Questionable Future
Finance and Investment Outlook for 2010
The questions couldn’t be more important as Arizona’s battered commercial real estate market works its way through yet another year marred by a stubborn recession. What solutions await troubled loans bundled in commercial mortgage-backed securities (CMBS) maturing over the next two years? Will property values bottom out soon? Is there financing for new projects in 2010? What are the opportunities for investors and how should they approach the market? Industry experts share their views: Finance Outlook “The Arizona market in particular — along with parts of California, Nevada and Florida — is right up there,” says Brandon Harrington, vice president in the Phoenix office of Cohen Financial. “We have really become problem solvers, rather than arranging financing.” A big problem, says Keaton Merrell, a principal with Legacy Capital Advisors in Phoenix, is that CMBS pools are managed by servicers, not the lenders who made the loans and sold them. “There is not a lot of takeout financing available for these loans,” Merrell explains. “There is Fannie Mae and Freddie Mac money available for multi-family, but office and retail are very tough to find debt for right now.” The hospitality sector also is a problem. The urgency of the situation didn’t dawn on servicers until recently, Harrington says, and industry observers aren’t sure how it will all shake out. “There is not a clear path,” Merrell notes. Here’s what CMBS servicers are doing so far, according to Harrington, Merrell and Jim Pierson, another principal at Legacy Capital:
Some servicers have reduced loans 50% to get them off the books, Pierson says. Money for refinancing may be available, but Merrell says what little there is will cost at least 7%, and Harrington says borrowers will face 60% to 65% leverage — not the loan’s original 80%. “It may require an equity injection from the borrower or bringing in a new equity partner to recapitalize the building,” Harrington says. Large and small CMBS loans face the same problems and solutions. Banks also have commercial real estate loans on their books. On Oct. 30, 2009, the FDIC adopted a new policy supporting prudent commercial real estate loan workouts. Harrington and Merrell have seen little to no impact in the local market related to the adopted policy. Pierson expects property values will be “stable to negative” this year, but he is more optimistic about 2011. Valuation will level out over the next two years and cap rates, which have risen, will not climb much higher, according to Harrington. There is little money available for new construction, with the exception of Fannie and Freddie public funding for multi-family. Interest rates of 7% to 8% and loan-to-value well below 80% are the new normal. Few people see a need for new projects in an overbuilt market for at least two years — including multi-family. Investment Outlook “There is no alpha male out there buying with confidence and volume,” Hepner says. “But once that leader establishes itself in this market, you will see pent-up demand deploy cash with fairly significant volume.” Some institutional investors are “marketing the size of their checkbook,” only to second guess themselves when a deal gets traction, Hepner adds. Wealthy individuals are finding better returns in other non-real estate investments. Steven Kindley, senior vice president of capital markets at Cassidy Turley|BRE Commercial in Phoenix (formerly Grubb & Ellis), is quoted by CoStar Group as saying much the same. Kindley sees a benchmark emerging, but also says, “We are working with many clients who have real access to cash and are saying they are ready to buy. But are these buyers really willing to step up in 2010? Has the fear of investing in an uncertain market shifted to greed to capitalize on the historic value opportunity?” Where should investors look for deals? Hepner recommends focusing on higher-end “commodity-type product such as office and industrial. Don’t buy cheaper B and C properties,” he says. “You’re not getting adequately paid for that incremental risk.” Helper likes Downtown Tempe, Scottsdale and the Kierland Commons area for office. The Southeast Valley’s small-bay industrial market offers good “bread-and-butter” investment opportunities as well, he says. Investors willing commit long term should consider bulk industrial space in the West Valley, Hepner adds. With no sure sign that property values have hit bottom, venture capital for new construction is nonexistent in Arizona — with the exception of selective funding from San Antonio-based USAA Real Estate Company, Hepner says. He expects liquidated properties will go on the market the second half of this year, setting the stage for investors to loosen their purse strings and sending a signal to venture capitalists. Hepner has three pieces of advice for serious investors:
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