Interesting Times

STRATEGY ON LEASE CONCESSIONS

Lebovitz said that CBL has been signing more leases at shorter terms (three years or less) than usual.

"We’ve done shorter terms so we’re not locked in at the lower rates," said Lebovitz. As a trade-off for agreeing to shorter terms and lower rental rates, Lebovitz said that CBL has a checklist of items they might negotiate to make the lease a win-win for both parties, including improving the percentage rent and the breakpoint. When retailers' sales improve, CBL's chance to sign leases at higher rents will improve. Additionally, "As sales pick up, then we’ll benefit from percentage rent as well," he said.

At Regency, Stein explained that the tables seem to be turning again in terms of what retailers are willing to give up in order to get lease concessions.

"In the past, whenever we were giving concessions to the retailers, we always got termination rights and we held those concessions to very short terms. Now, the retailers appear to not be willing to enter into those kind of lease modifications because they don’t want the risk of losing the store. They are looking more long-term," he said.

Stein added, "They’ve survived this long; which means they’ve got a loyal customer base and they don’t want to risk that. And frankly, we are seeing a lot of people talking about how they are not able to get any TIs at other centers and the lenders aren't keeping up the centers. So there is not only reluctance not to leave, but we’re getting a fair share of people wanting to move into our centers because they know we take care of them."

Since demand has improved somewhat, so has retailers' requirement for tenant improvement allowances, said Lukes at Kimco. "TIs have definitely pulled in a lot from six to eight months ago. Where that might be different is if the building is very old and needs to have a lot of work done to it," he said.

At Inland, Scott Carr, president of property management, said when it comes to expectations for tenant improvement allowances, he hasn't seen a significant change in what national tenants request, but small shop tenants are requesting landlord participation more than in the past.

RENT RELIEF REQUESTS

Zalatoris said that Inland has seen the amount of rent relief requests decrease significantly, but added that smaller, "Mom 'n Pop" tenants remain under pressure. CFO Brett Brown added, "We’ve definitely seen a slowdown in the requests and we've always taken the aggressive posture in responding to them. With our Mom and Pop tenants, the ultimate price that we extract is a right to recapture their space. That's a tough decision for someone who has a successful business that just needs to carry them through. We’re finding a lot of those Mom 'n Pop retailers seeing the light at the end of the tunnel and even backing off with some requests when we put them to that ultimate test."

"When a struggling small shop tenant's prospect for success appears limited, and given the decline in the formation of new small shop startup retailers, we often look to competing centers for replacement tenants," in dealing with such situations, said Zalatoris.

Michael Sullivan, SVP of asset management for Ramco said rent relief requests have gone "down to a trickle."

"Requests for rent relief are down substantially," said Coppola. "A year ago at this time, I think while nobody knew exactly where the failures were going to come, people were relatively convinced that they were coming. The profitability of retailers overall in our portfolio has dramatically improved [in comparison to] one year ago today, so our anticipation is that rent relief requests are going to be way down and unexpected failures will also be down from what they were last year."

WHERE IS MARKET RENT?

In addressing whether or not "market rent" has bottomed out yet, Stein at Regency said, "In most markets, it has bottomed. Obviously a lot of the rents that are out there have to reset to the new market, but it has bottomed. There are exceptions for that -- I don’t think we’ve seen it in the deserts; but I think pretty much everywhere else, we feel bottomed and that the retailers would tell you that they’ve hit bottom."

At Inland, Carr said, "I would say we are closing in on a bottom, because we’ve dropped pretty far," adding that 10% to 50% drops have been observed, depending on the sub-market and spaces involved. He thinks the bottom has definitely been reached on small shop rents. "Retailers realize that they can only go so low if they are going to have a viable landlord that can participate in a deal in terms of building out space and TIs," said Carr. In looking ahead, Carr said that opportunities to push rents on renewals and new leases are just starting to peak through, but overall, we should not expect the trajectory of rents trending up to happen even nearly as fast as the trajectory coming down has been.

UPTICK IN LEASING ACTIVITY

Kimco said that fourth quarter 2009 brought a "large uptick" in small shop leasing activity, and while rents were "wildly divergent" depending on the characteristics of their respective markets, in aggregate, new leases signed were still slightly higher than the previous tenant in the space.

Demand has also improved for junior anchor space, said David Henry, president and CEO at Kimco. "A lot of retailers are now submitting Letters of Intent on junior anchor spaces that four or five months ago had no activity, but I certainly wouldn’t expect the rent spread on the junior anchors to improve" soon, he said.

Inland said it is seeing an improvement in leasing activity. "The leasing velocity we are now experiencing and the quality of tenants with whom we are dealing, indicates that we are building a strong foundation for restoring occupancy and growing rental income within the portfolio," said Zalatoris.

Arthur Coppola at Macerich said while his firm isn't banking on it, he is hopeful that the recent increase in retailer interest will lead to an improvement in occupancy and rents spreads this year.

LOOKING AHEAD

At CBL, Lebovitz said that during 2009, retailers definitely had the upper hand in negotiations, but "as the economy improves, we will be able to get back to where we were, or even better with the retailers." Additionally, the lack of any new development puts landlords in a better position going forward, especially those that have made improvements to their shopping centers during this recession. That being said, Lebovitz does not believe rent spreads will improve dramatically this year, as the priority remains signing leases and improving occupancy.

Smith at Regency said, "Retailers are still struggling. Tenant failures and move outs remain a concern and pressure on rents is expected to continue until occupancy rates return to levels previously seen. This is particularly true in 'green' areas where [population] densities are light."

At Simon Property Group, David Simon said, "Part of what we’ll suffer for in 2010 is the deals we did in 2009. When we did them, the retailer was feeling a lot worse about things than they are today," said Simon. However, retailers remain intensely focused on expenses and rents and continue to close stores. "2009 was a challenging year in the retail real estate world and 2010 is going to be a challenging year, too," he added.

Addressing when he expects rent spreads to return to historical norms, "I don’t think we can get to historical numbers until there’s a stronger economy and stronger demand from retailers," said David Simon, adding that we're not in that environment yet. On the heels of this comment, Richard Sokolov added, "sales, cash flow and profitability have been substantially better for retailers," so that will work in landlord's benefit for negotiations in 2010, he said.

Looking ahead this year, Zalatoris at Inland said, "While showing signs of the improvement, the operating environment for retailers still remains challenging. We expect additional re-entrenchment in certain retail segments this year and potentially some national chain failures as well."

At CBL, Lebovitz said, "As retailers reformulated their business plans in 2009 to focus on controlling inventory levels and reducing cost, they reported improving margins and better profit ability. Despite the negative sales comps today, many of these retailers are better able to [manage] current occupancy cost, which goes well for the easing of the rent pressure, as we progress through 2010."

Sasha M Pardy, CoStar Group, 2-23-10

- Janet L Yellen, President and CEO, Federal Reserve Bank of
San Francisco, 2-22-2010

Given the dismal economic news we faced for so long, it’s a great relief for me to report that the tide appears to have turned. We are seeing convincing evidence that an economic recovery is well under way. Still, as I’ll explain in greater detail in a few minutes, the fact that the economy is growing again doesn’t mean we’re where we ought to be. Far from it. In particular, the unemployment rate is unacceptably high, creating real hardship for millions of Americans. But, at least we’re heading in the right direction.

Let me start with the good news. Real gross domestic product, or GDP, the broadest measure of a country’s total output, has turned around impressively. It rose at a robust 5.7 percent annual rate in the fourth quarter of 2009. That’s a very welcome change from the huge declines we saw during the recession. In fact, it’s the best gain in GDP we’ve seen in six years. If we were able to sustain growth like this, we would experience a vibrant V-shaped upswing like those that occurred following past severe recessions.

Unfortunately, I’m not at all convinced that a V-shaped recovery is in the cards. That fourth-quarter leap in GDP overstates the underlying momentum of the economy. Much of it was due to a slowdown in the pace at which businesses were drawing down inventory stocks compared with earlier in the year. Less than half of the fourth-quarter growth reflected higher sales to customers. Those sales did grow, but at a lackluster 2.2 percent. It appears that businesses are getting their inventories closer in line with sales, which is a good thing. But such inventory adjustments can be a potent source of growth only for a few quarters. I’d feel much more confident about the prospect for a sustained robust recovery if I saw evidence of more vigorous growth in actual sales.

On that front, the most recent data show consumers releasing somewhat their tight grips on their wallets. But that doesn’t mean that people have thrown caution to the wind and returned to their spendthrift ways. Indeed, my business contacts tell me the consumer mindset is still in a fragile state. Clearly, the big weight hanging over everyone’s heads is jobs. The current high level of unemployment is severely restraining income and undermining confidence as people worry whether they will have a paycheck in the months ahead. Even those with secure jobs may worry about their finances since debt burdens were near historic highs at the onset of the financial crisis and, since then, equity and house prices have declined sharply. At this point, households are actually paying down debt, a development that partly reflects the reluctance of banks to lend to households with battered balance sheets.

The housing sector appears to have stabilized, but here too I don’t see any signs of a sharp turnaround. New home sales and construction finally stopped falling last year and have been reasonably stable, albeit at very low levels, for several months. Existing home sales surged late last year in response to the homebuyer tax credit. But, the credit expires this spring, so this source of support won’t be around much longer. The housing sector has also been benefiting from the Fed’s policy of buying mortgage-backed securities. These purchases appear to have helped keep home finance rates low. But, the Fed is now in the process of tapering off these purchases and plans to stop them at the end of March. As support from Federal Reserve and other government programs phases out, there is a risk that the housing market could weaken again.

If the consumer and housing sectors aren’t up to the task of delivering a V-shaped recovery, can business investment spending do it? It’s true that, in past recoveries, business investment typically grew rapidly once the economy turned the corner. And, in the current recession, businesses sharply curtailed capital expenditures, so they will eventually need to rebuild capacity and replace old equipment. In fact, we have already seen a rebound in business spending on equipment and software, and recent indicators for this type of spending point to solid growth.

Arguing against too much optimism, however, is that businesses remain very nervous and exceedingly cost conscious. One of my contacts referred to a “scarring effect” in the wake of the recession that has left businesses focused on survival and leery of investing. Many businesspeople say they are concentrating instead on process improvements, keeping supply chains lean, waiting for purchase orders before they produce, and meeting increases in demand with higher productivity from their existing workforces. True, they are beginning to plan with greater confidence. But the watchword remains caution.

Even for those businesses ready to expand—especially smaller ones—financing remains an impediment. Credit is becoming more available, but terms such as collateral requirements can be onerous. What’s more, the crisis made businesses keenly aware that they can’t count on being able to get credit. Some of my contacts say they plan to keep more cash on hand, rather than investing it, as protection against a renewed credit crunch.

Meanwhile, commercial real estate remains a bleak spot and investment in nonresidential structures is likely to stay depressed for some time. The recession drove up vacancy rates for office, retail, warehouse, and other income-producing properties, severely reducing demand for new buildings. In addition, credit is tight. Lenders and investors are demanding extra compensation for risk, driving up commercial real estate financing rates compared with pre-recession levels. And the market for commercial mortgage-backed securities remains distressed, despite support from the Fed’s Term Asset-Backed Securities Loan Facility, or TALF. So, I just don’t see this sector contributing to growth for quite some time.2

Put it all together and you have a recipe for a moderate rate of economic growth, well below the spritely pace set in the fourth quarter. The current quarter appears on course to post growth of around 3 percent. I see the economy gradually picking up steam over the remainder of this year as households and businesses regain confidence, financial conditions improve, and banks increase the supply of credit. I expect growth of about 3½ percent for the year as a whole, picking up to about 4½ percent next year, with private demand coming on line to pick up the slack as government stimulus programs fade away.

In addition to some of the weak spots I already mentioned, a number of other factors are holding back recovery. First, even though the banking and financial systems are gaining strength, they still bear wounds from the financial crisis, and these will take a long time to fully heal. Second, losses on mortgages, commercial real estate credits, and other loans continue to mount, and the full weight of foreclosures and bank failures on the economy has yet to be felt. Finally, the Fed, as well as central banks in other countries, has faced limits in the amount of monetary stimulus we have been able to generate. That’s because we can’t push interest rates below the near-zero level where they’ve been for more than a year. To be sure, we’ve developed many innovative programs to make credit cheaper and more readily available. But, all in all, monetary policy can’t give the same kick to the economy that it delivered in past recoveries.

Earlier I noted that, even though the recession appears to be over, it does not mean that we are where we want to be. Even with my moderate growth forecast, the economy will be operating well below its potential for several years. Economists think in terms of what we call the “output gap,” which measures the difference between the actual level of GDP and the level where GDP would be if the economy were operating at full employment. The output gap was around negative 6 percent in the fourth quarter of 2009, based on Congressional Budget Office estimates. That’s a very big number and it means the U.S. economy was producing 6 percent less than it could have had we been at full employment. That’s equivalent to more than $900 billion of lost output per year, or roughly $3,000 per person.

I’m afraid that the economy will continue to operate well below its potential throughout this year and next. Let me do a little math for you. The San Francisco Fed estimates that the potential level of output is increasing roughly 2½ percent a year due to growth in the labor force and increases in productivity. Hence, over the next two years, potential output will increase by about 5 percent. My forecast is that real GDP will increase about 8 percent during that period, or 3 percentage points more than potential output. This implies that the output gap will shrink from its current level of negative 6 percent to around negative 3 percent by the end of 2011. In fact, I don’t expect the output gap to completely vanish until sometime in 2013.

This brings us to a subject that is of paramount concern to all of us—the job situation. This recession has been very severe, indeed. The U.S. economy has shed 8.4 million jobs since December 2007. That’s more than a 6 percent drop in payrolls, the largest percentage point decline since the demobilization following World War II. The unemployment rate, which was 5 percent at the start of the recession, rose to around 10 percent in late 2009. The rates of job openings and hiring are also stuck at very low levels. These statistics represent a tragedy for our country, our communities, and each of the families and individuals who have had to cope with a loss of livelihood.

There is a glimmer of good news on the employment front. The pace of job losses has slowed dramatically and some indicators, such as gains in temporary jobs, suggest that we may be close to a turnaround in the labor market. I was encouraged to see the unemployment rate drop from 10 percent to 9.7 percent in January. Nonetheless, given my forecast of moderate growth and a shrinking, but still sizable, output gap, I expect unemployment to remain painfully high for years. The rate should edge down from its current level to about 9¼ percent by the end of this year and still be about 8 percent by the end of 2011, a far cry from full employment.

I should warn that there is a great deal of uncertainty surrounding this forecast. In the past, a given level of economic growth produced a more-or-less predictable change in the unemployment rate. Historically, a pattern emerged in which unemployment declined by half as much as the difference in the growth rates of actual and potential GDP. This is commonly referred to as “Okun’s law” after the economist Arthur Okun, who first described this relationship back in the 1960s.

Let me sketch out how this should work. In my forecast, GDP growth exceeds the growth rate of potential GDP by 1 percentage point this year and 2 percentage points next year. According to Okun’s law, the unemployment rate should fall by about one-half percentage point by the end of this year and a full percentage point during 2011. These figures are in line with my unemployment forecast.

However, Okun’s law let us down big-time in 2009. Given that GDP was stagnant last year, the unemployment rate should have gone up by about 1¼ percentage points, according to Okun’s law. In fact, it shot up 3 percentage points. Understanding what happened last year has important implications for what unemployment does in the future.

Economists have come up with a number of possible explanations for why the unemployment rate rose so much last year. The first explanation for the failure of Okun’s law is that special factors not directly related to output growth may be pushing up the unemployment rate. One possibility is that the severe recession is fundamentally altering the labor market, shifting jobs away from such sectors as manufacturing, real estate, and finance to other sectors. This reallocation takes time. Until it is complete, we will see higher levels of unemployment. A second possibility is that extended unemployment benefits are artificially boosting reported unemployment rates because workers who collect unemployment checks may be saying they are looking for work even if they have given up. In the past, such people might not have said they were searching for jobs and would no longer have been considered part of the labor force and counted in the official unemployment statistics.

Still, there is little evidence that structural shifts in the labor market or extended unemployment benefits have had large effects on the unemployment rate. Take the unemployment benefits explanation. If true, we would expect to see a large increase in the labor force participation rate, that is, the percentage of people who are working or saying they are looking for work. In fact, currently, the labor force participation rate does not appear to be unusually high.

A second possible explanation is that last year’s enormous decline in employment was somehow an aberration. GDP was basically unchanged over the four quarters of 2009. But payroll employment fell by 4 percent over the same period. In other words, the economy produced roughly the same quantity of goods and services with 4 percent fewer workers, which translates into a 4 percent increase in output per worker. That’s a huge rate of productivity growth, well above estimates of the long-term trend in productivity gains that stem from such factors as improved technology. So, if we ask where Okun’s law went astray, we can see the fingerprints of this unusual pattern of employment and productivity last year. But that’s not the end of the mystery. What would cause employment to dive and productivity to soar during such a severe recession? And is it a temporary or permanent phenomenon?

Those who believe it’s temporary point to the unusual nature of this terrible financial crisis and recession. Its severity made employers believe that it would be a long time, if ever, before they would need as many workers as they previously had. The credit crunch may also have caused some to fear that they wouldn’t be able to borrow in order to meet their payrolls. These factors prompted employers to break from the normal cyclical pattern in which workers are laid off relatively slowly and some are kept in reserve in case demand picks up. In this scenario, workforces have been cut to the bone and perhaps beyond. Businesses were able to continue to produce the same level of output despite big cuts in their workforces by working their employees harder. But that can only go so far. If demand continues to increase and businesses become more confident, they will eventually begin hiring again. If so, productivity growth will slow and the unemployment rate will fall faster than usual, reversing its unusual rise last year.

There is an alternative explanation regarding the events of last year though that bodes poorly for rapid employment gains going forward. According to this view, last year’s large increase in productivity is here to stay. In that case, we won’t see a quick drop in unemployment and may be in for a jobless recovery akin to those in the early 1990s and early 2000s. This is closer to my view and broadly consistent with my forecast.

According to this perspective, the recession has forced businesses to reexamine just about everything they do with an eye toward restraining costs and boosting efficiency. Strapped by tight credit and plummeting sales, businesses have overhauled the way they manage supply chains, inventory, production practices, and staffing. Stores don’t order merchandise unless they think they can sell it right away. Manufacturers and builders don’t produce unless they have buyers lined up. My business contacts describe this as a paradigm shift and they believe it’s permanent. This process of implementing new efficiency gains may have only begun and we may be in store for further efficiency improvements and high productivity growth for some time. If so, the rate of job creation will be frustratingly slow.

I’d like to bring this discussion home now by talking a little about San Diego. Obviously, the area economy was hit hard during the recession, but it does seem to have weathered the storm better than many areas of California. And, significantly, the San Diego area has shown signs of a job market turnaround in recent months. Employment grew notably in October and the gains were largely maintained in November and December. To be sure, San Diego still has far to go. The unemployment rate was significantly above the national average in December, the most recent data we have.

San Diego is among the nation’s leading biotechnology centers and this industry has been a bright spot. Biotech accounts for about two-and-a-half times as great a share of employment and income here as it does nationwide. Biotech wasn’t entirely immune—if I may use that word—to the recession. But demand for medical services continued to expand and that supported the industry. It appears that local biotech employment has largely held up during the past two years. Makers of pharmaceuticals, medical equipment manufacturers, and providers of research and development services even registered significant employment gains. Moreover, growth should continue. After bottoming out in early 2009, venture capital spending has risen substantially, with an important share going to biotech.

The local housing market appears to be improving as well. Fortunately, San Diego never saw as big a subprime mortgage boom as Nevada, Arizona, and some other places in California. Nevertheless, home foreclosures have surged in the San Diego area, rising from under 1 percent in the fall of 2007 to slightly over 3 percent of existing mortgages in December of last year. The trend, though, may be heading in the right direction. Foreclosures declined slightly in San Diego in December, even as they continued to rise nationwide.

Overall, the San Diego economy will likely recover along with the national economy. At the same time, I would not be too surprised to see the recovery take hold here with a bit more vigor than in the nation as a whole for the reasons I mentioned a moment ago.

Let me move on to the outlook for inflation nationwide. You can get into quite a debate on this topic. Some people worry that sustained federal budget deficits and the huge increase in the Federal Reserve’s lending and stimulus programs could eventually lead to high inflation. Others take the opposite view, arguing that economic slack and downward pressure on wages and prices are pushing inflation down. I would put myself squarely in the second camp.

I’m no fan of persistently large budget deficits. I’ve warned against them throughout my career. But the real danger I see from them is not inflation. Rather, they may be harmful once the economy recovers because they are apt to boost interest rates and absorb private savings that would otherwise finance productive investments. This is potentially a serious problem in the long term that could reduce investment and lower living standards, although, in the short run, federal deficits have cushioned the blow from the financial crisis and recession. As far as inflation is concerned, there’s no evidence that big government deficits cause high inflation in advanced economies with independent central banks, such as the Fed. Japan is a case in point. Japan has run enormous fiscal deficits for many years and its government debt has risen to very high levels. Yet is has suffered from persistent deflation, not inflation.

I believe that the more worrisome challenge for price stability over the next few years stems primarily from the sizable amount of slack in the economy. Whether measured by the output gap, the unemployment rate, the manufacturing capacity utilization rate, or whichever measure you like, the economy is running well below its potential. As a result, inflation is already very low and trending downward. Over the past 12 months, the personal consumption price index, excluding volatile food and energy prices, rose a modest 1.5 percent. This increase in core inflation was below the 2 percent rate that I and most of my fellow Fed policymakers on the Federal Open Market Committee (FOMC) consider an appropriate long-term price stability objective. And, with slack likely to persist for years and wages barely rising, it seems quite possible that core inflation will move even lower this year and next.

So where does all this leave Federal Reserve policy? Traditionally, the main tool of Fed monetary policy is the federal funds rate, which is what banks charge each other for overnight loans. The Fed controls that rate by varying the amount of reserves it supplies to the banking system and we have pushed that rate to zero for all practical purposes. This is as low as it can go. Such accommodative policy is appropriate, in my view, because the economy is operating well below its potential and inflation is undesirably low. I believe this is not the time to be removing monetary stimulus. Consistent with that view, the FOMC has repeatedly stated that it expects low interest rates to continue for an extended period.

Of course, in response to financial and economic emergency, the Fed has done a lot more than simply lower the federal funds rate. It has provided secured loans to banks and other financial institutions to make sure key credit markets were functioning. It is also in the last stages of purchasing $1.25 trillion dollars of mortgage-backed securities guaranteed by agencies such as Fannie Mae and Freddie Mac, and $175 billion of the direct debt of these agencies. These programs were vital in preventing a complete financial breakdown, which would have done immeasurable damage to our society.

As financial and economic conditions improve, the need for such extraordinary support diminishes. Accordingly, the Fed has begun to phase out its emergency lending programs. Special lending programs for primary dealers in the Treasury securities market, for money market mutual funds, and for corporate short-term debt have already been ended. So too have we shut down special arrangements to make dollars available to foreign central banks. The Term Auction Facility (TAF) and the TALF, which respectively supported financial institutions and credit markets, will be largely closed next month.3 Finally, the Federal Reserve has readjusted the terms of its loans to banks and thrifts—so-called discount window lending. During the financial crisis, we encouraged depository institutions to borrow from us when they needed cash to meet essential obligations. Now that financial markets are functioning more normally, banks can meet their usual funding needs by tapping private markets.

As we carried out our emergency lending programs and eased monetary policy in response to the recession, our balance sheet swelled from roughly $800 billion to its current level of over $2.2 trillion. Despite the reduction in our lending programs, our balance sheet remains, for want of a better word, enormous, owing to our holdings of mortgage-backed securities and agency debt. Now I just said this is not the time to be tightening monetary policy. But eventually the economy will gain enough momentum and won’t need today’s extraordinarily low interest rates. When that time comes, we will begin to tighten policy and remove monetary stimulus. And when we start doing so, we will face some technical issues due to the size of the balance sheet, as Chairman Bernanke noted in recent Congressional testimony.4 Let me briefly outline our strategy.

In normal times, the Fed raises interest rates by reducing the size of its balance sheet, say by selling Treasury securities to the public. This draws in cash from the economy, or, as we say, reduces the supply of bank reserves, which in turn causes the price of those reserves, that is, the federal funds rate, to go up. Since the fed funds rate is the benchmark for banks’ cost of money, other short-term market interest rates tend to follow suit. Higher interest rates in turn help slow the economy and reduce inflationary pressures.

But these aren’t normal times. Our securities purchases have caused the quantity of reserves in the banking system to swell to something like $1 trillion—far above the pre-crisis level of around $50 billion. If we were to follow our standard approach of selling securities to raise interest rates, we would have to sell off many hundreds of billions of dollars of securities to reduce the supply of reserves enough to have any chance of pushing rates higher.

The problem with doing that is that such massive sales of mortgage-related and Treasury securities could be disruptive to markets and cause mortgage interest rates and other long-term rates to shoot up when we are still in the early stages of the recovery and the financial system, although improving, is still not at full health.

There is an alternative. To push up short-term interest rates without selling off our securities holdings, we can instead raise the interest rate that we pay on reserves held at the Fed. Because banks would have the opportunity to collect a higher reward for keeping funds on deposit at the Fed, they would demand commensurately higher returns on the overnight loans that they make in the federal funds market. So an increase in the interest rate paid on reserves would raise the fed funds rate and tighten financial conditions more generally. The ability to pay interest on the excess reserves that banks deposit with the Fed is an important new tool that Congress gave us just over a year ago. It will play a lead role when the time ultimately comes to tighten monetary policy. And, to make sure this works smoothly, we have developed some technical tools that can help keep the federal funds rate near our preferred target.5 Eventually, after economic conditions have improved and a policy tightening has begun, we may then start a gradual process of selling securities in order to help return the Fed’s balance sheet to its pre-crisis levels.

The bottom line is that we are already unwinding the emergency programs we set up during the financial crisis. When the day comes to start raising rates again, we have tools at the ready. But, for the time being, the economy still needs the support of extraordinarily low rates.

RBC Capital Markets, along with Retail Lease Trac, have updated their research on retailer planned store openings and found that the tide may be beginning to turn when it comes to retailer demand. For the first time in more than a year, the number of planned openings in the next 24 months has increased.

The research shows that the approximately 2,000 retailers the firms are tracking plan to open 65,464 stores during the next 24 months. That’s down from a high of 71,940 that the firms said they planned to open in October 2008, but up 1.6 percent from the figure the firms calculated in December 2009.

Click for larger image.

The firm planning the greatest number of openings in the next 24 months remains Quiznos. The other top 25 expanding retailers can be viewed in the accompanying chart. (Of note, the study does not include every chain. For example, Wal-Mart, Target and Macy’s are not included in the figures.)

According to the report, “While still early in the recovery, the general sense from the landlords is that retailers have, for the most part, successfully navigated the dangerous economic environment and are now more willing to discuss expansion plans. Some landlords have even suggested that there is a renewed sense of urgency with regard to retailers hoping to capture the best locations before their competitors do. With retail bankruptcies so far tracking at a very light level for the first month of the [first quarter] bankruptcy season, retailers could quickly find increased competition for quality locations while landlords begin to regain some of the pricing power lost over the past 18 months. While we expect the road to economic recovery to be long and bumpy, these early results are encouraging.”

–David Bodamer, Retail Traffic, 2-22-2010

Even as banking regulators and politicians deal with the fallout from the collapse of commercial real estate values and the subsequent impact on the banking systems, it appears that an increasing number of lenders are more inclined to jump back into the sector.

Total renewals of existing commercial real estate accounts increased 57% from November to December of last year, according to numbers released this week by the U.S. Department of Treasury. Treasury completes a monthly tally of lending activity of the nation's 20 largest bank, which control 57% of all U.S. banking assets.

While seasonality contributed to the increase -- as year-end is an active time for renewals -- new lending also more doubled in December from the previous month. Total new commercial real estate commitments increased 157%. That was the first increase in four months.

Citigroup's new CRE lending increased eightfold in December to $294.4 million. Loan renewals more than doubled to $282.3 million, reflecting an increase in capital?raising activities by real estate investment trusts, Citigroup said.

Even with new and renewals increasing, the big banks also increased their disposal of CRE assets on their books. Citigroup noted, for example, that its average total CRE loan and lease balances totaled $22.8 billion at the end of December, 3% lower than it was in November. The outstanding balance of CRE loans of all respondents fell 1% in December, and the median change in outstanding balances was a decrease of 1%.

Fifth Third Bancorp's average CRE balances decreased by approximately 1.3% in December compared to November. New CRE commitments originated in December 2009 were $196 million, which was up almost 50% from $132 million in November 2009. Renewal levels for existing accounts increased significantly in December 2009 to $1.2 billion versus November 2009 at $471 million due to normal year-end seasonal trends.

Even though Fifth Third's combined originations and renewals were higher in December than November, payments and dispositions of troubled CRE outpaced the higher levels of activity causing the overall balances to continue to decline. As commercial vacancy rates continue to rise, Fifth Third said it continues to monitor the CRE portfolios and continues to suspend lending on new non?owner occupied properties and on new homebuilder and developer projects in order to manage existing portfolio positions.

"We feel this is prudent given that we do not believe added exposure in those sectors is warranted given our expectations for continued elevated loss trends in the performance of those portfolios," Fifth Third reported.

Other Banks Follow Lead

What is happening among the majors also seems to be the route other banks say they will be more willing to take this year. According to findings from Jones Lang LaSalle's annual 2010 Lenders' Production Expectations Survey, bankers are predicting that loan production will increase this year.

The number of respondents that said they expect their loan production to range from $2 billion to $4 billion in 2010 doubled from last year to 43%. Showing even more future optimism, nearly 70% of respondents said their loan production will ramp up to $2 billion to 4 billion in 2011. In another encouraging metric, the number of lenders that expect to lend more than $4 billion jumped up 6% from 9.3% in 2009 to 15.2% in 2010.

"Lenders we spoke with say they'll be giving borrowers 24+ month extensions in order to avoid foreclosure on high quality, well-located assets," said Bart Steinfeld, Jones Lang LaSalle's managing director of the real estate investment banking practice. "With more than $1 trillion worth of commercial real estate loans expected to mature between now and 2013, it's no surprise that a majority of borrowers are placing significant importance on restructuring those loans. However, many financial institutions don't want to hold on to assets and now are coming to terms with the fact that they can no longer 'extend and pretend.' They're now realizing it makes good sense to move these assets off their balance sheets to create greater ability to originate loans this year."

The number of lenders willing to lend greater sums toward single-asset acquisitions is also shifting. In 2009, the majority of respondents indicated they would lend only $10 to 25 million on a single asset acquisition. In 2010, the greatest percentage of respondents was split evenly at 28% each among those willing to lend $50 million to $100 million and $100+ million (hence 56% will lend $50 million and more for single-asset purchases). In 2011, the number of lenders willing to lend $50 to $100+ million rises by 8% to 64% of respondents.

"A few life companies and investment banks we spoke with indicated that they're willing to lend $150 [million] to $500 million on large, single-asset acquisitions in 2010," said David Hendrickson, managing director of Jones Lang LaSalle's real estate investment banking practice.

Approaching maturities will continue to share the stage in 2010, with more than 67% of life company respondents acknowledging 40% to 60% of their portfolios will be allocated to the refinancing of maturing loans.

While liquidity within the capital markets is expected to turn from a trickle to a slow-but-steady flow in 2010, borrowers can expect the same tightened underwriting standards they experienced from life company lenders in 2009.

Loan to value ratios in 2010 will fall predominantly in the 50% to 70% range, according to more than 74% of life company respondents, and that number is expected to remain steady in 2011.

As for new conventional commercial real estate loans in 2010, 59% say most loan terms will range five years or greater, with an additional 28% indicating a preference for three to five year terms.

As for the sectors that lenders would most prefer to lend, a majority of respondents (27%) said they would single out multifamily for their loan dollars, while another 21% said they would focus on the office sector in 2010. The hotel sector stood out as the sector to which lenders are least likely to lend.

There was a significant increase in the number of lenders who said they are selling performing and non-performing loans. In addition, these lenders said they are prepared to accept significant discounts in 2010 to create liquidity and to rid themselves of these non-core or problem assets. For performing loans, 29% of respondents indicated they are selling performing notes at 90 cents on the dollar and another 24% are selling performing loans between 70 cents and 80 cents on the dollar.

"There is also increased interest in selling sub-performing, or "scratch and dent" loans," said Noble Carpenter, managing director of Jones Lang LaSalle's real estate investment banking practice. "Depending on the remaining term, interest rate, property type and market, over 45% of survey respondents indicated a willingness to sell these loans below 0.60 cents on the dollar.

Many lenders also said they have started or are considering asset, REO and loan sales.

"We're definitely seeing the bid-ask spread between buyer and seller narrow, and in many cases reach equilibrium. That alignment should be the impetus many lenders need to bring large and small balance loans and REO to market," added Wes Boatwright, managing director of Jones Lang LaSalle's real estate investment banking team.

Moody's says US commercial real estate prices increase 4.1% in December.

 US commercial real estate prices as measured by Moody's/REAL Commercial Property Price Indices (CPPI) increased for the second month in a row in December, rising 4.1%. It was the largest month-over-month increase in the nine year history of the CPPI and followed a small, 1% gain in November.

The volume of transactions also rose in December, as is typical for the end of the year.  Overall, 716 transactions totaling $9.0 billion were recorded in the month.

Moody's is uncertain whether the price increases represent passing the bottom of the market or are only the volatility of a market in transition.

"Although we are unable to conclude that the bottom to the commercial real estate market is here, we do believe that the period of large price declines is over," says Moody's Managing Director Nick Levidy.

"We will need to see data from the first few months of 2010 to develop a better picture of where things stand."

As of the end of December, prices are down 29.2% from a year ago and 39.8% from two years ago. They are 40.8% below their peak values.

Market Report, MSN Money, 2-22-2010

The retail sector has endured more distress over the last two years than any other property type, with the possible exception of hotels. As consumers in the U.S. have cut back on discretionary spending, thousands of establishments ranging from retailers like Circuit City and store operators such as Mervyns have closed shop or filed for bankruptcy.

However, as the economy stabilizes and retail sales figures begin to rise, lenders and investors are looking for signs that retail property prices have bottomed out. And as each quarter passes, compelling evidence is emerging that the next six to 12 months may provide a great window of opportunity for lenders and investors with funds to deploy.

Indeed, negative fundamentals have already been building for more than two years. Rents and occupancies deteriorated in record amounts across retail property types in 2008 and 2009. Regional mall vacancies hit 8.8% by year-end 2009, the highest level on record since Reis began covering malls in the first quarter of 2000.

Even the stalwart neighborhood and community center property type — long perceived to be stable given its association with grocery and pharmacy anchor tenants — has come under assault. Negative absorption was recorded in the first quarter of 2008, in lockstep with an economic contraction. By the end of 2009, vacancies had hit 10.6%, a level unseen in 18 years.

Pricing and transaction volume patterns followed accordingly. The average price per sq. ft. for strip malls fell by 42.6% from a peak of $216 in the second quarter of 2008 to $124 by the end of 2009. Over the same period, quarterly transaction volume fell by 64.8%, from $4.6 billion to just $1.6 billion, as risk aversion amid the credit crisis prompted investors to flee to safer havens.  

Got hope?

Where then is the resurgence of hope that might prompt investors and lenders to begin investing in retail properties? Not in fundamentals like rent growth in the near-term, which will remain depressed until well into 2011.

Given typical cycles in commercial real estate, a recovery in rents and occupancies will lag stabilization in the domestic economy and labor markets by at least 12 months. The critical question is whether the low level of transaction prices reflects this expectation of depressed income over the next two years, or if prices will fall further.

Capitalization rates, a key measure of expectations of property income and values, have begun to fall, one indication that investor appetite for retail properties has begun to turn. In fact, cap rates fell from a high of 10.0% in the second quarter of 2009 to 8.7% by the end of the year.  

This is partly driven by selection bias: transactions that occurred in the latter half of 2009 tended to be between well-capitalized buyers and sellers, with high quality properties boasting stable tenant rolls.

But this is precisely the job of the astute investor: to select properties that survived the devastation, purchasing them at bargain prices. And lenders — like investors — are now on the prowl for Class-A properties at Class-C prices, lending at conservative levels to properties that have weathered Darwinian conditions and emerged intact.

Interestingly, the biggest challenge that lenders and investors may face over the next six to 12 months is fierce competition for the best assets. Since we’re in for a few more years of distress, there are a scant number of investors that are willing to gamble on lower grade properties. This singular focus on better assets means that anywhere from 20 to 40 banks are competing to provide financing for higher quality properties.

Buyers also may need to compete with other interested parties for the most prized deals. The biggest example in the market today is Simon Properties, which recently publicized its bid for General Growth Properties. The offer has drawn much attention from analysts, with speculation that bids higher than the initial $10 billion may be placed given the quality of GGP’s assets.

And though retail rents and occupancies will continue to deteriorate over the next two years, current prices may already reflect this. The window of opportunity will close faster than expected if greater competition results in higher prices that depress returns. Now may indeed be the time to seriously consider investing in retail properties.

Victor Calanog, NREI, 2-18-2010

CARSON CITY – For only the second time, Nevada casinos posted a loss – but this time it was the biggest.

The state Gaming Control Board today released its “Gaming Abstract” for fiscal year 2009, which ended June 30, showing a net loss of $6.7 billion among the 260 major casinos in Nevada.

Clubs along the Las Vegas Strip, which makes up 53 percent of the gambling revenue in Nevada, registered a $4.1 billion loss. The only bright spot, from a financial standpoint, was that people drank more. Sales of booze rose by 2.5 percent while revenue tied to casinos, rooms and food dropped. But 36 percent were recorded as “comp” drinks.

“It was a horrendous year,” said Bill Bible, president of the Nevada Resort Association, which represents several casinos on the Strip. He said many of the casinos had three and four waves of layoffs to cut cost during this national recession.

The only other time Nevada gaming companies reported a loss was in 2003, of $33.5 million, said Frank Streshley, chief of tax and licensing for the board. The business downturn came in the middle of the national recession.

Every market except Elko County, with its strong mining business, showed a loss for the fiscal 2009, Streshley said.

“Although we have seen some improvement recently, this reflects a tough fiscal year,” Streshley said. He said there was a national and global recession, and high unemployment. At the Strip, he said there were fewer visitors and they were “spending substantially less.”

In a breakdown, the report shows downtown Las Vegas casinos suffered a $54 million loss; Laughlin casinos reported a $158.8 loss; Boulder Strip casinos registered a loss of $823.3 million and the casinos in the balance of Clark County posted a $1.3 billion loss.

On the Strip, Streshley said the $4.1 billion loss reflects a 686 percent drop from the previous fiscal year, when the clubs reported a profit of $709.4 million.

The report shows there were 98,711 employees at the Strip casinos, down from the 114,465 workers in fiscal 2008.

Streshley noted this downturn comes only two fiscal years after the Strip reported a strong $1.6 billion in net income.

Bible said casinos on the Strip and downtown closed rooms and towers and reduced expenses “but there were still terrible numbers.”

On the Strip, casinos reported $178 million in bad debts in the gambling portion of the business. That compares with $112 million in fiscal 2007. The casinos reported $1.3 billion in complimentary expenses that includes drinks, rooms and food.

Statewide, total general and administrative expenses hit $14 billion. Streshley said more than $5 billion of that were casinos writing down the value of assets.

By Cy Ryan, Las Vegas Sun, 2-19-2010

With the default rate on commercial mortgages held by U.S. depository institutions projected to reach 5% this year and not peak until 2011, the extremely tight credit conditions imposed by banks on borrowers are not likely to loosen anytime soon. So says Sam Chandan, global chief economist and executive vice president with Real Capital Analytics (RCA).

“If you believe that not only are we at a 15-year high in terms of the default rate of commercial mortgages being held by banks — but that there is the potential for that default rate to continue to climb over the next couple of years — then history tells us we must concede that credit conditions at least on the part of community and regional banks will remain unusually constrained over the next couple of years,” says Chandan.

Real Estate Econometrics, recently acquired by New York-based RCA, forecasts that the default rate for commercial real estate mortgages held by depository institutions will reach 5.2% by the end of 2010 and peak at 5.3% in 2011. At the beginning of 2009, the national default rate stood at 2.25%.

The root of the problem is that the U.S. economy has shed about 8.4 million jobs since December 2007. Such massive job losses have led to rising vacancy rates, falling rents and a sharp drop in net operating income for many owners of commercial and multifamily properties.

“We have millions of jobs that we need to replace before we experience aggregate new demand for commercial space in a way that can allow for sustainable increases and improvements in the underlying performance of the properties,” emphasizes Chandan. “That’s problematic for us.”

Chandan’s sobering remarks came Feb. 3 at the NAI Global Convention at Caesars Palace in Las Vegas during a panel discussion focusing on the state of the capital markets. Moderated by Brian Olasov, managing director of law firm McKenna Long & Aldridge, other panelists included Stacey Berger, executive vice president of investment advisory services for Midland Loan Services, and Richard Parkus, head of commercial real estate debt research for Deutsche Bank.

The audience included hundreds of brokers from NAI Global. Based in Princeton, N.J., the broker network includes 5,000 professionals spread across 325 offices in 55 countries. Stung by a precipitous decline in investment sales and leasing volume over the last two years, brokerages are ramping up efforts to capitalize on distress opportunities in commercial real estate.

The special assets solutions team at NAI, for example, works to preserve and recover value in underperforming assets. The services offered include asset management, property management, leasing, valuation and disposition.

Coming to terms with reality

In 2009, U.S. banks were largely in denial about the non-performing loans on their books, says Olasov. “Everyone laughed, everyone knew about the extent of the problems, but their public face was ‘we have no problems.’”

But this year will be different, Olasov predicts. “In 2010, I think it’s going to be a year of increasing recognition of these problems, and at least with respect to some banks the movement of those non-performing loans into the marketplace. And that could be an enormous opportunity.”

The problem is not concentrated in the global banks, which have relatively little exposure to construction loans and core commercial real estate, explains Parkus of Deutsche Bank based in New York. Rather it’s the community banks that are most at risk, he insists. Relative to their asset base, community banks have about 10 times more exposure to commercial real estate than large global banks.

“If you look at the smaller community banks, 10% of their assets are in construction loans. Something very close [to that percentage] is in commercial real estate loans. That’s really a huge problem for the entire economy,” emphasizes Parkus, who has conducted extensive research on loans contained in bank portfolios.

Compared with CMBS loans, a much larger percentage of loans in bank portfolios are secured by transitional properties — assets that are of lower quality and in more tertiary locations, says Parkus. He anticipates that the loss severities on troubled bank loans are going to be “very problematic.”

To put the scope of the banking problem into perspective, consider that the CMBS market accounts for about $670 billion in commercial real estate loans outstanding. That pales in comparison to the $2 trillion in commercial real estate loans outstanding among banks, according to Deutsche Bank. And of the approximately $1.4 trillion in commercial real estate loans due to mature now through 2013, CMBS loans only account for $156 billion.

Have we hit bottom?

The Moody’s/REAL Commercial Property Price Index shows that property values have fallen 43.7% since their peak in 2007. Some market observers say that the Moody’s figure distorts the true picture because there have been so few transactions, and the ones that have occurred have been mostly involved distressed assets.

“I guess my response is that distress properties are a very large percentage of the outstanding universe out there today,” says Parkus. “I tend to think these numbers are right. We have been projecting for the past 18 months that commercial real estate prices in aggregate would fall somewhere between 40% and 50%. We think that they are down 40% to 50% now.”

About 20% to 25% of that price decline stems from the “rolling back” of underwriting standards and the much higher financing rates in the market, according to Parkus. The drop in net operating income accounts for another 10% to 15% of the price decline.

Property prices have probably hit bottom, Parkus believes. “We don’t expect to see significantly [more] price declines. We do expect to see continued declines in commercial real estate fundamentals, rising vacancies and declining rents throughout 2010 at least, but at a much slower pace.”

Loan workout strategies

In the CMBS arena, the loan servicers have their hands full these days as the volume of troubled loans mounts. The only absolute is that there isn’t a one-size-fits-all approach to resolving issues.

“In commercial real estate workouts, it’s very situational,” explains Berger of Midland Loan Services based in Overland Park, Kan. “You have to understand the property, the market, the borrower, his motivations and capabilities.”

The first consideration is to determine whether the existing sponsor, or borrower, is part of the solution or the problem. A lot of debt issued from 2005 to 2007 went to unseasoned owners who were not good managers and who became overleveraged, says Berger. “In those situations, the solution is more likely that you are going to foreclose, take back the property and sell it in a very depressed market.”

Conversely, Midland is encountering many situations where the asset is of high quality, the sponsor is strong and the market is desirable. Quite simply, the problem is that the property is overleveraged. In those instances, Midland requests the borrower bring in fresh capital as part of the solution to either pay down the loan balance, or invest in the property.

As of Dec. 31, 2009, Midland’s active special servicing portfolio included 766 loans with an outstanding principal balance of $12.1 billion.

Back on the banking front, Chandan says that the Federal Deposit Insurance Corp. isn’t content to sit idly by and watch the commercial real estate loan crisis fester indefinitely.

“What we’ve heard from the FDIC is now that the immediate crisis in the banking sector — at least for the largest banks — has abated, it will in a more significant way begin to work with community and regional banks to ensure that some of these assets do start to move.”

That is sweet music to the ears of NAI members and brokers everywhere.

Matt Valley, NREI, 2-18-2010

FDIC Audits Point to Risky CRE Lending; Congress Warns of Dangers to Banking System

The autopsy of 16 bank fatalities completed this year have identified commercial real estate lending as the primary killer in more than half (nine) of the cases, and an accomplice in one other.

In the seven cases in which CRE was not specified, the primary culprit for the bank failures was identified as lending for acquisition and construction of development projects.

When the FDIC's Deposit Insurance Fund incurs a material loss at an insured depository institution, the FDIC Inspector General is required to make a written report identifying the causes of the loss. A material loss is defined as anything more than $25 million or 2% of an institution's total assets.

In reviewing the 16 material loss reports completed this year on banks that all closed last spring and summer, it becomes clear just how much of a toll commercial real estate took on these financial institutions. The closing of those banks has resulted in losses so far for the FDIC of $2.34 billion. The 16 banks audited had total assets of $7.62 billion at the time they were shut down. They were based in states from coast to coast including: Washington, Wyoming, California, Nevada, Utah, Colorado, Texas, Illinois, Georgia and North Carolina.

Last year in total, 140 banks failed with total assets of $170 billion. While the total cost to the Deposit Insurance Fund has not been tallied, losses have been averaging about 30% of assets. That would calculate to losses for the fund of about $52 billion for last year.

"Federal Reserve examiners are reporting a sharp deterioration in the credit performance of loans in banks' portfolios and loans in commercial mortgage-backed securities (CMBS)," Jon D. Greenlee, associate director, Division of Banking Supervision and Regulation for the Federal Reserve Board, told the Congressional Oversight Panel at a Field Hearing in January. "Of the approximately $3.5 trillion of outstanding debt associated with CRE, including loans for multifamily housing developments, about $1.7 trillion was held on the books of banks and thrifts, and an additional $900 billion represented collateral for CMBS, with other investors holding the remaining balance of $900 billion."

"Of note, more than $500 billion of CRE loans will mature each year over the next few years," Greenlee continued in his testimony. "In addition to losses caused by declining property cash flows and deteriorating conditions for construction loans, losses will also be boosted by the depreciating collateral value underlying those maturing loans. These losses will place continued pressure on banks' earnings, especially those of smaller regional and community banks that have high concentrations of CRE loans."

The U.S. Congress created the Congressional Oversight Panel in the fall of 2008 to review the current state of financial markets and the regulatory systems overseeing them. The panel was empowered to hold hearings, review official data, and write reports on actions taken by Treasury and financial institutions and their effect on the economy.

The Congressional Oversight Panel compiled extensive research and data on the state of commercial real estate and took comments from Greenlee and many others before issuing a 189-page report this past week entitled: Commercial Real Estate Losses and the Risk to Financial Stability.

The report is starkly downbeat in its assessment of CRE risks on the banking system.

"Over the next few years, a wave of commercial real estate loan failures could threaten America‘s already-weakened financial system. The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation‘s mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy," the report concluded.

Between 2010 and 2014, about $1.4 trillion in commercial real estate loans are expected to reach the end of their terms. By Congressional Oversight Panel estimates nearly $700 billion of that debt is presently 'underwater,' a situation in which the borrower owes more than the current value of the underlying property.

"It is difficult to predict either the number of foreclosures to come or who will be most immediately affected," the report concluded. "In the worst case scenario, hundreds more community and mid-sized banks could face insolvency. Because these banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery, and extend an already painful recession."

The problems facing commercial real estate have no single cause, according to the Congressional Oversight Panel. The loans they identified as most likely to fail were made at the height of the real estate bubble when commercial real estate values had been driven above sustainable levels and loans. The panel also noted that many loans were made carelessly in a rush for profit.

Other loans were potentially sound when made but the severe recession has translated into fewer retail customers, less frequent vacations, decreased demand for office space, and a weaker apartment market, all factors that increased the likelihood of default on commercial real estate loans.

Even borrowers who own profitable properties may be unable to refinance their loans as they face tightened underwriting standards, increased demands for additional investment by borrowers, and restricted credit.

The FDIC material loss reports also made it clear that most of the failed banks were either too aggressive in growing their commercial real estate lending portfolios and/or too ill prepared to manage the consequences. Specifically the FDIC auditors questioned the banks' loan underwriting standards on chasing deals either out of their territories or not consistent with their business plans. Those actions, in turn, prompted banks to pursue risky transitory and costly deposits to fund their growth.

The following is a summary of the reports examining the 16 banking failures.

• New Frontier Bank, Greeley, CO; $1.8 bil. in assets New Frontier failed because its board and management did not implement adequate risk management practices pertaining to rapid growth and significant concentrations of residential acquisition, development and construction (ADC) and agricultural loans.
  
  
• First Bank of Beverly Hills, Calabasas, CA; $1.3 bil. in assets First Bank failed because its board and management did not adequately manage the risks associated with the institution's heavy concentrations in commercial real estate (CRE) and ADC loans and investments in mortgage backed securities (MBS).
  
  
• Cooperative Bank, Wilmington, NC; $973.6 mil. in assets Cooperative Bank failed because its board and management did not adequately manage the risk associated with the institution's aggressive real estate lending, particularly in the area of residential.
  
  
• Strategic Capital Bank, Champaign, IL; $537.1 mil. in assets Strategic Capital's failure can be attributed to the board and management's speculative and ill-timed growth strategy involving high-risk assets and volatile funding. Strategic Capital's rapid growth strategy was in contravention to long-standing supervisory guidance related to CRE concentrations and securities.
  
  
• Cape Fear Bank, Wilmington, NC; $466.8 mil. in assets Cape Fear failed because its board and management did not implement effective risk management practices pertaining to rapid growth and significant concentrations of CRE and ADC loans.
  
  
• Mirae Bank, Los Angeles, CA; $410 mil. in assets Mirae failed because its board and management pursued an aggressive growth strategy centered in CRE lending and failed to ensure sound loan underwriting practices.
  
  
• Southern Community Bank, Fayetteville, GA; $380.6 mil. in assets Southern Community failed because of a rapid deterioration in asset quality that led to loan and operational losses that quickly eroded the bank's capital. The majority of Southern Community's lending was in CRE, with a particular focus on ADC loans.
  
  
• Westsound Bank, Bremerton, WA; $324.1 mil. in assets Westsound failed because its board and management did not implement risk management practices commensurate with rapid asset growth and a loan portfolio with significant concentrations in higher-risk ADC loans.
  
  
• America West Bank, Layton, UT; $310 mil. in assets America West Bank failed because the bank's board and management deviated from the bank's business plan and did not effectively manage the risks associated with rapid growth in CRE and ADC lending.
  
  
• FirstCity Bank, Stockbridge, GA; $291.3 mil. in assets FirstCity failed because its board and management pursued a strategy of aggressive growth centered in ADC lending.
  
  
• Great Basin Bank, Elko, NV; $228.8 mil. in assets Great Basin failed because its board did not ensure that bank management identified, measured, monitored, and controlled the risk associated with the institution's lending activities. The institution's loan portfolio included, but was not limited to, out-of-territory purchased participation loans from areas that experienced a significant economic downturn starting in 2007, and a concentration in CRE loans.
  
  
• Bank of Lincolnwood, Lincolnwood, IL; $217.4 mil. in assets Lincolnwood failed because the bank's board and management did not implement adequate risk management practices pertaining to a significant concentration in ADC loans.
  
  
• Millennium State Bank, Dallas, TX; $121.4 mil. in assets MSB's failure can be attributed to inadequate management and board oversight, an aggressive growth strategy centered in CRE lending, weak loan underwriting and credit administration, poor earnings, and an inadequate funding strategy.
  
  
• American Southern Bank, Kennesaw, GA; $113.4 mil. in assets American Southern failed because its board and management materially deviated from its business plan by pursuing a strategy of growth centered in ADC lending.
  
  
• MetroPacific Bank, Irvine, CA; $75.2 mil. in assets MetroPacific, a de novo bank, failed primarily because it lacked stable and consistent management and oversight as a result of significant turnover in key management positions. The bank's board and management were particularly ineffective in implementing risk management practices pertaining to adherence to the bank's business plan and rapid growth and concentrations in CRE and ADC loans.
  
  
• Bank of Wyoming, Thermopolis, WY; $72.8 mil. in assets The Bank of Wyoming's failure can be attributed to the board and management's pursuit of loan growth funded significantly with brokered and other non-core deposits. The bank's loan portfolio was concentrated in CRE and ADC loans made to out-of-area borrowers, obtained through loan brokers and participations purchased.

By Mark Heschmeyer, CoStar Group, 2-17-2010

While the CMBS market continues to struggle with record-breaking delinquency rates, several conduit lenders are cautiously re-opening their shops.

Word on the street is that JPMorgan Chase, Deutsche Bank, Goldman Sachs, and Bridger Commercial Funding are still originating CMBS loans, while Citibank expects to start looking at loan submissions soon.

But the rates and terms offered by these lenders just can’t compete with Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA). As a result, the product is seeing more success with retail, office, and industrial assets, than with multifamily properties.

Unable to Compete
Most of the shops looking for securitizable loans are talking a maximum 70 percent loan-to-value (LTV) and a minimum 1.30x debt service coverage ratio (DSCR), with 25-year amortizations. And these active CMBS players are generally quoting 10-year loans in the high-7 percent to mid-8 percent range. In contrast, all-in rates from the government-sponsored enterprises (GSEs) and FHA are still mostly under 6 percent, plus the leverage levels and DSCRs are more favorable.

Warehousing risk is one of the main concerns holding many lenders back. CMBS loans are “warehoused” or held on a balance sheet before they are securitized, and given the CMBS industry’s cloudy outlook, lenders are balking.

“It’s very difficult to price, structure, and underwrite loans without good clarity on the back-end execution,” says Clay Sublett, national production manager and CMBS director for Cleveland-based KeyBank Real Estate Capital. “There are really two big risks: One is that there’s no disposition, and the second risk is, there is a disposition, but it’s not profitable.”

KeyBank was once one of the industry’s more active CMBS players, having originated about $2.5 billion in securitized loans in 2007. But like many banks, the company is spending more time thinking about older originations than newer ones. As it tries to reduce its real estate exposure, the bank may restructure some of its balance-sheet construction loans by extending them and fixing the rate. 

“We are not currently considering new loans for securitization, but we’re looking at some of our existing loans with the idea that we might structure them into more securitizable type loans,” Sublett says.

Delinquency Rates Climb
Clearly, the hesitation for lenders is the climbing delinquency rates of CMBS product. January saw another wave of such delinquencies, according to two recent reports. The percentage of multifamily CMBS loans that are delinquent by 30 days or more reached 9.71 percent, according to market-research firm Trepp. If factoring in Stuyvesant Town/Peter Cooper Village, that rate would reach all the way up to 13 percent.

But the percentage of multifamily CMBS loans that are delinquent by 60 or more days is around 8.3 percent, according to Fitch. In January alone, 248 commercial real estate loans totaling $4.7 billion were transferred to special servicing.

There are a couple of reasons why the multifamily industry has the highest CMBS delinquency rate amongst real estate sectors, and they both concern the GSEs, according to Sublett. First, CMBS originators wanted to get a certain percentage of multifamily loans into each CMBS pool, so that Fannie Mae or Freddie Mac would view it as a qualified investment and buy the bonds.

But getting that percentage of multifamily loans was difficult because conduit lenders had a hard time competing with the GSEs, not only in proceeds and rates but also because the GSEs offered supplemental loans. “So the loans the CMBS originators got in the multifamily space were generally lower-quality borrowers and properties, and they had to stretch to get the product,” Sublett says.

Where did it all go wrong? CMBS loan originations became a pure volume game as lenders threw prudent underwriting practices out the window. And the creation of the Collateralized Debt Obligation market, where B-piece buyers could further sell off risk, was the beginning of the end.

“When the B-piece buyers found a way to further sell off the risk, they were much more willing to take riskier loans,” Sublett says. “Some of it was just the natural Wall Street extension of [the idea that] if a little bit is good, a whole lot is better. The thought was that any loan you could get through the securitization meat grinder was a good loan, because you made money on it.”

By Jerry Ascierto, Apartment Finance Today, 2-16-2010

No single buyer group is leading the charge for commercial property in 2010, but REITs look the best poised to make a significant impact, according to a new report from New York-based researcher Real Capital Analytics (RCA).
The dearth of transaction activity that began in 2008 and carried through much of 2009 finally began to ease in the third quarter and looks to continue into 2010. However, buyers are minus a lead dog to guide the way. The biggest bellwether appears to be the public REITs, which have already committed to acquire as much property so far in 2010 as they did for all of 2009. They’ve also raised an enormous amount of dry powder for the job, an estimated $30 billion.

Across the buying landscape, there does seem to be at least one consistent theme – a frustration at the lack of product. This is most evident when quality assets hit the market. They are quickly bid up by the pool of salivating buyers.
Among buying groups, foreign investors have yet to create a surge in buying activity. Equity funds targeting distressed assets also have raised enough capital to have a serious impact on the market, but their high return expectations are dampening real activity.

According to RCA, prospective investors are increasingly divided between two camps: core and opportunistic, and although they all are looking for bargains, few are finding them.

Core buyers complain that there are few suitable, quality assets on the market and competition for those that are available is steep, pushing pricing to surprisingly strong levels. Opportunistic buyers have been denied the expected tsunami of distressed sales and are now realizing RTC-like returns will be unlikely. Some may have to alter their initial investment strategies or lower their return expectations.

Just 10.8% of all sales in 2009 were associated with distress, but the composition of those buyers differs from non-distressed sales in some meaningful ways, especially within each property type. Overall, players from all sectors, except the public and private REITs, are active in the distressed space. Surprisingly, institutional investors are buying a significantly greater share of distressed sales than of non-distressed, and foreign buyers have been equally active in both arenas. Equity funds have been buying a slightly greater share of distressed than non-distressed properties.

Without decisive moves from REITs, foreign buyers or equity funds, the buyers in the market have largely been private and mostly local. Users, including corporations and governmental and educational entities, have also stepped up to become the second most active buyers of commercial property. As the market recovers, a shift away from private local buyers and users to national and international investors is expected.

By Ben Johnson, National Real Estate Investor, 2-15-2010

Carrie Bay, DSNews.com, 2-14-2010

Financial crises stink. In their wake, public debt explodes. Nations default. Economic growth falters. Taxes rise. Unemployment lingers.

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David Brooks

The current financial crisis is no different. The U.S. will have to produce 10 million new jobs just to get back to the unemployment levels of 2007. There’s no sign that that is going to happen soon, so we’re looking at an extended period of above 8 percent unemployment.

The biggest impact is on men. Over the past few decades, men have lagged behind women in acquiring education and skills. According to the Bureau of Labor Statistics, at age 22, 185 women have graduated from college for every 100 men who have done so. Furthermore, men are concentrated in industries where employment is declining (manufacturing) or highly cyclical (construction).

So men have taken an especially heavy blow during this crisis. The gap between the male and female unemployment rates has reached its highest level since the government began keeping such records.

In a powerful essay in The Atlantic, Don Peck reports that last November nearly a fifth of all men between 25 and 54 did not have jobs, the highest figure since the labor bureau began counting in 1948. We are either at or about to reach a historical marker: for the first time there will be more women in the work force than men.

Young people are the other group disproportionally affected by the downturn. High school and college grads are entering a miserable job market. In his Atlantic piece, Peck rounds up the academic research on what happens to people who enter the labor force in hard times.

College grads who entered the job market during the recession of 1981 earned 25 percent less than grads who entered when times were good. That earnings gap persisted for decades. Seventeen years after graduation, the recession kids were still earning 10 percent less than the boom kids. Over a lifetime, recession kids can expect to earn $100,000 less than their luckier cohorts.

It’s pretty easy to take these economic facts and draw stark cultural consequences. Long-term unemployment is one of the most devastating experiences a person can endure, equal, according to some measures, to the death of a spouse. Men who are unemployed for a significant amount of time are more likely to drink more, abuse their children more and suffer debilitating blows to their identity. Unemployed men are not exactly the most eligible mates. So in areas of high unemployment, marriage rates can crumble — while childbearing rates out of wedlock do not.

Young people who enter the work force in a recession, meanwhile, are psychologically altered. They are less likely to get professional-level jobs throughout life. They are less likely to switch jobs later in their career, even in pursuit of greater opportunity. But there’s also reason not to be too despairing. The country endured stagflation and recession between 1977 and 1983, and rebounded smartly in the 1980s and ’90s.

That’s because people are not passive pawns of economic forces. Recessions test social capital. If social bonds are strong, nations can be surprisingly resilient. If they are weak, things are terrible. The U.S. endured the Great Depression reasonably well because family bonds and social trust were high. Russia, on the other hand, was decimated by the post-Soviet economic turmoil because social trust was nonexistent.

This recession has exposed America’s social weak spots. For decades, men have adapted poorly to the shifting demands of the service economy. Now they are paying the price. For decades, the working-class social fabric has been fraying. Now the working class is in danger of descending into underclass-style dysfunction. For decades, young people have been living in a loose, under-institutionalized world. Now they are moving back home in droves.

The economic response to the crisis is everywhere debated, but the social response is unformed. First, we need to redefine masculinity, creating an image that encourages teenage boys to stay in school and older men to pursue service jobs. Evangelical churches have done a lot to show how manly men can still be nurturing. Obviously, more needs to be done, and schools need to be more boy-friendly.

Second, antipoverty programs have long focused their efforts on inner cities, but now there also is great vulnerability in working-class places like central Pennsylvania and rural Michigan. Many social workers are not exactly comfortable in socially conservative areas, but if the working class disintegrates, then look out.

Third, Facebook is great, but social networking sites do not by themselves create support networks when jobs disappear and poverty looms. Somebody has to provide institutions for unaffiliated 24-year-olds.

There’s no sign that government will nimbly repair these social gaps. It will probably be up to social entrepreneurs to take a midcrisis look at their priorities. Somehow there must be a way to use the country’s idle talent to address freshly exposed needs.

David Brooks, New York Times, 2-16-10

Greece's dysfunctional economy is now at the heart of a rescue effort that could be disastrous for the entire continent—and the rest of the world.

Plutus, the Greek god of wealth, did not have an easy life. As the myth goes, Plutus wanted to grant riches only to the "the just, the wise, the men of ordered life." Zeus blinded him out of jealousy of mankind (and envy of the good), leaving Plutus to indiscriminately distribute his favors.

Modern-day Greece may be just and wise, but it certainly has not had an ordered life. As a result, the great opportunity and wealth bestowed by European integration has been largely squandered. And lower interest rates over the past decade—brought down to German levels through Greece being allowed, rather generously, into the euro zone—led to little more than further deficits and a dangerous buildup of government debt.

Now Plutus wants his money back. Europe is entering unprepared into a serious economic crisis—and the nascent global recovery could easily collapse due to the unsustainable and Ponzi-like buildup of government debt in weaker countries.

At the end of the G7 meeting in Canada last weekend, Treasury Secretary Tim Geithner told reporters, "I just want to underscore they made it clear to us—they, the European authorities—that they will manage this [Greek debt crisis] with great care."

But the Europeans have not been careful so far. The issues for troubled euro zone countries are straightforward: Portugal, Ireland, Italy, Greece and Spain (known to the financial markets, and not in a polite way, as the PIIGS) had varying degrees of foreign- and bank credit-financed rapid expansions over the past decade. In fall 2008, these bubbles collapsed.

As custodian of their shared currency, the European Central Bank responded by quietly opening lifelines to all these countries, effectively buying government bonds through special credit windows. Europe's periphery was fragile but surviving on this intravenous line of credit from the ECB until a few weeks ago, when it suddenly became apparent that Jean-Claude Trichet, president of the ECB, and his German backers were finally lining up to cut Greece off from that implicit subsidy. The Germans have become tired of supporting countries that do not, to their minds, try hard enough. Investors naturally flew from Greek debt—Greece's debt yields rose, and its banking system verged near collapse as investors and savers ran from the country.

But it's not just about Greece any more. Thursday's European Union summit ended with vague assurances of mutual support but did not fundamentally change the financial markets' assessment. Other countries can also be cut off from easy ECB funding, so worries have spread through the euro zone to Spain and Portugal. Ireland and Italy are also up for hostile reconsideration by the markets, and Austria and Belgium may not be far behind. If these problems are not addressed quickly and effectively, Europe's economy will be derailed—with serious, if hard to quantify, implications for the rest of the world.

Germany and France are cooking up a belated support package for Greece, but they have made it abundantly clear that Greece must slash public sector wages and other spending; the Greek trade unions get this and are in the streets. If Greece (and the other troubled countries) still had their own currencies, it would all be a lot easier. Just as in the U.K. since 2008, their exchange rates would depreciate sharply. This would lower the cost of labor, making them competitive again (remember Asia after 1997-'98) while also inflating asset prices and helping to refloat borrowers who are underwater on their mortgages and other debts. It would undoubtedly hurt the Germans and the French, who would suffer from less competitiveness—but when you are in deep trouble, who cares?

Since these struggling countries share the euro, run by the European Central Bank in Frankfurt, their currencies cannot fall in this fashion. So they are left with the need to massively curtail demand, lower wages and reduce the public sector workforce. The last time we saw this kind of precipitate fiscal austerity—when nations were tied to the gold standard—it contributed directly to the onset of the Great Depression in the 1930s.

The International Monetary Fund is supposed to lend to countries in trouble, to cushion the blow of crisis and to offer a form of international circuit breaker when everything looks fragile. The idea is not to prevent necessary adjustments—for example, in the form of budget deficit reduction—but to spread those out over time, to restore confidence, and to serve as an external seal of approval on a government's credibility.

Despite the fact that the IMF was created after World War II essentially as a U.S.-Western European partnership, and despite the fact that Europe has strong representation at the fund and has always chosen its top leader, in this instance the fund has been reduced to not-entirely-helpful kibitzing from the sidelines.

Dominique Strauss-Kahn, the fund's managing director, said recently on French radio that the fund stands ready to help Greece. But he knows this is wishful thinking.

"Going to the IMF" brings with it a great deal of stigma; just ask the Asian countries that had to borrow from the fund during their crises of the 1990s. And many in Europe view the fund as an American-influenced institution—located three blocks from the White House for a reason—that would be invading Europe's territory.

In addition, French President Nicolas Sarkozy has serious personal reasons to push the IMF away. Mr. Strauss-Kahn is a serious potential challenger in France's upcoming elections; Mr. Sarkozy would hate to see the IMF play a statesman-like role on his home turf.

Chancellor Angela Merkel, currently maneuvering to ensure a German is the next head at the ECB, is also concerned. The IMF might take the position that ECB policies have been overly contractionary—resulting in a strong euro and very low inflation—and not appropriate for member countries in the midst of a financial collapse. If the IMF were to support Europe's weaker economies, this would challenge the prevailing ideology among Frankfurt-dominated policy makers.

Nations outside Europe, such as the U.S., are naturally reluctant to get involved. Sending Greece to the IMF would result in some international "burden sharing," as it would be IMF resources, from its member countries around the world, on the line, rather than just European Union funds. Is the U.S. really willing to share the burden through the IMF?

And how would the Chinese, for example, react if such a proposition came to the IMF? No industrialized democracy is in a particular hurry to find out.

What is the solution? One possibility is to recognize that the current euro zone might not make sense. This is not a decision that anyone will take this week, but it may well be the fast-approaching reality.

If Europe really does want to save this version of the euro zone from collapse, what would constitute substantive steps?

First, the EU leadership should recognize that, despite all its warts, the IMF has unique expertise in designing programs that pull countries back from the brink of financial collapse. The latest indications are that the IMF could be brought in as "technical assistance plus" to comb through the books of troubled countries, work with the governments to determine what macroeconomic programs are needed, and then monitor the conditionality of such programs while reporting back to the EU (and, more informally, to the IMF executive board).

These programs would involve some upfront fiscal austerity to bring nations on a solvent path, but perhaps not as much as in the Franco-German bilateral-bailout scenario.

Second, Europe must soon create a multilateral funding system that ensured adequate finance was available to each nation that adhered to these conditional programs. This could be pooled resources of EU nations, and could be supplemented with IMF financing.

Relying on money directly from France or Germany is unwise. Finding a robust deal directly between hard-pressed French and German taxpayers and Greek public sector trade unions will be difficult. German voters, in particular, are fed up with subsidizing other Europeans—who they feel, with some justification, have not made the adjustments they promised when the euro was founded. Greek civil servants, on the other hand, are already pushing back hard against what they are framing as unwarranted German intervention and harshness.

The Europeans will experience firsthand what the IMF has long known. When you ride to the rescue of a financially embattled nation, your arrival is appreciated for about 20 minutes. Then people become embarrassed, resentful and even angry.

Illustration by Adam McCauley

Third, the European Central Bank needs to adjust its policies, lowering interest rates further and allowing higher inflation throughout the currency union. If such looser money policies are not palatable to the Germanic core, then Berlin/Frankfurt should get on with the task of admitting that the euro zone itself is a failure.

Finally, if the troubled countries cannot adhere to the conditionality attached to their lifelines, the European Union needs a graceful way out. They need "living wills"—plans for countries to exit from the euro zone. The mere existence of such living wills could lead to serious complications—perhaps inviting further speculative attacks—but failing to prepare would be completely irresponsible.

Frankly, it would be a disaster for weaker euro zone countries to leave the bloc. Exiting countries would need to rewrite all their contracts in terms of new currencies, converting as many liabilities and assets as possible into those, and then manage a new monetary policy. There would be legal challenges in international courts to rewritten contracts—some of which would certainly constitute default. Building trust in any new currency is always difficult. But a German exit from the euro zone, in a huff, cannot be ruled out—although its consequences could be equally chaotic.

Even following Thursday's EU summit, an orderly resolution of these problems seems unlikely. The Germans will push for draconian cuts to Greece's government spending and public sector wages but they won't budge on relatively tight monetary policy and the overly strong euro—and they definitely won't agree to loosen their own (German) fiscal policy.

Ireland is already cutting hard. Such fiscal austerity leads to double-digit declines in GDP, and risks massive political revolts. Ireland's banks are today probably insolvent. Who can afford to repay their mortgages when wages are falling and unemployment rising? Irish house prices continue to speed downward. This is not an example of a "careful" solution—it is a nation in a financial death spiral.

Other EU countries will lobby for a continuation of the status quo. They would prefer the ECB keep lending to the periphery, and the problems be pushed off for another day. This too is no solution.

For now Europe will try to muddle through. Greece will promise a pound of flesh, hoping not to pay, and other nations will be spared with promises of continued financing—but just for now.

Financial markets know that this makes no sense, hence the "largest ever" short euro positions, betting on a further decline of the currency. If one country must make a substantial and painful fiscal adjustment, eventually the rest will follow. The implication for bondholders is obvious: Edge towards the door. Bond yields will stay high or creep up, until the next wave of financial crisis and contagion. The problems could easily jump beyond Europe; any sovereign with shaky finances can be hauled before the harsh court of international creditor opinion.

The Obama administration should not recuse itself from these problems. The U.S. must press Europe to act in a way that supports the broader global economy. We should encourage an orderly resolution to problems in Europe, and press the Europeans to bring in the IMF in an appropriate fashion. The U.S. must stop relying on Europe to be "careful," and instead cooperate assertively to help reduce the risk of further collapse in Europe.

American leaders must also address problems at home. Unless and until the U.S. puts in place a plausible process to take its own government debt off an explosive path—for example, through an independent but Congress-backed fiscal commission of some kind, with everything on the table—we are vulnerable to the same kind of debt dynamics that now plague parts of Europe.

This is not a call for immediate fiscal austerity; that is the path back to the 1930s. But no country can go on issuing your debt without consequence when the buyers declare, "Enough!" In the case of the U.K. and the U.S., the macro situation remains stable only as long as foreigners buy and hold our government debt. This is a major economic and national security risk.

Financial markets are telling us the euro zone is under threat, but the real message is much broader: Unsustainable debt dynamics can undermine us all.

On a monthly basis, retail sales increased 0.5% from December to January (seasonally adjusted), and sales were up 4.7% from January 2009 (easy comparison).

Click on graph for larger image in new window.

This graph shows retail sales since 1992. This is monthly retail sales, seasonally adjusted (total and ex-gasoline).

This shows that retail sales fell off a cliff in late 2008, and appear to have bottomed.

The red line shows retail sales ex-gasoline and shows the increase in final demand ex-gasoline has been sluggish.

The second graph shows the year-over-year change in retail sales since 1993.

Retail sales increased by 4.7% on a YoY basis. The year-over-year comparisons are easy now since retail sales collapsed in late 2008. Retail sales bottomed in December 2008.

Here is the Census Bureau report:

The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for January, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $355.8 billion, an increase of 0.5 percent (±0.5%)* from the previous month and 4.7 percent (±0.5%) above January 2009.
...
Gasoline stations sales were up 29.0 percent (±1.5%) from January 2009

- Calculated Risk, 2-12-10

With Movie Gallery announcing the first major bankruptcy filing of the year, retail real estate professionals are starting to get a handle on what 2010 will look like in terms of store closings.

So far the pace of announced closings has been noticeably slower than in 2009, when a glut of retailers announced mass closures, bankruptcies or liquidations soon after the holiday shopping season concluded. By this time last year, seven major retailers had filed for bankruptcy and about a dozen others announced mass closings. That’s not how things have played out so far this year.

Wilsonville, Ore.-based Movie Gallery’s decision will create a hole as the movie and game rental chain closes up to 760 locations as it restructure, but there have been few other large announcements from retailers. The question is whether 2010 will remain quiet or if there is a spurt of closings still to come, which is what some experts believe will unfold.

“I don’t think there is going to be any improvement from last year on the store closings,” says Howard Davidowitz, chairman of Davidowitz & Associates, a New York City-based retail consulting and investment banking firm. “If the consumer is weak, and the consumer will be weak, there is no way retail can be strong. It just doesn’t work.”

Last year, the U.S. retail industry saw 4,763 stores closings, according to ICSC. The figure was an improvement over the 6,913 stores closed in 2008 and comparable to 2006, when a total of 4,730 stores closed doors. But the number may be deceiving as many retailers kept stores in business last year by asking landlords for rent relief, says Matthew Bordwin, managing director and co-group head of the real estate services team at KPMG Corporate Finance LLC, an investment banking and advisory services firm. Bordwin notes that in 2009 his firm handled thousands of rent renegotiation assignments on behalf of retailers and expects that in many cases for the stores to stay afloat, those rents will have to be renegotiated again in 2010.

Click for larger image.

“For the most part, the marketplace isn’t changing that dramatically,” he says. Those tenants that normally paid $20 per square foot and received a temporary concession to pay $15 per square foot in 2009 might have to go back to the landlord and ask to pay $8 per square foot to survive.

Altogether, Michael Scott Wiener, president and CEO of Excess Space Retail Services Inc., a national real estate disposition and lease restructuring firm, predicts retailers will likely close 6,000 stores or more in the first half of the year. By the end of 2010, store closings might reach the 8,000 mark, he says.

Meanwhile, there still isn’t enough demand from expanding retailers to fill that glut of space. In recent months a number of concepts, including electronics seller hhgregg and fast fashion chain Forever 21, have embarked on major expansion campaigns. But those tenants are few and far between, notes Bordwin.

Most expanding chains are looking at five or 10 new stores, not 500. As a result, the overall vacancy rate for retail properties in the U.S. reached 7.6 percent in the fourth quarter of 2009, according to a recent report from the CoStar Group, a Bethesda, Md.-based research firm. And the availability rate for retail properties, which tracks both vacant spaces and spaces that are being marketed for new tenancy by landlords even though the old tenant hasn’t left yet, is now at 9.9 percent—up almost 400 basis points from the low point of 6 percent in the early months of 2006.

In the near term, this may be tough on landlords, but in the end it will make the industry healthier, say the experts. Davidowitz, for example, notes that he does not view all store closings as a sign of weakness. In fact, he advises retailers to evaluate their real estate portfolios on a quarterly basis so they can keep track of underperforming stores and weed out money losers. He believes that retail property owners should do the same and start considering alternative uses for their space if it doesn’t seem to be attracting new tenants. Already real estate professionals report seeing churches, medical facilities and government agencies spring up on corners that used to house strip centers.

“There will be in the next five years, a reckoning in the real estate marketplace,” says Bordwin. “Owners are going to have to figure out alternative uses for [their spaces] because there just aren’t enough tenants. In A-class locations, rents may be down, but in the long-term you’ll always have tenants looking to get in. Most markets will absorb B-class locations again. It’s once you get into [tertiary markets], those owners will struggle.”

–Elaine Misonzhnik, Retail Traffic, 2-10-10

MCLEAN, Va.—When Charles E. Haldeman Jr. became Freddie Mac's chief executive officer in August, the ailing housing-finance giant had already consumed $51 billion of government money to stay afloat. It's likely to need even more.

Freddie's federal overseers nevertheless have instructed Mr. Haldeman to focus on something that isn't likely to make the bleak balance sheet look any better: carrying out the Obama administration plan to allow defaulted borrowers to hang onto their homes.

On a recent afternoon, employees at Freddie's headquarters here peppered Mr. Haldeman with concerns about the company's future. He responded that they were "fortunate" to have such a clear mission—the government's foreclosure-prevention drive. "We're doing what's best for the country," he told them.

Freddie and its larger rival, Fannie Mae, were among the first big financial institutions to receive massive federal bailouts after the financial crisis hit in 2008. Government officials have been racing to fix bailed-out car makers and banks and are pushing to reshape the financial-services industry. But Fannie and Freddie remain troubled wards of the state, with no blueprints for the future and no clear exit strategy for the government.

Deputy Markets editor Dennis Berman says America still hasn't come to terms with the hole in its fiscal policy. He asks Evan Newmark what event would help the U.S. understand that there's something "terribly wrong."

Nearly a year and a half after the outbreak of the global economic crisis, many of the problems that contributed to it haven't yet been tamed. The U.S. has no system in place to tackle a failure of its largest financial institutions. Derivatives contracts of the kind that crippled American International Group Inc. still trade in the shadows. And investors remain heavily reliant on the same credit-ratings firms that gave AAA ratings to lousy mortgage securities.

Fannie and Freddie, for their part, remain at the core of a housing-finance system that inflated a dangerous housing bubble. After prices collapsed, sending shock waves around the world, the federal government put America's housing-finance system on life support. It has yet to decide how that troubled system should be rebuilt.

On Dec. 24, Treasury said there would be no limit to the taxpayer money it was willing to deploy over the next three years to keep the two companies afloat, doing away with the previous limit of $200 billion per company. So far, the government has handed the two companies a total of about $111 billion.

The government is willing to tolerate such open-ended exposure for two reasons. First, it sees the companies as essential cogs in the fragile housing market. Fannie and Freddie buy mortgages originated by others, holding some as investments and repackaging others for sale to investors as securities. Together with the Federal Housing Administration, they fund nine in 10 American mortgages. Worries about potential insolvency would cripple their ability to fund home loans, which would hamstring the market.

Second, the companies are a convenient tool for the administration to use in its campaign to clean up the housing mess.

"We're making decisions on [loan modifications] and other issues, without being guided solely by profitability, that no purely private bank ever could," Mr. Haldeman said in late January in a speech to the Detroit Economic Club.

Besides playing a key role in the loan-modification program, Fannie and Freddie have jump-started lending by state and local housing-finance agencies by helping to guarantee $24 billion in debt. They also are lending support to the apartment sector by becoming the main funders of loans to builders and buyers of apartment buildings.

By using Fannie and Freddie for such initiatives, the White House doesn't have to go to Congress for funding. The Treasury and White House can simply issue instructions to Fannie and Freddie via their federal regulator, the Federal Housing Finance Agency, or FHFA.

The government is "running Fannie and Freddie as an instrument of national economic policy, not as a business," says Daniel Mudd, who was forced out as Fannie Mae's chief executive in September 2008 when the government took control.

Assistant Treasury Secretary Michael Barr says that because Fannie and Freddie are "owned by the taxpayers in the middle of the biggest housing crisis in 80 years," it would be unrealistic to expect the companies wouldn't be used to help stabilize the market. He says the administration's actions have been "prudent" and "consistent with taxpayer protection."

The companies are political lightning rods. The government's decision to absorb unlimited losses followed the Treasury's approval of multimillion-dollar pay packages for senior executives at each company. Republican critics have blasted those decisions, demanding investigations and pay cuts.

Massachusetts Democratic Rep. Barney Frank, a longtime supporter of the companies, said last month that ultimately they should be abolished and replaced with an entirely new housing-finance system. Last Thursday, he said he would convene a hearing next month to review the future of housing finance and the federal government's role in it

Some housing experts contend that prolonged government intervention will make it more difficult and costly to eventually wean the companies off government support. "The more aggressively we continue kicking the can down the road, the larger the losses become and the harder it becomes" to address the companies' future, says Joshua Rosner, managing director at investment-research firm Graham Fisher & Co.

Edward DeMarco, acting director of Fannie and Freddie's regulator, the FHFA, says efforts to modify loans and to stabilize the housing market ultimately will help the two companies' bottom lines. "The businesses are trying to mitigate the losses and remediate the problems that led to conservatorship in the first place," he says.

As mortgage delinquencies rise, Fannie and Freddie are required to set aside more capital to cover anticipated losses. Each quarter, if their revenues are insufficient to meet those financial needs, the Treasury has to kick in more money.

With delinquencies still rising, the outlook is grim. At Freddie, 3.87% of single-family mortgages were at least 90 days past due at the end of December, up from 1.72% a year earlier. Fannie is worse: 5.29% were 90 days past due in November, up from 2.13% a year earlier.

For decades, both Fannie and Freddie were highly profitable. The housing bust hit both hard, sharply reducing the values of the mortgages they guaranteed, along with their investment portfolios, which were stuffed with riskier loans.

By September 2008, their capital reserves were so depleted that the government seized control of both companies, using a legal process known as conservatorship. In exchange for injecting money, the government has received preferred shares that pay a 10% dividend, along with warrants to purchase up to 79.9% of the common stock of each company.

The Obama administration had said it would weigh in on how to revamp the companies when it released its proposed budget earlier this month. Instead, the budget contained only a single line about the companies' future, promising to "monitor the situation" and to "provide updates…as appropriate." That stance reflects policy makers' uncertainty about how to proceed and a lack of urgency about resolving the problem.

Lawrence Summers, the president's chief economic adviser, has said the companies shouldn't be run permanently by the U.S. or be allowed to "return to the failed model of the past, where Fannie and Freddie relied on an implicit government [debt] guarantee to borrow cheaply."

Some Republicans have said the government should play no role whatsoever in the companies in the future, meaning no implied debt guarantee and no government directives to support affordable housing. The other end of the spectrum would be to turn the companies into government agencies.

Many housing-industry leaders believe the eventual plan will fall somewhere in between. Housing-policy experts assembled by the Center for American Progress, a think tank that has provided the White House input on past policy and personnel decisions, recently proposed that Fannie and Freddie be transformed into two or more companies whose profits would be capped like those of public utilities. There would be explicit federal guarantees on certain mortgage-backed securities. The new entities would be required to ensure that mortgages are available to low-income borrowers.

Others have proposed turning the companies into cooperatives owned by lenders, but subject to strict regulation.

With the fate of the two companies now largely in the hands of the government, employees have shifted their attention to the administration's loan-modification effort, called Home Affordable Modification Program, or HAMP. It provides financial incentives for banks and other owners of mortgages to reduce monthly loan payments for at-risk borrowers. Fannie and Freddie's job is to oversee how loan servicers—the firms that collect monthly payments on mortgages—are working with homeowners on the front lines.

The program is off to a slow start. The administration said it would offer three million to four million borrowers the chance to modify loans. Through December, loan servicers have signed up 903,000 borrowers for trial modifications. Just 66,000 have received a permanent fix so far.

Both Fannie and Freddie have struggled at times to adjust to the new marching orders. Fannie has warned in financial filings that the modification program had shifted "significant levels of internal resources and management attention" from other parts of the business, which could lead to a "material adverse effect" on the business.

At Freddie, David Moffett, the chief executive who took over when the federal government assumed control, left last March after only six months, partly because it became clear that regulators would be calling the shots.

He says he and others warned administration officials that the loan-modification goals were unrealistic, that borrowers whose homes weren't worth what they owed were unlikely to take part, and that many participants would be likely to re-default within months. "They really didn't want our views," Mr. Moffett says.

Treasury's Mr. Barr says that isn't true. The Fannie and Freddie officials he worked with, he says, "were quite supportive of the program, of the structure and the basic design," and "were integral to the formulation."

Since then, Freddie has taken some heat for problems with part of the loan-modification drive. In an October report, the government said Freddie failed in its job as the program's auditor. Its task is to make sure loan servicers deal correctly with applications from borrowers for payment relief. Freddie says it has reassigned the vice president responsible for the effort.

Freddie's current chief executive, Mr. Haldeman, 61 years old, says it was immediately "very clear" to him that the loan-modification program was a top priority of the Obama administration. But the program isn't his only headache. As foreclosures mount, Freddie finds itself with title to more and more homes. The company wants to price them to sell, but doesn't want to put downward pressure on overall housing prices.

"Imagine having to keep the lawns mowed, the lights on, and the property secured for one house, let alone more than 40,000 homes all over the country," says Mr. Haldeman. "It's not an easy process."

John A. Koskinen, a turnaround specialist who became chairman of Freddie's board when the government stepped in, says that in all his years working for government agencies and troubled companies, "I've never been in one with as many challenges."

Last spring and summer, as interim CEO, he had to recruit executives to fill the top three jobs. Filling those jobs has put the company on firmer ground, he says, and having a clear mission—even a government-mandated one—is helping morale. "At least the getting yelled at by your neighbor in the grocery store is behind us," he says.

Loan standards today are tighter than they have been in decades. That means the default risk on loans guaranteed recently by Fannie and Freddie is much lower than it was a few years ago. But their mistakes during the housing boom are expected to continue burning holes in their balance sheets.

The Mortgage Bankers Association estimates that mortgage delinquencies won't peak any sooner than the middle of this year. At the current pace, around 6% of Fannie's loans and 4.9% of Freddie's are expected to go into default over the next 18 to 24 months, producing losses that would raise the price tag on Treasury's bailout to $175 billion, according to October estimates by investment bank Keefe, Bruyette & Woods Inc. The bank has since said that even that dire forecast is too optimistic.

Former FHFA head James Lockhart, the companies' top regulator until last August, says the U.S. is unlikely to ever fully recoup its investment in the two companies.

—Nick Timiraos and James R Hagerty, Wall Street Journal, 2-9-10

In crisis there usually is opportunity.

Now, here's the opportunity if the latest global financial-market upheaval worsens: The U.S. government, still the borrower that never lacks for lenders, can launch a major economic-stimulus plan to be financed by yet more sales of Treasury securities.

Frightened global investors would again be happy to shovel their money into Treasuries at low-single-digit interest rates.

The U.S. would, in effect, then recycle those dollars back into the economy, preferably through business and personal tax cuts this time rather than another pork-barrel spending bill. Real jobs would be created, finally putting the economy back on sound footing, boosting tax revenue and eventually paring the deficit.

Everybody wins!

The economic and fiscal policy of madmen? Maybe.

This is the deficits-are-good-for-you argument, which at this point sounds almost treasonous. Haven't we all embraced the idea that the U.S. faces certain ruin from its soaring debt?

Baloney, says Marshall Auerback, an investment advisor who also is a member of the brain trust at the Roosevelt Institute. He believes that the deficit hawks are dead wrong, and always have been.

The far greater risk to the economy, he and others in his camp assert, is that the Obama administration will cave in to calls for fiscal piety exactly at the moment when the economic recovery needs more oomph.

Of course, with the deficit projected at $1.6 trillion this fiscal year and $1.3 trillion the next, it hardly looks like Washington is exercising budgetary restraint.

Yes, the U.S. can borrow aggressively -- and it should, Auerback wrote this week on the blog of the Roosevelt Institute, a not-for-profit group that promotes the values of Franklin and Eleanor Roosevelt.

He has some esteemed company. Joseph Stiglitz, the Nobel laureate economist, derides the critics of deficit spending as "deficit fetishists" who are ignoring what he believes is the clear and present danger of rampant unemployment.

"The long-run cost of not addressing this issue is greater than the [deficit] cost imposed on our society by a long shot," Stiglitz said at a forum of business leaders who met at the White House in December.

The 50-year-old Auerback takes deficit defense beyond even what many advocates of Keynesian government intervention support. He really believes that deficit spending is always desirable.

I called him to ask how he could make that case, particularly given what has been happening in Greece, Portugal and Spain this week. Investors, fearful of ballooning budget deficits in those nations, have sharply pushed up market interest rates on the countries' bonds. That in turn helped trigger a heavy sell-off in European stocks Thursday that spread worldwide.

The British-born Auerback, who lives in Denver, is a portfolio strategist for money manager RAB Capital in London. Besides his gig with the Roosevelt Institute, he is a consultant to bond fund titan Pimco in Newport Beach.

After working in money management for 27 years, Auerback says, he has increasingly become interested in government policy.

Not surprisingly, a main thrust of his deficit defense is that the U.S., as the source of the world's reserve currency and the largest economy by far, retains financial flexibility that Greece, say, would never have.

The federal government can create money at will, and its spending "is constrained only by what our population chooses as national goals," Auerback said.

Although foreign creditors such as China have become major buyers of U.S. debt, he notes that they've obviously done so because it has served their purposes. Auerback doesn't see why that should change any time soon, even though the Chinese grumble publicly about the level of U.S. borrowing.

Besides, government-bond investors prize liquidity, and that's still what Treasuries provide above all other bond markets. It isn't just hubris to say that, for the time being, the world doesn't have an alternative to the Treasury market.

As for the two most-cited fears about deficit spending -- that it will drive up inflation and interest rates -- Auerback points to the U.S. experience of the last 30 years: The government spent more than it took in for mostly that entire period, yet inflation and rates remained in long-term decline.

Still, it doesn't seem far-fetched that foreigners could at some point decide the U.S. had become less creditworthy. Pimco bond guru Bill Gross, among others, has warned that the country won't hang on to its AAA credit rating forever.

Then what? Let's say investors decided to demand higher yields on Treasuries than the current paltry rates. That would devalue older bonds issued at lower rates, but it also would make new Treasuries more attractive to investors.

Presumably many Americans who have no appetite for a five-year T-note paying 2.2% might be very interested if the yield just got back to the 4.5% level of 2007.

As Auerback notes, because the government creates money, "Debt owed by the government yields net income to the private sector, unlike all purely private debts, which merely transfer income from one part of the private sector to another."

Higher T-bond yields would cost the government more but also would pump more income into the economy, and could encourage more homegrown financing of the deficit.

The risk, however, is that higher Treasury yields would sharply drive up all other interest rates. That could be deadly for housing, for example.

Another key risk is that the rising supply of deficit-generated dollars at some point could spark a currency crisis that would result in a rapid devaluation of the buck. That would hurt Americans' purchasing power, but it also would put the country on sale for foreigners, which in theory should lure capital back. It isn't as if American assets have no value just because our national debt rises.

Besides, the dollar's appeal has to be judged against its main rivals -- and at the moment, it's hard to argue that the euro and the yen are more attractive.

Putting aside the questions of interest rates, inflation, currency values and other unknowns, the most compelling case Auerback can brandish against the deficit hawks is this: To pare back government spending now, when the Treasury can borrow with ease, is to risk short-circuiting the global economic recovery for no good reason.

"If your economy collapses, the deficit will go up inexorably," he said.

Auerback favors a temporary deficit-financed elimination or reduction of the Social Security payroll tax, which would boost income of both businesses and consumers. Both Democrats and Republicans ought to be able to agree on that kind of stimulus, he said.

The most specious argument for slashing the deficit, Auerback contends, is that rising debt constitutes intergenerational theft because it burdens future generations.

If you want to commit intergenerational theft, he said, hack spending on education and other things that "give our children and grandchildren the resources they need to compete" in the future. "That is the true intergenerational theft."

Tom Petruno, Los Angeles Times, 2-6-10

Several positive developments are emerging in the real estate capital markets, providing a glimpse of optimism as investor sentiment appears to rebound.

As of December 2009, the average commercial mortgage rate fluctuated between 7% and 7.2%. Spreads over the 10-year Treasury ranged from 360 to 420 basis points, down from a range of 430 to 500 basis points in the third quarter of 2009.

Mortgage spreads for core retail, warehouse and office properties contracted by about 50 basis points. Spreads for apartment and hotel properties remained essentially unchanged over the same period.

Meanwhile, all tranches in the commercial mortgage-backed securities (CMBS) market have rallied appreciably. Spreads on the AAA CMBX index have narrowed by more than 85 basis points over the past three months.

We believe that both mortgage and CMBS spreads will continue to drift downward, albeit at a slow pace, as real estate fundamentals continue to stabilize over the next 12 months.

Despite some improvements in the capital markets, commercial mortgage debt remains both expensive and difficult to obtain. We believe that the lending environment will continue to improve in 2010, including an increasing volume of CMBS originations.

Financing gap continues

Those improvements will not, however, likely be enough to fully accommodate the $1.1 trillion of commercial real estate debt that will mature over the next three years, 2010 through 2012.

With underwriting requirements remaining tight, traditional balance sheet lenders under stress and reluctant to lend, and regional bank failures rising, we expect a continuing financing gap in the market in 2010.

According to Real Capital Analytics (RCA), distressed assets in the U.S. surged to $203 billion as of December 2009. We expect the amount of distress to grow considerably as more loans mature over the next two to three years. The end result could be excellent opportunities for buyers of distressed assets in 2010 and 2011.

Valuations plummet

The total return of the NCREIF Property Index (NPI) declined by 2.1% during the fourth quarter and by 16.8% for the year, the worst annual performance in the 32-year history of the index. Still, this figure is slightly better than the projected 17.5% decline that we made at the beginning of the year.

The income portion of the return was resilient at 6.2%, but prices declined by 22%, a much steeper annual drop than during previous real estate downturns.

National transaction volume across all five property sectors totaled $18.1 billion in the fourth quarter of 2009, improving from $13 billion in the third quarter, but down from $20.1 billion in the fourth quarter of 2008.

The average capitalization rate for all properties sold over $5 million rose 20 basis points to 8.1% in the fourth quarter of 2009, up 80 basis points from the same period a year ago.

Our review of a wide variety of market metrics suggests that commercial real estate transaction volume may be bottoming out. We expect to see more transactions over the next several months as an increasing number of investors look for distressed or undervalued opportunities in commercial real estate.

Job growth is imminent

The U.S. economic recovery gained additional strength during the fourth quarter, thanks to broad-based improvement across most business sectors and geographic regions.

After rebounding by 2.2% in the third quarter of 2009, real gross domestic product (GDP) surged 5.7% during the last three months of the year. Growth exceeded expectations mainly due to a jump in business spending and inventory restocking.

Several significant challenges remain, however, including tight credit and high unemployment. Looking forward, we expect a slow recovery process with a few bumps in the road.

We believe that the fiscal and monetary policies of the U.S. government and Federal Reserve will continue to be flexible and accommodating in 2010, supporting economic growth of 3% over the next 12 months.

Although the U.S. is technically out of recession, the labor market continues to struggle. Since the beginning of the recession through December 2009, a total of 8.4 million jobs were lost nationwide, according to the recent revisions to the employment numbers.

The national unemployment rate climbed to 10.1% in October, and though it has since receded to 9.7%, it remains at the highest level in decades.

Despite these negative indicators, we now see early signs of recovery in the labor market. The four-week moving average of initial jobless claims continues to trend downward, pointing to a deceleration in the pace of layoffs.

Average hourly earnings and the hiring of temporary workers are on the rise. With many firms reporting better-than-expected earnings and moderate sales increases over the past two quarters, we believe we will likely see job growth before mid-2010.

Consumer spending showed encouraging signs of improvement during the fourth quarter, with 2009 holiday sales rising by 2.3% over the depressed levels of the same period a year ago.

Preservation mode

However, U.S. consumers continued to increase savings and reduce household debt in the face of negative wealth effects.

The personal savings rate rose to 4.7% in November 2009, up from 3.8% one year earlier. We continue to believe that consumer spending will likely remain muted until the job and housing markets stabilize.

The December Consumer Price Index (CPI) increased by only 0.1% over the previous month and by 2.7% year-over-year, primarily due to volatile energy prices.

We believe that inflationary pressure should remain subdued over the next 12 to 18 months as a result of relatively weak demand and low capacity utilization.

The combination of a government tax credit for first-time buyers and historically low mortgage rates contributed to increased demand for residential housing over 2009.

The U.S. housing market showed signs of stabilization with the Standard & Poor’s/Case-Shiller home price index climbing modestly for six straight months from June through November.

However, both new and existing home sales declined larger-than-expected in December, suggesting a rather fragile housing recovery.

We believe there is a potential risk of additional home price declines in 2010, if the government stimulus assistance is withdrawn and mortgage rates increase substantially.

By David Lynn, National Real Estate Investor, 2-8-2010 

These days it’s hard to pick up a newspaper or turn on a news program without encountering stern warnings about the federal budget deficit. The deficit threatens economic recovery, we’re told; it puts American economic stability at risk; it will undermine our influence in the world. These claims generally aren’t stated as opinions, as views held by some analysts but disputed by others. Instead, they’re reported as if they were facts, plain and simple.

Skip to next paragraph

Paul Krugman

 

Yet they aren’t facts. Many economists take a much calmer view of budget deficits than anything you’ll see on TV. Nor do investors seem unduly concerned: U.S. government bonds continue to find ready buyers, even at historically low interest rates. The long-run budget outlook is problematic, but short-term deficits aren’t — and even the long-term outlook is much less frightening than the public is being led to believe.

So why the sudden ubiquity of deficit scare stories? It isn’t being driven by any actual news. It has been obvious for at least a year that the U.S. government would face an extended period of large deficits, and projections of those deficits haven’t changed much since last summer. Yet the drumbeat of dire fiscal warnings has grown vastly louder.

To me — and I’m not alone in this — the sudden outbreak of deficit hysteria brings back memories of the groupthink that took hold during the run-up to the Iraq war. Now, as then, dubious allegations, not backed by hard evidence, are being reported as if they have been established beyond a shadow of a doubt. Now, as then, much of the political and media establishments have bought into the notion that we must take drastic action quickly, even though there hasn’t been any new information to justify this sudden urgency. Now, as then, those who challenge the prevailing narrative, no matter how strong their case and no matter how solid their background, are being marginalized.

And fear-mongering on the deficit may end up doing as much harm as the fear-mongering on weapons of mass destruction.

Let’s talk for a moment about budget reality. Contrary to what you often hear, the large deficit the federal government is running right now isn’t the result of runaway spending growth. Instead, well more than half of the deficit was caused by the ongoing economic crisis, which has led to a plunge in tax receipts, required federal bailouts of financial institutions, and been met — appropriately — with temporary measures to stimulate growth and support employment.

The point is that running big deficits in the face of the worst economic slump since the 1930s is actually the right thing to do. If anything, deficits should be bigger than they are because the government should be doing more than it is to create jobs.

True, there is a longer-term budget problem. Even a full economic recovery wouldn’t balance the budget, and it probably wouldn’t even reduce the deficit to a permanently sustainable level. So once the economic crisis is past, the U.S. government will have to increase its revenue and control its costs. And in the long run there’s no way to make the budget math work unless something is done about health care costs.

But there’s no reason to panic about budget prospects for the next few years, or even for the next decade. Consider, for example, what the latest budget proposal from the Obama administration says about interest payments on federal debt; according to the projections, a decade from now they’ll have risen to 3.5 percent of G.D.P. How scary is that? It’s about the same as interest costs under the first President Bush.

Why, then, all the hysteria? The answer is politics.

The main difference between last summer, when we were mostly (and appropriately) taking deficits in stride, and the current sense of panic is that deficit fear-mongering has become a key part of Republican political strategy, doing double duty: it damages President Obama’s image even as it cripples his policy agenda. And if the hypocrisy is breathtaking — politicians who voted for budget-busting tax cuts posing as apostles of fiscal rectitude, politicians demonizing attempts to rein in Medicare costs one day (death panels!), then denouncing excessive government spending the next — well, what else is new?

The trouble, however, is that it’s apparently hard for many people to tell the difference between cynical posturing and serious economic argument. And that is having tragic consequences.

For the fact is that thanks to deficit hysteria, Washington now has its priorities all wrong: all the talk is about how to shave a few billion dollars off government spending, while there’s hardly any willingness to tackle mass unemployment. Policy is headed in the wrong direction — and millions of Americans will pay the price.

WASHINGTON — In a federal budget filled with mind-boggling statistics, two numbers stand out as particularly stunning, for the way they may change American politics and American power.

But the second number, buried deeper in the budget’s projections, is the one that really commands attention: By President Obama’s own optimistic projections, American deficits will not return to what are widely considered sustainable levels over the next 10 years. In fact, in 2019 and 2020 — years after Mr. Obama has left the political scene, even if he serves two terms — they start rising again sharply, to more than 5 percent of gross domestic product. His budget draws a picture of a nation that like many American homeowners simply cannot get above water.

For Mr. Obama and his successors, the effect of those projections is clear: Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors. Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country’s influence around the world eroded.

Or, as Mr. Obama’s chief economic adviser, Lawrence H. Summers, used to ask before he entered government a year ago, “How long can the world’s biggest borrower remain the world’s biggest power?”

The Chinese leadership, which is lending much of the money to finance the American government’s spending, and which asked pointed questions about Mr. Obama’s budget when members visited Washington last summer, says it thinks the long-term answer to Mr. Summers’s question is self-evident. The Europeans will also tell you that this is a big worry about the next decade.

Mr. Obama himself hinted at his own concern when he announced in early December that he planned to send 30,000 American troops to Afghanistan, but insisted that the United States could not afford to stay for long.

“Our prosperity provides a foundation for our power,” he told cadets at West Point. “It pays for our military. It underwrites our diplomacy. It taps the potential of our people, and allows investment in new industry.”

And then he explained why even a “war of necessity,” as he called Afghanistan last summer, could not last for long.

“That’s why our troop commitment in Afghanistan cannot be open-ended,” he said then, “because the nation that I’m most interested in building is our own.”

Mr. Obama’s budget deserves credit for its candor. It does not sugarcoat, at least excessively, the potential magnitude of the problem. President George W. Bush kept claiming, until near the end of his presidency, that he would leave office with a balanced budget. He never got close; in fact, the deficits soared in his last years.

Mr. Obama has published the 10-year numbers in part, it seems, to make the point that the political gridlock of the past few years, in which most Republicans refuse to talk about tax increases and Democrats refuse to talk about cutting entitlement programs, is unsustainable. His prescription is that the problem has to be made worse, with intense deficit spending to lower the unemployment rate, before the deficits can come down.

Mr. Summers, in an interview on Monday afternoon, said, “The budget recognizes the imperatives of job creation and growth in the short run, and takes significant measures to increase confidence in the medium term.”

He was referring to the freeze on domestic, non-national-security-related spending, the troubled effort to cut health care costs, and the decision to let expire Bush-era tax cuts for corporations and families earning more than $250,000.

But Mr. Summers said that “through the budget and fiscal commission, the president has sought to provide maximum room for making further adjustments as necessary before any kind of crisis arrives.”

Turning that thought into political action, however, has proved harder and harder for the Washington establishment. Republicans stayed largely silent about the debt during the Bush years. Democrats have described it as a necessary evil during the economic crisis that defined Mr. Obama’s first year. Interest in a long-term solution seems limited. Or, as Isabel V. Sawhill of the Brookings Institution put it Monday on MSNBC, “The problem here is not honesty, but political will.”

One source of that absence of will is that the political warnings are contradicted by the market signals. The Treasury has borrowed money to finance the government’s deficits at remarkably low rates, the strongest indicator that the markets believe they will be paid back on time and in full.

The absence of political will is also facilitated by the fact that, as Prof. James K. Galbraith of the University of Texas puts it, “Forecasts 10 years out have no credibility.”

He is right. In the early years of the Clinton administration, government projections indicated huge deficits — over the “sustainable” level of 3 percent — by 2000. But by then, Mr. Clinton was running a modest surplus of about $200 billion, a point Mr. Obama made Monday as he tried anew to remind the country that the moment was squandered when “the previous administration and previous Congresses created an expensive new drug program, passed massive tax cuts for the wealthy, and funded two wars without paying for any of it.”

But with this budget, Mr. Obama now owns this deficit. And as Mr. Galbraith pointed out, it is possible that the gloomy projections for 2020 are equally flawed.

Simply projecting that health care costs will rise unabated is dangerous business.

“Much may depend on whether we put in place the financial reforms that can rebuild a functional financial system,” Mr. Galbraith said, to finance growth in the private sector — the kind of growth that ultimately saved Mr. Clinton from his own deficit projections.

His greatest hope, Mr. Galbraith said, was Stein’s law, named for Herbert Stein, chairman of the Council of Economic Advisers under Presidents Richard M. Nixon and Gerald R. Ford.

Stein’s law has been recited in many different versions. But all have a common theme: If a trend cannot continue, it will stop.

By David E. Sanger, New York Times, 2-1-10

Yesterday I posted some data from the Census Bureau that suggests there are about 1.8 million excess vacant housing units in the U.S. (above the normal levels).

IMPORTANT: The housing stock includes both owner occupied and rental units. I suspect many of the excess units absorbed will be by renters.

This raises a key question for the economy and jobs: How much longer until these excess housing units will be absorbed?

The answer depends on 1) how many net units are added to the housing stock, and 2) how many net households are formed. The table below shows about 650 thousand net housing units added to the stock in 2009.

Housing units include single family homes (included as 1 to 4 units), apartments (5+ units), and mobile homes. Demolitions are subtracted from the stock (note: demolitions are the hardest to estimate).

In 2009, because of the recession, fewer than normal net households were formed (probably around 650 thousand), so the excess inventory was not reduced.

NOTE: Table is based on Completions. Housing units added to stock:

We expect our September quarter will be the most challenging as the tax credit for home sales will have expired. As we move past the selling season, we'll be able to get a better read on core demand and we'll adjust our business accordingly.

The manufactured homes data is from the Census Bureau (and demolitions are estimated).

The good news is the population is growing at around 2.6 million people per year. And based on normal household formation to population ratios, this would usually mean 1.1 million or more net new households formed in 2010. Unfortunately job growth will probably be weak in 2010 and hold down household formation, but this suggests the number of excess units should finally start declining in 2010 - perhaps by more than 600 thousand units, perhaps even cut in half. (note: this doesn't include 2nd home buying that might also reduce the number of excess units).

Those expecting a sharp increase in residential construction this year will probably be disappointed since there are still a large number of excess vacant housng units - and, as I've noted many times, residential investment is usually one of the engines of recovery (both for GDP and jobs) - so I expect those looking for a "V-shaped" recovery will be disappointed too.

We are still a long way from significant job growth in residential construction, but we might actually see progress in reducing the excess inventory this year.

By Calculated Risk, 2-3-10

Although determining value remains a difficult task because there have been relatively few transactions, the Moodys/REAL Commercial Property Price Index numbers show a 40% drop for multifamily properties from the market peak to the third quarter of 2009.

“Starting in 2010, we are going to see a lot of loans mature where the properties are well located. And given the economic climate, the occupancy level is acceptable. But the problem is the value is gone,” says Bacon.

Some owners whose equity has essentially been wiped out could begin to neglect properties, explains Bacon. “They don’t fix the roof. They start getting sloppy about who they let in. You end up with an asset in very bad shape, which can often create a political problem. Nowadays, we (Fannie Mae) get government funding. Everybody expects us not only to be the investor, but the manager of apartments in some sense.”

Ultimately, a raft of properties could be in need of being recapitalized, says Bacon, but it’s not clear where that capital is going to come from. “Who is going to be the white knight?”

Bacon’s insights came Tuesday during a lively panel discussion titled “And Now What?” at the annual Mortgage Bankers Association convention for commercial real estate and multifamily financing. The show, “CREF 10”, drew 2,000 attendees, up from about 1,700 the year before, according to an MBA spokesperson. The Mandalay Bay Convention Center is the site of the four-day conference, which ends Thursday.

Twin billing

David Twardock, president of Prudential Mortgage Capital Co. based in Newark, N.J. says he has two major concerns regarding the health of the apartment industry. One is that the job market won’t improve significantly to help fill up apartments and office buildings that are currently plagued by high vacancies. The other concern is the threat of rising interest rates.

“For almost all of my 28 years in this business, interest rates have been coming down. I don’t think anybody is prepared for that kind of [rising interest rate] environment,” says Twardock, whose company provided $7.6 billion in financing to the commercial and multifamily real estate industry in 2008.

“If I had to pick one [scenario], I’d rather have interest rates go up and jobs go up because that means rents are going to go up eventually and I can get out of this,” says Twardock. “But I straddle those two worries.”

Michael May, senior vice president of multifamily sourcing for Freddie Mac, is on alert for a potential change in borrower psychology. “Right now most people are looking to the future and seeing pretty positive real estate fundamentals. There is absolutely no supply coming on the market. The demographic trends are positive. There is a positive story, you just need to get to the other side,” explains May.

At the moment, some apartment owners running into major cash flow problems are reluctant to give back properties to the lender. In their view, the market is bottoming out. They’re willing to weather the storm and wait for more favorable pricing and fundamentals to return, says May.

If borrowers wake up one day and find themselves in a stagflation situation, the psychology could change in a hurry, cautions May. “If that happens I think we’re going to wake up overnight and have a serious asset management problem, and that worries me a lot.”

Carol Galante, deputy assistant secretary for multifamily housing with the U.S. Department of Housing and Urban Development, says what concerns her is the wave of borrower workouts that will inevitably occur over the next two years.

“I am doubly concerned that as a governmental entity, I don’t have all the flexibility and the tools that I’d like to have to work through this period,” says Galante. “On the other hand, I think it’s an historic opportunity for picking up assets, if we can figure out a way to unfreeze them and get them recapitalized. It’s an historic opportunity to recapitalize properties at historically low values.”

By Matt Valley, National Real Estate Investor, 2-3-10

China’s property market “bubble” is set to burst as the government curbs credit growth and clamps down on speculation, according to independent economist Andy Xie.

As bank lending slows, “it’s very difficult to see this demand continuing,” Xie, formerly Morgan Stanley’s chief Asian economist, told Bloomberg Television in Hong Kong today.

Tougher property policies may lower 2010 sales volumes 10 percent, compared with an earlier forecast for growth of as much as 5 percent, BNP Paribas said in a report today. The Shanghai Composite Index has slid 10 percent this year, the worst performer among the 94 global gauges tracked by Bloomberg, on concern that China will add further lending curbs. The index dropped 0.2 percent to 2,934.71 today.

Shanghai Mayor Han Zheng said Jan. 31 property prices are “too high,” undermining sustainable development of the nation’s commercial hub. Asset bubbles are the “real worry” as China emerges from the global financial crisis into a “boom time,” central bank advisor Fan Gang said in Beijing yesterday.

Residential and commercial property prices in 70 Chinese cities rose 7.8 percent in December from a year earlier, the fastest pace in 18 months, the National Development and Reform Commission said. China’s economy expanded 10.7 percent in the fourth quarter, as the government’s 4 trillion yuan stimulus package and a record 9.59 trillion yuan of new loans last year fueled the fastest growth in two years.

Speculation

The government last month raised the amount of money banks are required to keep as reserves and re-imposed a sales tax on homes sold within five years of their purchase. Premier Wen Jiabao pledged in December to stabilize property prices, crack down on speculation and keep housing affordable.

The government told banks to raise interest rates on third mortgages and demand bigger down-payments, a person with knowledge of the matter said. The China Banking Regulatory Commission warned lenders of the risks from “hot money” flowing into the property market, the person said, requesting anonymity because the agency hasn’t published the measures. Mortgage defaults are rising, the person said, without giving figures.

“We’re seeing some significant measures that have been introduced in the last couple of weeks,” Xie, who correctly predicted in April 2007 that China’s equities would tumble, said. “If these changes are implemented, the demand from third-flat buyers is going to dry up and it’s going to have a major impact.”

Vacant

Many properties bought for investment are now left vacant and rental yields are low, pointing to a “bubble,” Xie said.

Shanghai Zendai Real Estate Co. agreed to pay 9.22 billion yuan ($1.35 billion) for a plot of land adjacent to the city’s riverside Bund area, according to the Shanghai Real Estate Trading Center. Zendai is paying 34,148 yuan per square meter for the lot, the highest per meter price paid for land in China this year, according to property Web site Soufun.com.

“Developers paying record prices for land might get trapped this year,” Xie said.

Property prices will be “flat” this year, BNP Paribas analysts Trevor Cheung and Frank Chen said in their report.

Chua Kong Ho, Haslinda Amin, Bloomberg, 2-2-10

Real estate securitization was one of the great innovations in finance in the last quarter-century. In an unprecedented way, it allowed vast sums of money to go into the real estate market from people who traditionally did not take part in it. But the people making the loans did not need to worry if they would be repaid, and in the end the entire edifice collapsed.

Now, with the securitization market nearly dead, getting that market going again is vital to providing Americans with mortgage loans. Securitization may need to be reformed a little, but it remains critically important to a well-functioning economy. That is the conventional wisdom, at least among many bankers and economists.

Most of it is right, except that “unprecedented” part. Although few people remember it, another wave of private securitizations once altered the real estate landscape, particularly in New York, but also in Chicago and other American cities, Floyd Norris writes in his latest column in The New York Times.

That wave ended pretty much like this one did.

That fact should raise questions about whether the securitization machine should be patched up and back in business to operate without government guarantees.

Perhaps, instead, we should find a way to get banks and other long-term investors, like insurance companies, to make — and keep — most of the real estate loans that are needed in society.

The original wave of securitizations took place in the 1920s, when the United States went on the greatest building boom ever. Many investors saw how rapidly real estate prices were rising and wanted in on the action. The builders and brokers were only too happy to oblige.

To be sure, the securitizations were not as complex as the ones invented in recent years, but they were not all simple either. Most were bonds backed by one commercial building whose construction was being financed, but there were also pools of residential mortgages. Some of the bonds included warrants for partial ownership of the building, and some were convertible into stock.

There was even something similar to the exotic C.D.O.’s, or collateralized debt obligations, that failed so spectacularly. Those securities were not directly backed by real estate, but were instead supported by other securities that had such backing. One 1920s bond was called a “collateral trust” security, with a claim on a building’s profits but not on the building itself.

“Easily obtainable financing via public capital markets corresponded with an urban construction boom,” reported William N. Goetzmann and Frank Newman in a paper just released by the National Bureau of Economic Research, titled “Securitization in the 1920s.”

“Regulation and centralization were glaringly absent,” they add. “Ultimately the size, scope and complexity of the 1920s real estate market undermined its merits, causing a crash not unlike the one underpinning our current financial crisis.”

Yet the lessons of that boom and bust have largely been ignored. Everyone remembers the 1920s and the stock market crash of 1929, but there has been little data collected on what happened to real estate securities or even on how large a market it was. It turns out that real estate securities constituted a major market, and began to falter before stocks did.

“The breakdown in their valuation, through the mechanism of the collateral cycle, may have led to the subsequent stock market crash of 1929-30,” they wrote.

If Ben Bernanke had been thinking of that, do you think he might have been more hesitant to say that the subprime mortgage crisis had been “contained” in 2007?

The paper by Professor Goetzmann, the director of the International Center for Finance at Yale University’s School of Management, and Mr. Newman, a former Yale student who is now an analyst for the hedge fund Protégé Partners, appears to be the first to delve into the available data, which Mr. Newman had to dig up.

Professor Goetzmann, who teaches both real estate finance and financial history, said he grew interested in the subject after coming across old real estate bonds and wondering what the story was behind them.

The story, it turns out, is one intrinsic to the New York skyline. From 1929 through 1931, according to data compiled by Mr. Newman, 128 buildings that were 70 or more meters in height, or about 230 feet, were completed in New York City. That was the most ever.

Over the last three years, 2007 through 2009, the figure was 87. That was the highest number in nearly 30 years.

It is notable that the record construction period continued for two years after the Depression had begun, just as cranes dotted the New York skyline last year even as the worst recession since World War II went into its second year. Big buildings take time to plan and to build. Once begun, the best course may be to finish, even if the economy offers little hope for leasing out the space.

Today, those who say securitization is necessary to get the economy moving again argue that the process brings together investors and those with the capacity to make loans, and that banks simply do not have enough capital to make the needed loans.

It was pretty much the same story in the 1920s, Professor Goetzmann and Mr. Newman reported.

Real estate bond firms “generally served simultaneously as originators, underwriters and distributors,” they wrote. “Performing these three functions proved incredibly lucrative in an optimistic real estate market. So long as investors were easy to locate, bond houses could collect substantial fees for these services without having to part with much, or any, of their own capital.”

So it was for Wall Street firms that snapped up mortgage lenders earlier in the last decade. Among the biggest in mortgage origination, underwriting and distribution were Lehman Brothers and Bear Stearns.

A major difference between then and now is that most of the real estate securities issued in the 1920s went to build structures, many of which still stand and provide housing or employment. A much greater proportion of real estate securitizations in the last decade went to help people buy existing buildings, an activity that left behind no such legacy.

Among the buildings financed with bonds was the Waldorf Astoria Hotel, whose bonds were issued on Sept. 1, 1929, about as bad a piece of market timing for the buyers as can be imagined. The bonds held their own for a few months, but plunged before the hotel opened in 1931.

In 1942, Conrad Hilton began buying up the Waldorf bonds for less than 5 cents on the dollar and was, he recalled in his memoir, “Be My Guest,” deemed to be the kind of sucker who might buy the Brooklyn Bridge.

“In New York, hotels are dead,” a real estate broker told Hilton. “There are too many of them.” Hilton kept buying the bonds, and eventually took over the Waldorf. It was a much better investment for him than it had been for the original bond investors.

If economists and regulators had recalled the securitizations of the 1920s, they might have realized that the recent boom in real estate securitizations was not what they took it to be: a result of American financial ingenuity that created ways to spread risk to those who could best afford to bear it and in the process made financing more available and less expensive.

It was, instead, the same old speculative enthusiasm, even if it was wearing fancy new clothes. Investors who had seen real estate prices rise thought that trend could not end. Wall Street sharpies thought they had found a way to make lots of money while not bearing the ultimate risk if the game suddenly ended.

As it turned out, the sharpies were wrong. They too got swept up in the carnage — just as their predecessors had in the 1930s.

New York Times Dealbook, 1-29-10

Institutional investors are making big plans to invest more heavily in commercial properties in 2010, despite major write-downs that have left some portfolios worth half of their value since the market peak in 2007.

Leading the way as one of the pension fund bellwethers is the California Public Employees’ Retirement System (CalPERS), with $206 billion in total assets under management.

Its chief investment officer, Joseph Dear, says he is not afraid to jump back into the steaming cauldron that is the commercial real estate investment market, even after being badly burned in the last two years.

“Real estate has been tough for us, but opportunities are going to be developing and we’d like to take advantage of the distress in 2010,” says Dear.

Surprisingly, this statement comes after CalPERS’ real estate portfolio lost an astounding 50% of its value in the year ended Sept. 30, 2009, dropping to $13.5 billion.

“We took a huge hit in real estate,” admits Dear. “It’s a hugely painful lesson.” He also notes that there is lingering concern over the health of commercial real estate. “The fundamentals still aren’t good and there may be further write-downs, but our write-down in the portfolio was as realistic as we could possibly make it.”

The flaws of CalPERS’ previous investment strategy are well documented, including overly aggressive leverage and poor underwriting coupled with ill market timing. The fund’s board of directors has made moves to right its past mistakes. It recently fired several of its advisors and instituted strict new oversight guidelines on new investments, along with hiring Dear to lead the charge.

In the short term at least, Dear, who joined the fund in March 2009 fresh from his stint as executive director at the Washington State Investment Board, inherited a portfolio that is expected to rack up further losses.

Pension Consulting Alliance, the fund’s lead real estate advisor, predicts that the value of CalPERS’ real estate portfolio will continue to decline for at least the next 12 months.

Dear would not specify how much CalPERS might plow into real estate, but the fund could invest $6 billion in the sector, based on its target of 10% of total fund assets.

Jumping back into the fray seems logical to some. “It’s the only way to take advantage of a bad situation,” says Hessam Nadji, managing director of research services at Marcus & Millichap. “Having written [the portfolio] down, now it’s really important to write it back up. The only way to do that is to take a position in the market and make new investments.”

Among pension funds, CalPERS is not alone in returning to the real estate markets. In January 2010, the Ohio Public Employees Retirement System approved new commitments totaling $600 million into funds run by JP Morgan and UBS. These commitments follow previous investments of $200 million in the same funds in 2004 and 2007, respectively.

Meanwhile, the Teacher Retirement System of Texas and USAA Real Estate Co. have entered into a joint venture that plans to invest more than $300 million in commercial real estate across the country.

Making commitments is one thing, but finding deals is another, as competition has become fierce. Private equity players alone have amassed some $173 billion in dry powder waiting for the “right opportunities” in distressed assets or problem loans along with everyone else.

Still, Nadji believes institutional investors will be among the buyers at the front of the line. “We’re seeing them come out of defensive mode, come out of write-down mode and try to position the capital that’s been raised for more opportunistic investments going forward.”

Real estate investment trusts (REITs) also are aggressively scouting deals, after raising some $32 billion of equity and debt in 2009. “They are in an optimal position now that their stock prices have rebounded, and we’re seeing them bid a lot more on assets that we’re marketing versus six months ago,” says Nadji. “They’re in the hunt. They’re not coming in as the top or second buyer, but they’re becoming more aggressive.”

In the near term, core investments, including downtown office properties in established, stable markets like Washington, D.C. and New York, will likely be at the top of the institutional investors’ shopping lists.

“There already has been an increasing emphasis on the pursuit of core assets in major markets,” says Steve Pumper, executive managing director at Transwestern Commercial in Dallas. “This trend will continue to increase as core prices stabilize.”

Recent evidence suggests that price declines may have bottomed. The latest Moody’s/REAL commercial property index registered a 1.0% increase in property prices in November, the first in more than a year.

By Ben Johnson, National Real Estate Investor, 1-28-10