The commercial real estate market is also adding to the confusion and creating a drain on the capital markets because buyers and sellers are not anywhere near agreement on value today. Buyers believe the market is falling apart; sellers think this is just a short-term stumble and market conditions will improve soon. Both sides have data to support their opinions. Buyers focus on the negative headlines about the economy and how it will inevitably impact real estate, while sellers argue that real estate continues to hold up over time.
For example, commercial property vacancy rates for office, retail, industrial, apartments and self-storage are actually the same or lower than they were in 2003 and 2004. The Moody’s/REAL Commercial Property Price Index is now 5.5 percent below its peak in October 2007, which is not that bad when compared to the overall stock market being down about 20 percent. Additionally, the delinquency rate for commercial mortgage-backed securities (CMBS) loans is still less than 1 percent and close to its all-time historical lows.
All things considered, plenty of conflicting information exists to create a big discrepancy between buyers and sellers. This discrepancy has led to a significant slowdown in properties changing hands. It’s estimated that total commercial real estate transaction volume is off by almost 75 percent compared to the prior year.
So what does all this confusion mean to the property owner looking for debt? First, let us focus on one of the largest providers of capital to the real estate industry over the past five years: CMBS. This market is all but shut down due to previously mentioned issues. Investors are concerned about buying loans originated in 2006 and 2007, since they believe they were too aggressively underwritten. This combined with negative data about our economy has contributed to the illiquidity in the market.
CMBS has only provided about $12 billion of debt to the market over the first six months of this year with little in the pipeline for the remainder of the year. At the same time last year, the CMBS market provided $137 billion and ended the year at $224 billion. In other words, 2008 may end with only 5 percent of the volume provided to the commercial real estate industry in 2007 by the CMBS market.
So what types of lenders have filled this CMBS void? So far, it has been commercial banks and life insurance companies. But there is continued concern that the banks are under tremendous pressure and may be pulling back soon. For example, it is estimated that commercial banks have written down less than 1 percent of their residential and land assets as bad debt. Some experts predict this could increase by as much as 26 percent over the next five years.