According to the Moody’s REAL Commercial Property Price Indices (CPPI), US commercial real estate prices have declined 42.7% since the market peaked in October 2007. However, in September the index posted the largest one month price increase in the index’s nine-year history, a 4.3% increase. Since bottoming out in the third quarter 2009, the index has generally flattened out with monthly volatility partly based on economic uncertainties and a lack of sales volume. The lack of sales volume is partly due to the lack of available mortgage funds.
With over $1 trillion worth of commercial real estate loans expected to mature between now and 2013, lenders appear to be placing significant importance on restructuring existing loans, as opposed to making new loans. “Delay and Pray” practices delay foreclosures by altering the terms of payments, and/or extending the time a borrower has to pay down a loan. Federal Deposit Insurance Corporation Chair Sheila Bair said in an Oct. 13 speech that these policies are useful in helping the commercial real estate sector recover by offering opportunities to restructure.
At a recent American Bankers Association conference that I attended, there was much chatter about the adverse effects that the Dodd-Frank bill will have on the cost of credit. Hank Paulson, the former Treasury secretary, opined in The Wall Street Journal that higher capital and liquidity requirements will give us more stable long-term growth. He rejected the notion that these requirements will slow economic growth. In the short term however, with many smaller banks concerned about the adequacy of their capital reserves, commercial real estate lending seems to have decreased in priority at many institutions.
According to the November 29th edition of the Mortgage Employment Index from MortgageDaily.com, the headcount in real estate finance employment dropped by nearly 1,000 in the third quarter 2010. In October 2005, mortgage employment peaked at 535,400 based on government data. In September 2010, the industry-wide headcount had decreased to 246,400, according to the index.
As we move past 2010, it appears that the industry can expect more conservative underwriting standards in 2011. As banks rewrite existing mortgages, the burden of deriving reasonable market value estimations on distressed properties will fall on the shoulders of the real estate appraisal industry. With many markets experiencing large vacancy rates, volatility in rental rates and terms, and fewer sales, creativity and a solid knowledge of appraisal fundamentals are essential in estimating the market value of unstable properties in unstable markets. In deriving value estimates utilizing discounted cash flow methods, there are numerous projections that need to be made, and the reasonableness of each projection is key to obtaining a reasonable value estimate. Such projections require substantial research and thus an investment of time. In deriving market values utilizing direct capitalization techniques, there are fewer projections required; however each projection takes on paramount importance.
Many predict that commercial real estate values have bottomed out, and that they will remain at these levels until employment picks up and occupancy rates increase. With economic distress spreading in Europe, US states teetering on bankruptcy, and an uncertain political landscape, any projection on where commercial real estate values are headed is clearly subjective.
-Jonathan Fischer, MAI
Jonathan Fischer, MAI, is a Managing Director in NAI Global’s New York City office and works with investors and financial institutions as a member of NAI’s Special Asset Solutions group.
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