Mark Zurlini
While the residential real estate market appears to be bottoming out in the New York metropolitan area, the commercial real estate market is still lagging behind, in part because of the same disconnect between owners and lenders that dominated the residential market for so long. Commercial property owners don’t want to settle for lower prices and commercial real estate lenders are unwilling to finance overpriced properties.
In combination with the lack of liquidity, this gap means the transaction volume has diminished dramatically, especially at price points of $50 million and more and especially in certain commercial property sectors — hotels are the worst, multifamily is the best and retail and office rank somewhere in the middle. The slump in the commercial real estate market raises two questions: When will the market return? What do commercial real estate lenders do in the meantime?
In order for liquidity to return to the commercial real estate market, a couple of things have to happen. First, the banks need to start making money. Second, confidence needs to be reestablished. The TED spread — an indicator of perceived risk in the general economy — reached a historic level of 465 basis points last October, meaning that banks effectively stopped lending to one another.
At that point, the federal government’s Troubled Asset Relief Program program was introduced, resulting in a significant narrowing of the TED spread. The TARP program, one of a number of government measures adopted to address the sub-prime mortgage crisis, purchased assets and equity from financial institutions in order to strengthen the financial sector. As a result of the increased confidence in the banking industry, the TED spread has become tighter, leading to more lending among banks.
In addition, the Term Asset-Backed Securities Loan Facility program is providing direction and financial support for the disposition of toxic assets, which will eventually free up bank reserves for renewed lending. Originally set up to buy newly issued securities backing consumer and small-business loans, the program has been expanded to include older toxic assets. The problem has been pricing these securities, but the participation of private investors is expected to help create market prices.
With the restoration of profitability and confidence, liquidity can be expected to return to the commercial real estate market during the next 18 months. Moving forward, commercial real estate lenders can expect to see increased competition, which will result in a fight for business that will create an improved climate for borrowers. However, it will take at least a year for current trends to start turning around.
One side effect of the troubled economy has been an increased demand for asset managers as banks, private equity firms and other owners of distressed properties seek out experienced managers. The role of the asset manager is important at any time, but is especially critical in an economy in which the failure to properly manage assets can spell the difference between survival and failure. The primary function of the asset manager is to insure that the properties under management — whether large commercial asset portfolios or small multifamily projects — achieve a rate of cash flow and a level of performance that equal or exceed the expectations of the property owners. He or she occupies a delicate position between the property owner and such aspects of property management as tenant relations, budgeting, operating expense analysis and control, insurance and real estate tax reviews, capital improvements, environmental conditions, energy management programs, lease analysis, debt analysis and market awareness.
The manager determines the most cost-efficient ways to increase profitability based on these various aspects. While the asset manager should be knowledgeable about all related professional disciplines, the emphasis should be on the ability to monitor and coordinate these activities. The asset manager should have strong data management systems, a competent in-house support staff, a competent group of outside professionals, strong cash management and billing systems and a strong market presence.
With each property presenting different issues and opportunities, a major factor in successful asset management is creativity. The asset manager should have the experience to anticipate and deal with complex situations, especially in a troubled economy. The manager, as well as the process, should also be able to adjust to constantly changing market conditions. Throughout the process, the manager should be able to foresee and plan for the big picture, as well as be knowledgeable about day-to-day operations.
We have never experienced a contraction as violent as this before. In prior periods of financial meltdown, we did not witness long lists of financial giants closing or being taken over. And the chances are strong that the situation is going to get worse before it gets better.
The model that produced these and other institutions is broken. A new business model and an environment characterized by greater transparency and oversight needs to be created in order for commercial real estate lenders to survive. In the meantime, financial institutions should ensure they have experienced asset managers on hand to preserve or enhance the value of their properties and to achieve maximum cash flow and profitability.
As the meltdown in the commercial real estate market deepens, financial institutions will need to stay as healthy as possible in order to take advantage of the new opportunities and to emerge as survivors of the current crisis in commercial real estate.
— Mark Zurlini is a principle at Palisades Financial responsible for underwriting, performing due diligence and overseeing asset management operations.