Wednesday, March 10, 2010

Getting Weary of the Sibyls

These days, people are falling all over each other to repeat, retweet, recast and report dire predictions about the state of the commercial real estate business. They are the hysterical oracles of modern day, much like the Sibyls of Ancient Greece. Most often, they trot out the widely broadcast news that $1.4 trillion in commercial real estate mortgages are due to mature between now and 2014. I have no reason to doubt the figure, but I say, “So what?”. I am purely speculating, but I suspect that there was an equal amount of debt during the four years between 2006 and 2010. The problem in commercial real estate is not the size of the debt, it is the value of the underlying collateral. We appear to be under water. In fact, some borrowers are drowning.

Real estate loans are placed based on the appraised value of the property being mortgaged. In years past, a investor could borrow 80%, even up to 90%, of the appraised value. Recently, the loan to value (LTV) ratios available to borrowers have dropped to about 60-65%. Additionally, property values have dropped by 20-30% in many cases. Let’s do the math. In 2005, a borrower took out an $800,000 mortgage with a five year term on a $1,000,000 property (80% LTV). When the loan matures in 2010, the property is now worth $800,000 and the bank is willing to loan $480,000 (60% LTV). The borrower owes more than the bank is willing to lend. This is the dilemma that real estate investors, developers and business people are faced with in today’s climate.

However, some good news recently was delivered to my “in box.” Jim Collins is a mortgage broker with First Southern Mortgage in Knoxville. He had just returned from a Commercial Real Estate (CRE) Finance conference. Relating to the previous paragraph, Jim said, “There is plenty of long term, fixed rate money available (for the right deals). Our experience is that many loans originated in the easy credit times of 2005-2008 are overleveraged and we cannot take out the existing debt.”

The remainder of his comments clearly indicates a sea change in attitude toward commercial real estate lending.

“All in all, the mood was optimistic. With very few exceptions, Life (Insurance) Companies have CRE allocations for 2010 and are looking for business. The panic to hoard cash is in the past and everyone is looking to get back to the business at hand...investing money. While most everyone would like to do conservative loans in the 60% to 65% (LTV) range, a few recognize that there just aren’t that many low LTV deals in the market and pressure will drive leverage points up. A couple of Life Companies openly admitted, “If we are going to be doing 75% LTV deals by the end of 2010, then we might as well offer it now and try to pick off the best product in the market.”

“Conduits are gingerly reentering the market. Securitization is testing the waters again with loans up to 70-75% LTV.” Conduits, more formally known as commercial backed mortgage securities, are one of the main sources of funding for commercial real estate, along with life insurance companies and pension funds.
I shouldn’t have to tell you that this is good news. It is not a silver bullet, but it should quiet some of the Sibyls.

Friday, March 5, 2010

Who Benefits from Urban Outfitters?

The Central Business Improvement District’s (CBID) board of directors recently approved a $500,000 grant to support the location of an Urban Outfitters store on Market Street in downtown Knoxville. For the record, I fully support and commend the actions of the CBID Board and Tim Hill and his staff at Hatcher-Hill Properties who solicited Urban Outfitters to consider Knoxville for expansion. Downtown developers and boosters have long sought a “catalyst project” to spur additional growth and development in the city center. I agree with Mr. Hill’s statement at the CBID meeting that Urban Outfitters can be that catalyst.

What I found interesting was the example he used to highlight the catalytic possibilities. He talked briefly about the Third Street Promenade, a downtown redevelopment project in Santa Monica, California. Urban Outfitters apparently committed early to this project. He mentioned four additional retailers who followed UO’s lead – Old Navy, Barnes & Noble, Apple and Pottery Barn. No one thinks that national retailers of this caliber will blindly follow Urban Outfitters into largely unproven markets like downtown Knoxville; however, let’s assume that UO exceeds its sales projections downtown. Other retailers will know about their success and will want to locate there. That is the nature of a catalytic project.

My questions are, “What happens when Pottery Barn and Old Navy call? Shouldn’t we be discussing it now? And Who exactly should be leading the discussion?”

Look at it practically. Apple’s footprint of less than 6,000 square feet can be accommodated easily; however, Old Navy Stores are generally between 20,000- 35,000 square feet. Barnes & Noble stores range from 25,000 – 67,000 square feet. Pottery Barn is a modest 10,000 – 14,000 square feet. If Urban Outfitters is the catalyst for their potential interest, it can reasonably be assumed that these retailers would want to occupy space nearby. Is it beyond possibility that Market Square could be taken over by national retailers? Others have suggested Jackson Avenue, specifically the McClung Warehouses, as a possible retail corridor. Although, if you are a retailer whose impetus for being in Knoxville is the benefit of co-tenancy with Urban Outfitters, would Jackson Avenue be a viable location?

In a random and admittedly limited poll, I asked people what building downtown is suitable for the next large retailer. One hundred percent of the respondents chose The Penney’s Building . And what about the third choice for a large retailer? Most people did not have an answer. The Campbell Building? The Farragut Building? Marble Alley?

The point is that we should be planning now. The grant approved by the CBID was not a desperate attempt to save downtown. It was an endorsement of downtown’s vibrancy and acknowledgement that sometimes major steps forward require a little catalyst. Let’s start talking about what happens when our catalyst catches fire.
In the most recent Loopnet Pulse Poll, 1500 Owners, investors and brokers were asked to time the recovery, which was defined as the point in time when commercial real estate transaction volumes will increase.

















45% of respondents answered 2010; 35% said 2011 and 20% said 2012. Data shows show that transaction volume increased 40% in Q4 2009 over Q3 2009. Although Q4 2009 was 24% lower than Q4 2008, that result was much better than the 65% drop in the Q1-3 2009 period as compared to Q1-3 2008.

When asked to name the biggest obstacle to completing transactions, 50% of respondents cited debt financing and 25% referred to high asking prices. Interestingly, 50% of the responses from the investor group said high asking price was the biggest obstacle.















60 % of the respondents believe that commercial prices will bottom in 2010. However, only 45% expect that transaction volumes will increase in 2010. This discrepancy suggests that there will need to be a period of stable pricing before buyers will reenter the market in earnest.

Note: Moody’s/ REAL CPPI (commercial real estate pricing index) ticked up slightly in November. Does this represent a change in sentiment that will result in buyers taking action?