Friday, December 04, 2009

Real Estate Challenges


•Residential and commercial property values (combined) fell $8 trillion, or almost 20%, through mid-2009 (Economist)
oHousing starts are up slightly, but inventories remain very low
oResidential building permits at all-time lows
oNew commercial developments at near stand-still

•23% of U.S. homeowners owe more on their mortgages than their properties are worth
oNevada, Florida, Arizona & Michigan hit hardest
ofollowed by California, Virginia & Georgia (Wall Street Journal – 11/24/09)

•U.S. home prices forecast to hit bottom in early 2011 (JPMorgan Chase) – another 10-15% drop in prices

•Over 90% of first-time buyers are financed by FHA conforming loans
oQualification requirements for FHA are increasing due to defaults in recent loans – 1 in 8 loans are in default
Increase in down payment from 3.5%
Higher credit scores required
oFHA reserves for default insurance have fallen below statutory requirements – will need U.S. Treasury assistance

•Fannie Mae and Freddie Mac were the primary financiers in 2009 for residential housing
oHold __% of mortgages originated in U.S. in 2009
oSole lender for multi-family
oBoth are seeking additional federal government assistance – must be recast/recapitalized in 2010

•Fed will stop buying mortgage loans in Spring 2010, which will adversely impact residential mortgage rates (4.95% for 30-year fixed in October) – estimated to jump 100 basis points

•Tax credit for home purchases will expire in April 2010 (just as Fed mortgage purchases expire)

•Demographics will drive future demand
oYoung and old moving to higher-density in-fill locations
More need for attached product – both rental and “for sale”
Urban planning more important
Build near amenities – museums, entertainment, restaurants/retail
oRental demand will grow faster than population
Loan requirements for young require 10-20% down payment
Aging adults selling suburban homes and moving into more affordable housing
Immigrant population
oResales are 80% of residential market – only 1% of population buys a new home
oImmigration represents 28% of U.S. population growth in 2000’s and will level in the future at about 30%
oHouseholds w/o children will represent largest % of homebuyers


•Vacancy rates escalating (3Q09 numbers) reflecting lack of demand:
oOffice – 19.4%
oRetail – 18.6%
oWarehouse – 13%
oHotel – occupancy rates at 58.7% (680 basis point drop YOY)

oRents down 40-70%
oTransaction volumes down significantly – 90% in NYC in last 2 yrs.
oLong-term demand will shrink
Centralized offices no longer needed
Retail space will compete with traditional office space (store front commercial locations)

oDemand for space down dramatically
oRents down in all property types
oDisintermediation of internet impacting retail space
oAmerican consumer spending $$ in 2009?
Liquor – up 12%
Restaurants & bars – up 10%
Big box discounters – up 7%
Everyone else is down w/ autos at bottom
oNo loans for inventory or finish-out of retail space
oRetailer bankruptcies will continue to empty big boxes and strip centers
oInfill grocery-anchored strip centers and fortress regional malls will survive

oVacancy rates at 8.4% in 3Q09 (off 580 basis points YOY)
oRents soft in all markets
oExpected to recover in late 2010
oGlint of hope due to favorable demographic demand
oScarce construction set stage for rebound – shortage by 2012

oSector is “totally slammed”
Financed with adjustable-rate mortgages
Late-cycle deals will be on market in 2010
oHas most potential to recover sooner

•$1.4 trillion of commercial real estate loans to be refinanced in next 18-14 months
o1/6 of all construction loans in trouble category (6/09 FDIC report)
oCMBS roll-overs of $250 to $300 billion annually through 2015 (PWC/ULI)
oBanks hold 55% of commercial real estate loans

•Little or no development
o2-3 years for market to come back
oLittle financing available & where available
60-65% loan-to-value ratio
7.0-7.5% interest rates
1.4 debt-service coverage
oPrice of existing assets below replacement cost
oClimate change and “green” initiatives put on hold

•Transaction volume down dramatically – 90% from 3Q07 to 3Q09
oImpediments include
Lack of financing
Sizeable gap between bid/ask on price
Volume of distressed properties coming to market

•Official unemployment rate of 10.2% (Dept of Labor)
oIncluding “discouraged” workers (those who have given up finding a job after months of looking), the rate is estimated at 13%
oAdding “part-time workers for economic reasons” (i.e., couldn’t get a full-time job), the rate is estimated to be 19.2% or 30.6 million people (CNN)
oNet job loss continues

Banking Issues

•FDIC will close over 300 banks in 2010 – a fraction of the “zombie” banks (an estimated 5,000 branch banks need to be closed in Texas alone)
oDoes not have the funds to continue foreclosing banks
oCharging “healthy” banks $50 billion to rebuild capital base
oWill likely need bailout from U.S. Treasury

•TARP funds not being used for lending – rather to meet Fed capital requirements

•Fed is proposing to raise capital requirements for all banks that will further discourage lending

•All interest rates expected to rise, resulting in
oDownward pressure on real property values
oConstraint of business expansion
oReduced consumer spending
oHigher cap rates on all property classes

•Banks currently dealing with residential crisis – expected to address consumer credit debt and then commercial loan issues

•Current $7 trillion U.S. deficit expected to rise by $14 trillion over next 10 years (assuming current interest rates)

oWill have to print dollars to deal with deficit – can’t issue much more debt
oChinese, Japanese and EU will not continue to buy U.S. debt w/ impending inflation

Baen Predictions (University of North Texas Real Estate Professor):

•Dollar drops 40% in next 12 months
•Cash is king in short-term – crap after that
•Growth will be through hyper inflation
ocan’t be debt since it has driven growth for last 15 years
ogo long on fixed interest rates
ohard assets should appreciate
•20% possibility of a depression – will be blamed on terror or some international issue, not debt
•U.S. housing market will be socialized – on the Stockholm model
•Buy hard assets with reasonable leverage – will be repaid with inflated dollars
•Invest in the 6 G’s:
oGround (real estate)
oGas (oil & gas)
oGrub (commodities)
John Baen Director of Economics and Real Estate at UNT