Interesting Times

Brace yourself for the worst year in commercial real estate since the “1991-1992 depression,” according to Emerging Trends, a joint report by PricewaterhouseCoopers and the Urban Land Institute released this afternoon. Commercial property values could drop 15% to 20% from the peak realized in mid-2007. Losses could be even more severe for lesser-quality commercial properties in secondary markets, the gloomy report concludes.

“The aftershocks of rampant over-the-top lending that batter the entire credit system leave property markets substantially overleveraged and vulnerable to significant depreciation,” the report states. Controlled development, which has largely shielded the commercial sector, is no longer providing protection from the one-two punch of the ongoing housing meltdown and tight credit softening demand as consumers curtail spending and employers cut jobs.

The emerging consensus of more than 600 real estate professionals, including investors, developers, lenders, brokers and consultants is that the U.S. financial and real estate markets will bottom out in 2009 and flounder well into 2010. Investors can expect more foreclosures and delinquencies and a limping economy that will continue to crimp property cash flows....

The subprime mortgage mess is just the tip of the iceberg. Stricter lending standards and the weak economy continue to drain the housing market; property owners are drowning in debt, lenders are not lending, property income flows are at a trickle and there is an unprecedented avoidance of risk. “The worst is over” in the housing market, emphasizes Blank. “The crisis is ending, but there is more pain to come. Pricing needs to revert to 2003 and 2004 levels. Expect a bottom in late 2009.”

Only when financing gets restructured will pricing stabilize, giving the industry a foundation from which to start digging out of this hole, write the authors of Emerging Trends. Lenders will have to move bad loans off balance sheets, using auctions to speed up the process, and force distressed owners to become motivated sellers.

At that point, cash and low-leverage buyers will be king; surviving banks will impose strict lending guidelines; commercial mortgage-backed securities will revive, but must "reformulate."

There are no quick fixes, although the recovery could begin as early as 2010. Authors of the report say the industry will see a return to discipline and a back-to-basics approach to underwriting and deal structure. As the markets deleverage and correct, patient, disciplined, long-term investors will be rewarded. ...

The apartment industry is the most promising sector for investors in 2009, with moderate-income apartments in core urban markets near mass transit offering the best buy. Distribution/warehouse is the second most favorable property type, according to survey respondents.

Meanwhile, downtown office space is expected to outperform suburban office. Retail development has generally hit bottom, while housing faces more foreclosures and no rebound in values for 2009.

(From National Real Estate Investor Newsline