Commercial Real Estate: Pockets of Improvement But Long Slow Recovery Ahead

Q4 Sentiment Index Remains Flat Amid Weak Job Growth, Ongoing Refinancing Difficulties, Uncertainty Over Government Policy

WASHINGTON, Nov. 1, 2010 /PRNewswire-USNewswire/ -- Commercial real estate markets are in for a long, slow recovery amid persistently high unemployment, ongoing concern over government policy, uneven availability of capital for refinancing, and other factors dampening market activity, according to The Real Estate Roundtable's Q4 survey of over 110 senior commercial real estate executives.

The latest survey suggests continued incremental improvement in market activity, pricing and transaction volume as well as access to capital, although this is largely limited to well-leased, well-located "class A" properties — often in so-called "gateway" cities — prompting anecdotal references by survey respondents to a "bifurcated market."  Aside from the most high-profile projects, said one respondent, "serious shortages exist for the majority of the industry in tapping both debt and equity."

The overall Sentiment Index dropped by one point this past quarter, to 73, but has been on a relatively flat trajectory since the beginning of the year and appears likely to stay that way for some time.  Asked how real estate market conditions will be one year from now, fewer respondents in the Q4 survey said they expect conditions to be "much better," while more respondents projected only "somewhat better" conditions.

"Positive opportunities certainly exist; however, our industry overall will continue to be weak until the job market improves," said Roundtable Chairman Daniel M. Neidich (Dune Real Estate Partners). "More than anything, we need a return to hiring, which would boost consumer spending, lift occupancy levels and operating income, and begin to repair the dramatic erosion of commercial property values, which are fundamental to owners' ability to obtain debt and equity capital," he said. "That's why we continue to urge policymakers to look at policy ideas through a 'job creating prism.'"

Added Roundtable President and CEO Jeffrey DeBoer, "There remains a high degree of caution — over the economy, the elections, the fate of expiring tax provisions, and other issues — that continues to hold back job creation, which in turn is holding back recovery in commercial real estate.  Jobs are key, since that's what drives demand for office, retail and warehouse space, and it's what drives business and leisure travel and hotel occupancy levels."

Reinforcing the sense of a flat trajectory in the marketplace, the percentage of Q4 survey respondents who said debt availability is better today than a year ago remained unchanged from the previous quarter. However, less respondents in the latest survey said debt conditions are "much better," while more respondents said they are only "somewhat better." There was also a slight uptick since Q3 in the percentage of respondents saying debt availability is "somewhat worse" today than one year ago.

On the equity side, the percentage of respondents who said equity availability is better today than one year ago declined slightly between Q3 and Q4 (from 78 percent to 75 percent), with less respondents now saying these conditions are "much" better.  The percentage of respondents who said equity conditions are "about the same" increased by 2 percentage points in the latest survey.

Despite signs that capital markets are slowly improving — as well as reports that large amounts of equity capital are "waiting in the sidelines" — "there is insufficient debt to fully recapitalize assets or refinance existing deals," said one respondent. "Thus, there is a lot more improvement needed before the real estate and capital markets can be said to be functioning properly."

Looking ahead, slightly more participants in The Roundtable's Q4 survey projected that debt and equity availability would be "about the same."  Fewer respondents said conditions would be worse, suggesting that capital markets will continue their slow trajectory of improvement.  Still, respondents expressed ongoing concern about market fragility and the lack of financing for "B" assets.

In addition to the estimated $1 trillion equity gap in commercial real estate—caused by property devaluation and higher lender demands for equity—the commercial mortgage-backed securities (CMBS) market remains far from the capacity needed to refinance maturing loans.  Once the second largest source of commercial mortgage debt (after banks), CMBS issuance plummeted from $230 billion in 2007 to $1.36 billion in 2009, and only recently began to recover — thanks in part to the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF).

However, problems remain, in part due to pending securitization regulations required by this year's financial overhaul law ("Dodd-Frank") and new accounting standards requiring issuers to keep securitization transactions (and associated risk) on their balance sheets (FAS 166-167).  A Fed report on Oct. 19 concluded that the "cookie-cutter" approach to "risk retention" in the financial overhaul law would not help revive financial markets, and could ultimately reduce credit availability. http://federalreserve.gov/boarddocs/rptcongress/securitization/riskretention.pdf.

A PDF of the entire Q4 Sentiment Survey Index is available online at www.rer.org.  

SOURCE Real Estate Roundtable