Froth in Commercial Real Estate
The news media has been intensely focused on the subprime lending crisis ever since some of the largest monoline subprime lenders went belly-up earlier this year. However, years of cheap money and loose lending standards did not only effect the residential real estate market. In many cases commercial real estate lending standards were just as loose as residential lending standards. In a New York Times article this morning Jim Duca (pictured above) of Moody's warned "underwriting has gotten so frothy we have to take a stand."
Jim isn't the first one to cry foul about commercial lending standards. Many were shocked when it was revealed that Blackstone's huge $36 billion Equity Office Property was priced with a sub 5% cap rate. I don't know about you, but locking up such a substantial amount of money at under 5% seems like a waste. In their defense, Blackstone had already lined up the sale of many of those properties at similarly ridiculous valuations and their own IRR calculations were undoubtedly rosier.
Due to structural differences between the residential and commercial markets, it is improbable that the commercial market will unwind as quickly as the subprime residential market. Commercial mortgages never got as exotic as the residential market and the interest only variety typically feature large balloon payments at the end of the term (typically 10 years). Due to these factors fallout may yet be years off. The root of the problem is not complexity of the loans, rather it is underwriters using inflated rent projections in their underwriting decisions and investors letting them get away with it.
For example when Blackstone bought EOP they had already reached a deal with Macklowe properties to sell off 5 midtown Manhattan office buildings in the EOP portfolio. The buildings currently rent for $55-59 a square foot but the projections in the Macklowe pro forma called for rents to increase to over $100 a square foot. Without those rent projections it is unlikely Macklowe could have justified buying the properties for $7.25 billion. Relying too heavily on exponential income increases like those in the Macklowe deal are the surest way to get the attention of guys like Jim Duca at Moody's. As the credit agencies tighten up investors demand higher interest to offset their risk, putting pressure on lenders. Though this will slowly squeeze the spigot of cheap money it may be too late for many who -- like subprime borrowers currently watching their equity fall and mortgage rates rise -- might quickly be underwater when rents moderate and the income isn't enough to cover their encumbrances.
The question is, how much excess has their been and when, if at all, will this effect companies like Credit Suisse, Deutsche Bank and GE?
1 comment:
Does anyone know who the largest commercial lenders are?
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