CRE Midwest

A Tale of Two Recoveries

Expectations for a modest recovery in the Capital Markets in 2011 have been “spot on” as the activity of the second half of 2010 was pivotal and has continued led into the first quarter of 2011. A continuation of the “cleansing” of distress assets has resulted in greater velocity in the debt markets, albeit still rather slow and steady compared to the past.

By Ed Wlodarczyk

Senior Vice President-UGL Services Capital Market Services

Expectations for a modest recovery in the Capital Markets in 2011 have been “spot on” as the activity of the second half of 2010 was pivotal and has continued led into the first quarter of 2011. A continuation of the “cleansing” of distress assets has resulted in greater velocity in the debt markets, albeit still rather slow and steady compared to the past. Significant increases in lending activity have been seen with life companies and large commercial banks. Additionally, more CMBS issuances have resulted in revised volume estimates for 2011 ranging now from $30 to $50 billion.

Institutional investors have started to improve their forecasts for the future of commercial real estate and have initiated new allocations for 2011 in commercial real estate investments. Private Equity funds full with capital have started to spend and will continue their spending ways throughout 2011. Many are back or soon will be back “on the street” raising more money for the next generation fund as bid/ask spreads for their prospective acquisitions narrow.

Low interest rates and a continued “soft” prediction from the Fed on future rate hikes through 2012 have speared on a resurgence of investment in all asset classes. Overall, core property values have adjusted within a range of 15-30% from their lows based on region and asset class.

Ok this sounds great so what’s the catch?

Simple, the new world order is described in a few words. The Haves- Assets that are Core, Mission Critical, Having Good Fundamentals and a Stable Sponsor, that are located in Gateway Markets with Positive Cash Flow and Good Long Term Tenancy.

Several billion dollars of investor capital is now chasing investment grade tenanted assets with a minimum lease term of 15 years, where the asset is described as critical to running the tenants’ business (such as the firms headquarters or key manufacturing or research and development facility) and will survive a bankruptcy reorganization filing should one occur. Additionally, the asset should be located in a major metro or secondary market that is a critical driver for the satisfactory performance of tenants existing and future business plans.

Assets of this caliber have been and will continue to fetch high investor interest which will result in greater valuations. Lenders are also hungry for these types of assets and their pricing will reflect that appetite accordingly.

So what happens to the “The Have Nots”?

Specialty type assets such as golf courses, ice rinks, busted development deals; or those non core lower grade types that lack the location or technological improvements or the quality of tenants that usually do not sign long term leases.

One of the biggest challenges over the last 3 years has been dealing with the “pretend to extend” mentality of lenders. Opportunistic buyers have been deeply disappointed with this logic. The biggest fear in the market is that banks will begin to foreclose at a brisk pace which will begin a downward spiral effect on the capital markets.

Unfortunately, this is and will be the case for “the have nots” through the remainder of 2011 and well into the future. This will include many of the legacy CMBS issuances which are maturing through 2015.

Refinancing non core assets will be very difficult without an infusion of additional or new equity from the borrower. Short term “bridge” or “mezzanine” options may have to be considered but those usually will come with a high price tag. Lenders of these types of notes will require double digit rates, usually in the mid teens all in. Given the current CMBS issuance predictions the market is still way behind the $100 billion per year needed to clear the legacy loans.

There is definitely a yield premium available for these types of assets located in secondary and tertiary markets; however, liquidity still remains very challenging. Valuation may also be effected, as well, since most owners of troubled or under water assets do not have the ability to mitigate current or future maintenance or capital issues the asset requires.

So how do we fix this?

The largest seller pool driving the most sale velocity that will take place in the next few years will be lenders, banks and special servicers. Market momentum will help in the future, as more of both groups trade which will enable financing requirements to continue to ease.

The best advice is to begin an early dialogue with the lender and/or special servicer. Hire a professional that can work through the multiple of layers and processes in an effort to start developing alternatives to a workout process.