Are REITs selling below their appraised value? Maybe not...
interactive.wsj.com
September 21, 1998
Commercial-Property Market Cools Off Amid Credit Crunch
By DAVID D. KIRKPATRICK
Staff Reporter of THE WALL STREET JOURNAL
An odd thing is happening in the commercial real-estate market: Rents still are rising, but the prices of office towers, apartment buildings and hotels are beginning to come down for the first time in six years.
Real-Estate Funds Rummage Overseas
The decline reflects the recent tumult in global capital markets. Economic woes in Russia, Asia and Latin America have made investors more risk averse, cutting the demand for commercial-mortgage-backed securities and other investments. Lenders that depend on reselling commercial mortgages as securities are pulling back, making loans harder to come by. With fewer potential buyers able to get loans, demand for commercial properties is slowing, even though rental revenue remains robust.
"There is a definitive credit crunch," says Stephen Siegel, president of Insignia/ESG Holdings Inc., a New York brokerage company. "With less money available, I would expect it to bring down prices as much as 15% to 20% in some places."
He says the office properties are the most susceptible to the softening of demand because their prices have risen the most quickly, while retail properties will be less affected because they haven't been bid up as fast.
Visible Effects
The effects already are visible. Just last month, a midtown Manhattan office building for sale by John Hancock Mutual Life Insurance Co. attracted several bids of more than $240 million. Now two bidders remain, SL Green Realty Corp., a real-estate investment trust based in New York, and a joint venture between Vornado Realty Trust and investment company Taconic Investment Partners. The price under discussion is less than $225 million, according to people involved.
"Until two months ago, money has been coming out of everybody's ears," says Mark Edelstein, a real-estate lawyer at Milbank, Tweed, Hadley & McCloy in New York. "Now suddenly you can't just call three people and get three loans."
Some deals are even at risk of falling apart. New York developer Harry Macklowe is scrambling to complete the pending acquisition of a Manhattan office building after his lenders at Deutsche Bank raised the requirements to finance the deal. A spokesman for Mr. Macklowe said he expects the deal to be completed.
Other loans face last-minute renegotiations. In Atlanta, NationsBank Corp. abruptly raised the interest rate and decreased the size of its mortgage to Taylor Simpson Group, a New York real-estate firm, on the eve of its deal to buy the Peachtree Center for $245 million, according to people involved. The deal closed two weeks ago. NationsBank and Taylor Simpson declined to comment.
Landlords to Benefit
If the decline in commercial-property values continues, long-term landlords may benefit, analysts say. Lower property values create less incentive to build new buildings, and more difficult lending standards discourage new development. That promises to keep rents from falling as far in the event of a recession.
Home sales and residential mortgages are a somewhat different story. Residential mortgage interest rates remain low, following the yield on treasury bonds, and home prices still are fairly strong. Even so, Friday's report of a 5.5% drop in housing starts during August could signal a slowdown in residential sales.
The downturn in commercial-property prices is in sharp contrast to the last real-estate cycle, when almost all property companies were private and the lenders were often savings and loans. "In the late 1980s, the smartest real-estate people anticipated deteriorating prices several years before lenders," says Eric Hemel, analyst at investment bank Merrill Lynch. "In this case, the credit markets seem to be alarmed before we've seen any sign of significant deterioration on the ground."
The main reason for the decline is the prominent role investment banks play in real-estate lending. In the first half of the year, about $40 billion of commercial mortgages were securitized and resold, adding to an existing market of about $160 billion. Many of the loans were made by other banks and then securitized on Wall Street. Those banks and securities firms are much more reluctant to lend now that the market for the bonds is drying up.
Switch to Traditional Lenders
Firms such as Credit Suisse Group's CS First Boston Corp., Lehman Brothers Holdings Inc. and Nomura Securities Co.'s Capital America unit often made short-term acquisition loans for more than 95% of a property's value. Now many of the Wall Street firms, including First Boston and Lehman, are pulling back, forcing property buyers to turn to more traditional lenders. Those lenders, such as commercial banks and insurance companies, customarily require borrowers to put up at least 25% of a property's value.
The Wall Street firms and the banks that feed them loans face the possibility of losses because the resale value of their loans declined unexpectedly. The extent of any losses won't be known until the loans are sold. Nomura's Capital America plans this month to securitize and resell many of the $6 billion in loans it made during the past six months and expects to report a $200 million loss for the period, according to people at the company. Last week, Capital America announced the resignation of the unit's flamboyant founder, Ethan Penner, credited with creating the commercial-mortgage-backed securities market.
"The damage appears to be significant" in commercial-mortgage-backed securities, says Thomas Curtin, managing director of investment bank Warburg Dillon Read, a big lender to REITs.
Warburg and other banks are continuing to make loans for syndication to other banks. But a letter this summer from the Federal Reserve Board warning about too much exposure to real estate made many of them more cautious as well, Mr. Curtin says.
Insurance companies still are lending, too, but they aren't racing in to fill the void and they also have been raising interest rates, along with the rest of the market, says James Digney, senior vice president of Metropolitan Life Insurance.
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