans underwritten with DSCRs between 1.10 and 1.25 with an inability to meet debt service requirements. This is especially evident with the partial-term interest-only loans that will begin to amortize or those that have recently converted.
- A cautious outlook for the hotel sector remains as many sizeable hotel loans from 2005-2008 vintage pools have reported poor or declined results in 2009 (especially on the luxury side) and / or continue to be transferred to special servicing for imminent default. Many properties had to significantly lower rates to maintain an acceptable level of occupancy across the country and in some cases have experienced severely distressed net cash flow performance as a result. Our expectations are that more of these loans may be asking for debt relief in the near future and may ultimately default if a resolution is not reached.
The 5 and 7 Year cliff refi issue is particularly notable in a delinquency exposure chart by vintage, where it is all too visible that 10 Year paper in need of rolling is going delinquent at an alarming rate: well over a quarter of all outstanding 1999 CMBS is in delinquency as there is nobody willing to fund a roll of the underlying debt!
And when looking at the most important category of all: liquidations and loss averages, these show no improvement either, as prevailing loss averages amount to about half of total outstanding principal (a finding confirmed recently by Chicago Real Estate Daily, which confirmed that a development site in the South Loop was auctioned off for $11.3 million on total debt of $25.3 million: a less than 50% recovery).
- Both liquidation activity and average loss severity for these liquidations has been on the rise over the trailing 12-months, especially in the past few months of 2010. An additional $762.9 million in loan workouts and liquidations were reported for June 2010 across 126 loans, at an average loss severity of 49%
- Since January 2005, over $10.9 billion in CMBS liquidations have been realized, while only 48 of the last 61 months have reported average loss severities below 40%, including 21 below 30%.
- Annual liquidations for 2009 totaled $2.18 billion, at an overall average severity of 42.1%. The overall average was clearly brought downward by the number of loans that experienced a minor loss via workout fees and / or sales or refinance proceeds being near total exposure, while the true loss severities by our definition averaged 62%.
- Comparatively, annual liquidations for 2008 totaled $1.297 billion, at an overall average severity of only 24.9% while liquidations in 2007 totaled $1.094 billion at an average severity of 32.8%.
- Liquidations in 2006 totaled $1.93 billion at an average severity of 30.2%, while 2005 had $3.097 billion in liquidations at an average severity of 34.2%.
A table of montly average losses shows that there is little to be cheerful for if one is a CMBS investor: in fact half of little may be the best bet (especially for multifamily, industrial and retail property types).
Full RealPoint report here.
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How do vacancy and rental rates tie to these numbers? It is fairly logical to think that they are depressed because they directly impact cash for debt services, but it would be interesting to see what kind of deterioration lag is built into the delinquency rates as the owners were supporting debt service with external cash flow. This kind of analysis can be like reading tea leaves on how much more deterioration we can expect.
Here in FL rates have actually increased (commercial space) due to the belief that a recovery was pending any second. The result was many businesses have moved to areas with cheaper rent. A friend of mine closed her shop and moved to TX saying the business here in FL was depressed with property owners buying into the recovery notion and jacking up prices....TX offered a better deal. Many businesse cannot afford to move and are merely shuttering.
Wow thats pretty ironic. I assume the ones jacking up prices are doing so as a last resort (though youd think keeping them stable or lower would make more sense) as they've lost enough money on empty lots that theyre trying everything they can..
I was in Fort Myers about a month ago and not a pretty sight in terms of residential either.
Are you able to say where in FL you are referring to?
I was struck by the trend in Chart 9. High delinquency in 1999 era origination, low in 2002. That means that the loans given during periods of economic duress to enterprises sufficiently tough and disciplined to establish themselves in difficult times have better ability to survive. Establishing long-term growth at the top, the opposite.
That would make '07 a good short bet.
- Ned
i read somewhere that in the depression cre was sold for the cost of the elevators.
In SF, Russ Building (The biggest highest office bldg.)
leases traded at about $.10 on the
dollar around 1930-31. A much quicker process without
CMBS and without Government to buy the paper.
Capt. Iceberg dead ahead.
As long as they keep paying those dividends, and as long as holders of REIT stock don't need the cash, CRE will continue to soar. Simple as that.
Imagine a run on REIT to liquidity...wonder what would happen to the markets....probably nothing. It seems to ignore all logic now.
If there was a run on liquidity, it means the market would have reached sanity. The house of cards would collapse. Until the markets leave the loony bin, logic will be ignored.
You can get your ARM rolled over. A friend just did it with his $1.15 million ARM...
Only two caveats: First, his appraisal showed a whopping $150K drop in appraised value over the last two years and second, he had the $150k sitting in an IRA that he was willing to bring to the new ARM closing.
Why did he do this? First I suspect he didn't want to uproot his children. Second, his ego. And third, he's deluding himself into thinking the property will go back up again in fairly short order....
Sorry guys, this is somewhat off topic. But here in central NJ, I am seeing residential construction picking up. Yesterday, I dropped my car for wheel alignment and decided to walk back home (3 miles) and noticed atleast 4 luxury residential construction. Also, during morning while I am driving to office, these days I see trucks with construction material like tevayek and boards.
I am not sure what is going on in NJ. Is recovery really picking up or NJ is isolated..
I hope this trend makes its way to the tri-state area, will just allow me to re-negotiate my rent.....lower.
I have seen this sort of thing too, in neighborhoods where 1/4 of existing homes have for sale signs. The only thing I can think of is, these are people with enough ready cash to do whatever they want, and what they want is a custom designed house built exactly to their tastes, in exactly the location they want to be. That's just a guess, but I can't think of any other reason to invest in something that is guaranteed to drop below construction cost the moment the key is handed over.
My take is, builders build until someone cuts off the money.
The money hasn't been cut off because lenders are already in too deep to quit.
I've seen the same here in AZ.. they just completed a warehouse next to
several that are foreclosed on. And building residentials next to neighborhoods
swollen with foreclosures.
I'm wondering how much of it is contractual.. I recall when leaving Kelly AFB
they were building an aircraft paint hangar ($$$), even though the base was closing.
When I asked why? I was told it would be more expensive to cancel the contract.
So build on... eventually it will all have to be settled with reality.
I own a small building company in central Jersey. There has been a bit of an "unfreezing" in residential construction, but I wouldn't characterize it as a genuine uptick.
Some folks who were planning to renovate back in 2008 put those plans on hold, and now decided to go ahead with them. If you're gonna be stuck with the home you have, you might as well make it into one you like. And some homeowners see a forced sale in their future, and want to get the home into saleable shape.
Developers who were building spec homes put their plans on hold, and now are restarting some of them in an attempt to recoup some of the sunk costs.
I was talking to a friend who own a major blueprinting company and they've seen no uptick in residential blueprinting. He sees few new building plans, just reprints of 3 - 4 year old blueprints. Local architects are downsizing/closing left and right.
I think this small bounce is just buttoning up loose ends... a few developers clearing the pipelines, finishing the best of the unfinished projects. In short, there is a bit more business, but its all short term.
You can't even make the case for a slower rate of change as April to May delinquencies were less than most recent May to June.
No worries though, CNBC told me all is good.
The ability for self-delusion is limitless among CRE investors, and second only to residential builders in misplaced optimism. That's probably a good thing as otherwise we'd have far less selection and higher prices.
Anecdotal information from our area. Our current lease is expiring next year and we are looking for a new building. The rates that we can get are roughly 70% to 80% of what we could get 5 years ago. There is a fair amount of property available and other small businesses (left) in the area are also looking to decrease costs by moving to buildings with lower "gross" rates ... taxes by area play a big part. Activity seems fairly brisk, but it is a reshuffling down in cost rather than new businesses starting up or moving in. The large publicly funded real estate companies seem to want to have the building filled and are very willing to deal. The smaller real estate companies that are privately funded or funded directly by specific pension funds are not willing to deal nearly as much.
I should do a little pictorial of the empty CRE on a loop I frequently drive. The carnage is amazing, and this in a county that, only two years ago, was the fastest-growing in the state.
Local government's response, of course, was to borrow using 'Build America' bonds to insure a massive *new* development featuring 19 luxury hotels, 400 condos, gazillions of square feet of retail space, etc. So far, not one shovel has been turned on the new development.
For now, the Federal Government simply will not let CRE default at anywhere near realistic numbers. For one thing, it would destroy local banks, which invested in this garbage (and is also, apparently, heavily into more esoteric forms of speculation).
It's called, scare tactics. The middle class doesn't want to hear any bad news, and since the Government is terrified to tell them any bad news, the band plays on.
The only question is, where, in the details, is the Mellonesque liquidation interest. Continued government support would suggest that the powerful are NOT withdrawing government from the society. But that is not the case, so how is it looting--which it is--for the Government to continue to insist that there not be foreclosures on CRE? It sounds like gathering in the last dollars before the whole thing becomes unsustainable and is then abandoned.
We're all serfs, they live in Central Park West.
Regional banks are being allowed to fail in record numbers:
See bank-implode.com
A lot of CRE losses are being eaten up by the CDIC through this mechanism.
This tends to support CRE prices, as the properties don't have to be sold into this
down market...
Part of the looting process is the liquidation of small and regional banks. Part of the ability to perpetuate the looting is predicated upon consolidation of power. Those institutions that pose systemic risk are ensured a spot at the trough. This is why there has simply been a consolidation of power rather than a diffusion, post lehman. (also why any attempt to compartmentalize the institutions is vigorously defended... it's the lynch pin for everything).
All of the entities (including the FED) are eventually going to get thrown to the wolves. There has been a great bank robbery in progress for a very long time. Even basic salaries are theft to a large extent, given the industry has been propped up solely by government intervention. Obviously the record bonuses are universally accepted as looting... but the entities are meaningless... people are just siphoning off monies, taking risk of the entities collapsing off the table... new entities will be started with the siphoned capital and they'll purchase everything at pennies on the dollar.
In 2008 when we had the run on banks [if you'll remember el erian talking on CNBC that he told his wife to take all the cash out of the atm (no idea how they slipped that one through), it was at this time] that nearly crippled the whole industry. At that time, uncertainty was rampant. When Uncle Sugar stepped up to the plate in support of TBTF, it caused an instant panic and run on small and regional banks, as they did not get the same support. We were literally on the precipice of... well, what's coming anyway... implosion. (they ended up raising the FDIC insured limits to help stem this problem). I see no change in their policy... At the time, it was widely speculated that the smaller and regional banks would be fed to the TBTF in an effort to bolster their balance sheets and prop up the system. Shit assets would be either dumped onto uncle sam and/or sold at extreme haircuts. Now it seems that the FED bought enough time and cooked enough geese to bolster cash positions of TBTF enough for the hedge against immediate collapse. Oddly, some of the larger regional players have been able to weather the storm because of their acquisitions of smaller banks... most of it is accounting gimmickry, but to a large extent, it's one of the few/best avenues of growth.
At any rate, consolidation is the name of the game... if they can capture enough liquidated assets cheaply enough to pad their own balance sheets, they get to stay alive. If not, they die. But, contemporaneously, the principal actors (not necessarily shareholders) are siphoning off money as a hedge against collapse of the entities. No telling how long it gets to last. But, the days of massive QE 1 are over... there will be more QE, but it will be in smaller and smaller amounts... rounds of musical chairs that kill off a couple of the lame members of the herd... the rest of the herd feasts until consolidation is complete. And, if the whole industry fails, then they've got that contingency covered through the aforementioned siphoning... they'll buy the assets back from the failed institutions that gave them their record bonuses/salaries (after all, they know which ones are the best performing and where they're stuffed away)...
and, contemporaneously with all of it, reduction in the size of government... at all levels... attempting austerity is a bitch.
An anecdote and a question.
Anecdote: a friend owns a great deal of CRE in central/southern Cal. He reports on the one hand that he is 100% leased for the first time since the 1990s and refuses to renegotiate any ongoing leases; but OTOH, renewals and new tenants are receiving gigantic rent reductions.
Question:
Most Markit CMBX prices appear to be in an uptrend for some time. Does this mean anything?
http://www.markit.com/en/products/data/indices/structured-finance-indices/cmbx/cmbx-prices.page?
was wondering where all of your CRE articles had gone to. You were really cranking them out last year!
Great analysis!