2012 CRE Markets: Up, Down or Sideways?

By Maura O'Connor

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It’s January, so it must be prediction time.  I’ve been listening, watching and reading to see if there’s any consensus about what’s happening in commercial real estate (and CRE finance) nationally, and what folks in the industry think will happen in 2012.  The answer is that no one seems to know.

At the recent Commercial Real Estate Finance Conference in South Beach, Miami, Florida, the general consensus seemed to be that both investors and lenders are seeking safety in the deals they are doing.  That’s understandable in a market that Moody’s says has fallen about 45% from the peak overall.  But there seemed to be no overall consensus about whether the overall CRE market has stabilized or bottomed out yet. 

About a third of the folks seemed to think it has stabilized overall and is not likely to fall much further.  The optimists focus on the following:

• Financing is available at very low rates for deals provided the deals are based on rational assumptions, including actual leases (not ambitious pro formas), purchase prices that reflect current CRE values.
• Unlike residential real estate, commercial real estate was not generally overbuilt. 
• CMBS financing is being retooled to make it more attractive, and various players are starting new lending platforms.
• Life insurance companies have remained important providers of CRE credit. 
• They also expect to see continued flows of money into the commercial real estate market, if only to provide an alternative to the very low rates of return offered by bonds and the highly volatile gyrations of the stock market.  
• There’s a lot of foreign money seeking a home, and the US remains a safe place to invest for foreign individuals, companies and sovereign funds seeking safety—and willing to take relatively low returns – despite the repeated fiscal and other lunacies of our governmental leaders.

Another third thought the commercial real estate and financing market was very mixed, with the high end properties having stabilized and even risen in value, particularly in top tier markets such as New York City and Washington, D.C.  This “middle of the road” group generally thought the market was comprised of three distinct groups of properties: 

(a) the top tier properties, which have generally recovered due to a flight to quality in uncertain times,

(b) mid-tier properties generally stabilizing in value; and

(c) lower quality / value add properties falling in value over the past year. 

Many in this group see compression in pricing (as measured in cap rates) between the first two categories of properties.  Some in this group further opined that various “food groups” of commercial real estate were more in demand, than others, with the least favored type generally being either retail or office, and the generally more favored type being industrial, hotel and other (multifamily, senior housing and other commercial projects).  Retail is less attractive due to uncertainty about retailers’ stability in light of the generally poor job market, as well as the perception that new web-enabled buying patterns diminish the amount of demand for retail space.  Office is, of course, driven by job growth, which is generally poor across the country other than in a few areas:  Washington, D.C., where the government never seems to stop growing, nor do its vendors; New York, where the financial industry has, with significant assistance from the government and taxpayers, made significant steps towards recovery; and Silicon Valley, which is having another tech boom, this one focused on social media and how to monetize it.  Some folks in this group note that where, as in the current market, buildings are often priced at less than replacement cost,  pointing out that it’s hard to go wrong if you have enough patient equity to stick it out for a while.

The remaining third of the folks I’ve heard seem to be more pessimistic:  they are focused on several factors that they think may indicate that worst may not yet be over:

• the ambient uncertainty of an election year;
• the fact that a lot of 5 year loans written in 2007 will become mature this year and may not be refinanceable (primarily due to a shortage of equity to fill the gap between the expiring debt and the new debt available)  – which may lead to yet more defaulted CRE loans, more foreclosures and more falling CRE prices (including falling rents spurred by competition from troubled buildings);
• the dismal job market for most Americans, coupled with most Americans’ financial retrenchment;  
• capital flow from Europe has slowed significantly;
• the European financial mess may trigger a further economic downturn if it turns out a lot of US banks and financial institutions are enmeshed contractually in dealings with European banks and businesses;
• the lack of “B” piece buyers limit the size of the potential CMBS market, as do some of the conflicts and other difficulties in servicing CMBS loans;
• the looming threat of further economic slowdowns caused by oil price spikes, commodity price hikes or geopolitical disturbances.

I tend to think that we’re bumping along the bottom now, like the middle group, but with a somewhat more pessimistic bias.  It seems to me that we are seeing very thoughtless discussions about our collective national priorities and finances (as part of the political silly season) at a time when we have the need to balance our inherited privileges as Americans against our responsibilities to right our civic ship so that it can sail on for a long time for the benefit of our citizens. 

This requires both moderating our spending and raising enough tax income to pay our way as we go (or to move towards doing so).  It also requires a realistic reappraisal of our role in the world:  do we really have the resources and desire to be the world’s policeman?  Do we want to leave trade barriers so low that our economic competitors can take all our manufacturing business, and with it both the jobs of many of our citizens and the upside potential of technological advances that come most frequently through tinkering with the manufacturing process?  Do we want to provide access to our markets for goods produced in ways and using power that is polluting the world at an increasing rate?  What safety net do we want to provide to our fellow citizens – or do we want our fellow citizens to be at risk of ruin from unpredictable health care or predictable old age -- and how do we expect to pay for it?

Unfortunately, the quality of the debate on public issues by our would-be political leaders strikes me as ranging from hopelessly irrelevant to silly to grossly negligent.  With so few attempts to build consensus for rational and responsible societal answers to the seemingly intractable problems we face as a country, I think the likelihood of a government-induced or aggravated “Black Swan” event is high, and so personally tend to be more on the pessimistic side concerning the likely changes to the CRE markets for 2012.  What about you?  Do you agree or disagree?  It would be interesting for the GlobeSt.com readers to weigh in with your thoughts.

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