Real Estate Recovery?

As we close out a sixth straight week of stock market gains you would be forgiven for thinking that the worst is over as the market may have anticipated the turnaround and all should be well again in six months time. Or is this just a bear market rally? There were five bear market rallies of over 20% in the middle of the depression between 1930 to 1932!

Also keep in mind that the corporate bond market had 35 defaults in March, the highest volume for a single month since the depression, and the default rate has increased from 1.5% to 7% in one year and is predicted to climb to over 14% by the end of this year.

I don't mean to sound like a pessimist, these are just facts, and I do believe we still have a lot of pain to go through before we have navigated around the corner. On the bright side, recessions have proven to make companies and individuals more innovative and can spur on entrepreneurs. They can also create greater efficiencies and therefore produce greater long term profits. For example, General Motors has not been innovative or operating efficiently for some time but it has taken a major recession to give it a call to action, but it maybe too late for GM, but not for others.

There are many opportunities created in down cycles and we must be poised to take them. We may be over the worst in the housing market, but next up is commercial real estate, and it could get ugly!

Public-Private Investment Program (PPIP)

As a follow up to my last Blog Post I have had a lot of inquiries from clients as to how the PPIP could benefit them. As it is currently structured the loans intended to be auctioned off would be in pools. Therefore it is not intended for individual investors who wish to bid on a specific individual loan. This is unfortunate as allowing for individual investors to get involved could open up a much larger market for the loans and possibly create a better market price for the selling banks.

Admittedly this could create an administrative nightmare for the Government, however once the FDIC has assessed a loan and determined how much they would be prepared to lend to the buyer of that loan, then the Government's role is complete. The FDIC will have to assess and underwrite each loan individually even if it is part of a large pool so there really is no extra work created. Once the loan has been purchased it is the buyer's responsibility to service it, which can be easily outsourced, or the buyer may wish to enter a foreclosure procedure if the loan note is in default, again the buyer's responsibility.

There is great opportunity to buy the loans if investors have the financial clout to get in on the game. Syndicates of investors could benefit by pooling their resources in order to raise enough funds to make competitive bids on the loan pools. It is not out of the question for the Government to modify this program in some way to allow for individual loans to be sold through this process, and I will keep you posted should their position change.

Commercial Real Estate, the next shoe to drop?

I will give a detailed review of the commercial real estate market in my next newsletter. The commercial market is in a coma at the moment with very little activity which does not allow for any real assessment of where market values could be. There have been some extreme example of how market values may have plummeted, like the John Hancock Tower in Boston which recently sold for $660 million including debt, down from its last sale price of $1.3 billion only three years ago, a staggering 50% drop in value.

Indications are that commercial values have fallen from between 25% to 40%, with some observers predicting further drops on the way. Large layoffs are reducing office space requirements, there have been major retail bankruptcies and store closures and industrial output has also declined dramatically, which all leads to reduced real estate needs. Some tenants are not renewing leases, or are renegotiating current leases for less rent or less space. The income statements of commercial properties are starting to feel the pain of the greater economy.

What will compound these problems is the maturity of the debt on commercial real estate, especially the Commercial Mortgage Backed Securities (CMBS) which were levered very highly. With banks reluctant to refinance debt of large real estate loans, the owners of property will be left with two options, to invest more equity or sell their property. These equity cash calls or fire sales would have a huge impact on commercial market values.

Watch for more in the next newsletter. I will look at the highly levered CMBS market and how a lot of these products are beginning to mature now and through the next three years.

Residential Housing

We have watched the housing market decline since mid 2006, probably one of the longest periods of declining prices in US history. There appears to be value in residential again and although mortgage rates are at historically low levels (even hysterically low!), the majority of mortgage applications are for refinancing and not for acquisitions. This is down to fear.

The jobless rate has been rising at a dizzying speed and people losing their jobs are not in the position to be buying their first home or trading up. Those fortunate enough to be in steady employment are bitten with the fear factor of potentially losing their job. Therefore no one who feels insecure about their long term employment prospects will venture out to buy a new home either.

What will get the housing market kicked in to gear again is consumer confidence driven by confidence in ones job security. Once the jobless rate appears to have leveled off this maybe enough to get those in steady employment to come out of their shell and recognize the value in current residential house prices. This in turn will help the construction industry recover which is a major cog in the economy. We may not be far from the tide turning on the jobless rates.