Real estate

Now this is what a real stress test should look like. Bloomberg quotes a banking insider that "China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60 percent in the hardest-hit markets." And just in case it is unclear what the reality of the situation is, because as Europe demonstrated all too well, nobody would test for something which is not already priced in, China is effectively telegraphing to the world that it is bracing itself for a more than 50% plunge in select real estate values. "Banks were instructed to include worst-case scenarios of prices dropping 50 percent to 60 percent in cities where they have risen excessively, the person said, declining to be identified because the regulator’s requirement hasn’t been publicly announced. Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent." The doubling in stress is somewhat to be expected considering the tens of trillions in renminbi pumped into the banking system via whole loans and other CDO products, most of which have gone into building up empty cities, vacant apartment complexes, and unused infrastructure projects. As we noted previously when discussing the recent Fitch report on shadow funding of the real estate bubble, the nearly 50 million in vacant units, the ugly truth about the Chinese bubble is slowly starting to leak out.

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%.

While some industry participants are heralding the recovery in commercial real estate, other experts warn that this is a false recovery and it's too early for such proclamations...

Interesting things have been happening in the real estate markets, but does it mean we are in a real estate recovery?

Where has my mid-tier non-performing real estate gone???

The bank that has been bailed out a hundred times before is, shockingly, rumored by Bloomberg to not pass the stress test. In other news, all Greek banks are doing swell for now.

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.

Many people have asked me how SRS and REITs share prices can defy gravity the way they have given the abysmal state of commercial real estate (CRE). Well my opinion is that the equity and the debt markets have allowed agent and principal manipulation to the extent that it materially distorts and interferes with the market pricing mechanism.

For all who think that the Fed has received the Ukrainian-cum-Marriott Garden Inn unlimited one-hour special giftset only from the TBTF banks, you are wrong: it appears the broke real-estate industry has also provided some favors to the FRBNY, and is now demanding, and receiving, preferential treatment. Tishman Speyer, whose 5.7 million sq. foot portfolio acquired from Blackstone in 2007, has been unable to renovate its insolvent properties as lenders have been unwilling to negotiate a restructuring. One of the lenders is none other than the Federal Reserve, which took over loan commitments by Bear Stearns. Crains New York reports that the FRBNY has finally relented and at what likely is a loss to taxpayers, has given Tishman $100 million to restructure its loans at preferential terms. Tishman's take on this development was pretty clear: "It's great for our tenants and it's great news for everybody we do business with,” said Casey Wold, Tishman senior managing director in Chicago. “We now have enough capital to improve the properties and lease up the entire portfolio to stabilization." Thank you taxpayers - you now have indirectly bailed out the following Chicago properties: Civic Opera Building, 10 & 30 S. Wacker Drive complex,1 N. Franklin St., 161 N. Clark St. and 30 N. LaSalle St.

There is a massive structural imbalance in residential real estate that will take at least a decade or more to unwind. 26 million homes for sale and 70 million missing buyers do not add up to a bull market. 80 million retiring baby boomers are putting huge generational pressure on the market. Losing a city the size of San Francisco in demand every year. A replay of 1929 to 1955 when prices remained flat? (XHB).

Here comes the latest destabilizing Central Bank "intervention" in Europe. The Bank of Spain, doing what Fed and the Treasury should have done with domestic toxic loans backing worthless real estate, has notified lenders that they should be prepared to set aside much greater loss reserves against assets, "such as real estate, acquired in exchange for bad debts once the holdings have been on their books for more than two years." The staggered loss provision schedule will call for a 10% loss assumption for real estate acquired in foreclosures, 20% for real estate held for more than a year, and 30% for anything held for more than 2 years. Bloomberg reports that Spanish lenders have foreclosed upon property worth nearly €60 billion, which means that very soon Spanish banks, which as we pointed out earlier are already suffering a liquidity crunch as a result of loss of access to Commercial Paper, will have to take an incremental up to €18 billion in asset write-downs, a development which will have a major adverse impact on Spain's banking sector once it funnels through the banking system, and especially once the need for liquidity spikes yet none is found.

It may take a while, but the fictitious valuations of CRE REITs will eventually come to reflect what is actually going on in the actual physical real estate world. It may be like matter meets anti-matter, investment banking secondary offering meets bricks and mortar reality. After all, the antics in Germany and greater Europe are not doing anything to actually help the debt markets.
I think I feel another "I told'ja so" coming on...

Even as the market is now surging on rumors of massive pan-European bail outs (someone explain to us how a tsunami of failed banks is equity positive... or for that matter how imminent monetization is EUR positive), Bloomberg is reporting that the liquidity crisis in Europe has struck smack in the middle: after the FinMin released a draft bill to forcibly write down real estate asset holdings by 10, investors in certain mutual funds have panicked and attempted massive redemptions, which in turn forced redemption halts by these funds which likely are woefully undercapitalized to begin with. This is just the beginning of the liquidity squeeze moving from the periphery to the core.

With populations soaring at the bottom end of the economic spectrum, the demand for new apartment buildings is going to be huge. Immigrants joining impoverished gen Xer’s and Millennials aren’t going to live in cardboard boxes under freeway overpasses. Institutions combing the landscape for low volatility cash flows and limited risk are starting to pour money in.

If Goldman Sachs wanted to reduce its exposure to subprime mortgage investments, why didn't it simply sell the assets it owned? Two reasons: First, those large sales would have sent a signal that something was terribly, terribly wrong, and thereby pushed prices down further. That's how supply and demand normally works. Second, Goldman professed to be market maker, which uses its trading book to instill confidence. It ostensibly bought, sold and inventoried mortgage securities to provide stability and liquidity to the marketplace. Of course, we now know that such market confidence was entirely misplaced. To sidestep these issues, Goldman and other major banks found a solution that subverted the laws of supply and demand, and escaped the price discovery of a transparent marketplace. They fabricated synthetic CDOs, such as Abacus 2007 AC-1. These toxic assets, invented out of thin air, made the meltdown worse than it otherwise would have been.