DENVER — Bill Hoffman’s business goes up as the performance of commercial real estate loans goes down. With more than $1.4 trillion in commercial real estate loans slated to mature between 2012 and 2015 and many borrowers still underwater, the CEO of Trigild, a San Diego-based distressed real estate, loan recovery and receivership specialist, fully expects his business to continue thriving.
Unlike lenders and investors, Hoffman doesn’t lay awake at night worrying about the euro debt crisis or the ripple effects of an economic slowdown in China. “I hate to say that because we sound like an undertaker. I prefer that you think of us as an emergency doctor. You’ll never want to see us, but when you need us we’re there,” Hoffman said half-jokingly during a panel discussion Thursday morning at the National Association of Real Estate Editors (NAREE) Conference in Denver. Hosted at the historic Brown Palace Hotel downtown, the panel discussion was titled, “Commercial Real Estate: The Crash That Never Happened?”
Hoffman outlined a scenario that he believes will cause a relapse in the recovery of commercial real estate prices. If the mortgage on a property is 120 percent of the value and the loan is coming due, it is going to be extremely difficult for the borrower to raise any more equity, he said. “I think that when those $1 trillion to $1.5 trillion in loans come due, you’ve got another pile of commercial real estate that is going to be dumped onto the market. That’s going to lower the prices again.”
Prices in major U.S. markets have appreciated 37.5 percent since the January 2010 trough, according to Moody's/RCA Commercial Property Price Indices (CPPI) national all-property composite. By comparison, prices have risen 21.4 percent for properties in non-major markets.
With more than 25 million square feet of commercial and multifamily properties in its portfolio, Trigild manages more than 200 real estate assets. The company serves as receiver for many of these projects.
As maturity defaults continue to loom on the horizon, Hoffman expects that portfolio to grow. (A maturity default occurs when the borrower fails to pay the lender the balloon payment, or principal balance, when the loan expires.)
Banks not out of the woods
Bob Jacobs, chief investment officer for Denver-based The Broe Group, which owns, develops and manages commercial real estate assets, described the title of the panel session as “catchy,” but emphasized that the commercial real estate market did “crash” during the most recent downturn.
“There are a lot of former developers and real estate owners who are now much less wealthy than they used to be and have been dragged through the dirt,” said Jacobs. “There are a lot of guys who have experienced the crash, and I think there is a lot more to come.”
The banks have been slow to recognize their losses, pointed out Jacobs, because they don’t have the capital needed to absorb the losses. Meanwhile, the Federal Deposit Insurance Corp. (FDIC) has shut down hundreds of banks and entered into loss-share agreements with the acquiring banks “with basically instructions to put those assets in a drawer and don’t take them out for another five years,” explained Jacobs.
“There are a lot of hidden assets underneath the table, both in the banking system and the CMBS system. It may not be as high-profile and political as the single-family bust has been, but it’s still there,” he added.
The delinquency rate for loans held by FDIC-insured banks and thrifts 90 days or more past due decreased 0.13 percentage points to 3.44 percent in the first quarter of 2012, according to the Mortgage Bankers Association.
Marcel Arsenault, chairman and CEO of Louisville, Colorado-based Real Capital Solutions, which specializes in workouts, said the commercial real estate market is in a “false recovery” that is driven by artificially low interest rates. The 10-year Treasury yield, for example, is hovering around 1.6 percent, near a historic low. “Eventually we have to go back to norms on interest rates, which means at that point the last shoe is going to drop,” said Arsenault.
An institutional investor buying a Class A office building in San Francisco at a 5 percent cap rate today could be in for an unpleasant surprise two or three years from now when the Federal Reserve starts to raise interest rates, he explained.
Irrational exuberance over multifamily?
Valuations in the multifamily sector have been pushed to the limit, according to Jacobs of the Broe Group, with cap rates as low as 5 percent for stellar properties in select locations. Vacancies are at an all-time low in most places, driving rents sharply higher. What concerns Jacobs is that many borrowers are using floating-rate debt to achieve their desired returns. “That’s typically not a good place to be when you are borrowing short term with a long-term asset. Everything has to go right in that scenario.”
Meanwhile, developers today are willing to assume the risks associated with new construction for a 7 percent return or less, said Jacobs, compared to the historical expected norm of 10 percent to 12 percent.
Overall, there is a lot of capital chasing multifamily. “It’s being financed with short-term, floating-rate debt or long-term, government-subsidized debt in the form of Fannie Mae and Freddie Mac. I just think it’s going to be a very modest return scenario.”
Glass is three-quarters full
Despite the choppy U.S. economic recovery, Ken Riggs, chairman and president of Chicago-based Real Estate Research Corp., remarked in a later session that commercial real estate offers some of the most attractive risk-adjusted returns in the market today. “For the next five years, commercial real estate will become much more of an investment class — even for individuals.”
Case in point: Several registered, privately traded funds are targeting 401(k) investors through broker-dealers. Jones Lang LaSalle is rolling out such a fund, and ING Clarion is introducing one as well, according to Riggs. It’s a big opportunity. TIAA-CREF, a client of Real Estate Research Corp., has a 401(k) investment portfolio for real estate of $15 billion, up from $7 billion a few years ago.
— Matt Valley