The present upswing in the residential markets has been artificially induced by temporary incentives such as the First-Time Homebuyer Credit . However, human nature being what it is, once our government runs out of money for these incentives and puts an end to them, the residential housing market will go right back down and probably descend to depths even lower than it’s ever been before in the baby boomer generation. Given that we are in hock up to our ears to other countries that invested in our real estate, we all better start learning to speak Chinese if we’re going to end up working for these foreign investors and start renting from them after they buy the real estate we lose to foreclosure.
From a February 17, 2010 article in Builder magazine, an “expert” states, “With the decline in activity following the original expiration of the housing tax credit firmly behind us, we believe this data continues to support our view that housing demand continues to stabilize if not slowly reemerge” (ref. Michael Rehaut, a housing analyst with J.P. Morgan). I find Rehaut’s statement to be hilarious, like when former U. S. President Herbert Hoover boldly stated, “Prosperity is just around the corner”, right before The Great Depression when the only things just around the corner were people selling pencils and apples after losing their jobs.
As pessimistic as I am on the near-future prospects of our residential markets, I believe that our commercial real estate markets are in for a real blood bath soon. As a whole, New York City has been the economic center for the U. S. ever since the institution of our modern financial system. NYC still remains home to Wall Street, the biggest casino in the world, where fortunes are made and lost almost daily. Given the commercial credit markets and information leaked via that great equalizer, the Internet, it came as no big surprise when lenders began foreclosure proceedings last Tuesday on the $3-billion Peter Cooper Village/Stuyvesant Town , a joint venture led by Tishman Speyer Properties and Blackrock Realty that was acquired for $5.4 billion in 2006 (great timing, guys!).
On a much smaller scale, one of my mentors, Scott Lane, who is Director of Education of our local Real Estate Investors Association, the Capitol City Real Estate Investors, warned me in late 2005 that the residential mortgage brokers in our REIA were complaining that a lot of their loan programs were being eliminated. Despite Scott’s warning, I still foolishly bought some properties with those now-defunct loan programs as part of my exit strategies and now I’m sitting on a few extra houses I wish I didn’t have. The gist of this story is if small-time investors like people in our REIA knew that this problem in the credit markets was coming before it actually became a problem starting in 2006, how could the big guys like Tishman Speyer Properties and Blackrock Realty miss the mark with this given all their resources to perform due diligence? I may be wrong, but I’m guessing that pride kept them from killing the project before it got to this point. When you’re as big as them and you commit to a project, maybe their only choice was to proceed despite those early warning signs in the markets since losing face by backing out would have been worse to their investors and bond holders.
Almost all the news I see regarding commercial real estate has a pessimistic outlook. The Congressional Oversight Panel has warned that a wave of commercial real estate loan failures could threaten America's already-weakened financial system over the next few years. From a recent MarketWatch reference, “The panel, chaired by Harvard law professor Elizabeth Warren, says it remains "deeply concerned" that commercial loan losses could jeopardize the stability of many banks, particularly the nation's mid-size and smaller banks.”
So, should we be worried? Only if you bought properties like those experts at Tishman Speyer Properties before 2007. I sense a lot of opportunity in the midst of the gloom-and-doom chaos and that a whole new generation of multi-billionaires will emerge from this mess. The nouveau riche will be those bold enough to ignore negative media hype and take action to grab the equity and cash flow left behind by those left in the dust from the foreclosures and other distress. Cash is king now and if you know where to find it, then you will be part of his majesty's royal court. In my previous post, I illustrate only one way to get cash for opportunities such as this and profit from it, but it does require a very different mindset to implement strategies such as this since this is a market that has never been seen before in our lifetime.
Despite the very real possibility of an abundance of commercial loan defaults, I believe that the commercial real estate market is healthy for those who used common sense and sound investing principles up to and throughout this market downturn. As a case-in-point, stabilized commercial income properties still have healthy debt-service-coverage-ratios (DSCRs). From Dan Yeh’s commercial mortgage metrics blog post on February 18, 2010 in The Scotsman Guide, the table below shows average DSCRs for all commercial Loan Posts in 2009, segmented by major property type and region:
For multifamily income properties, lenders typically require that the DSCR be at least 1.25 nowadays. As long as a property is stabilized, the Average DSCR table shown above indicates that there is plenty of margin for error given the average DSCRs for their respective regions in the country. It appears that any distress was mainly caused by investors who depended more on appreciation rather than on sound value investing principles. There is nothing wrong with the properties themselves, but rather with the ways they were purchased and then financed. The solution appears to lie within the financing. Here, I make a key point that my mentors taught me: The money in real estate has always been in the financing, not in the actual real estate. If you can fix the financing on a distressed property, then you can solve the problem with that property.
Especially in times like now, fortune favors the bold. I think that this is the best time in our lives to grab as much of the gold as possible that the real estate gods have thrown in our paths.
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