The Quake is Over, but the Aftershocks Are Darn Persistent

CRE Finance World, Summer 2012

The Quake Is Over, but the Aftershocks Are Darn Persistent Director of U.S. Capital Markets, CFA, Senior Real Estate StrategistSuzanne MulveeStephen Miller Debt and Risk Management Research Property & Portfolio Research, Inc. Property & Portfolio Research, Inc. M acroeconomic Overview Recovery UnderwayMarket FundamentalsFigure 1 PPR54 Vacancy by Property Type Employment gains are starting to mount, with more than 3.6 million jobs added since the labor market first found traction in late 2009. With jobs comes increased consumption, pushing up corporate profits and leading to new hiring. Wobbly at times, this virtuous cycle has been spinning since late 2009 and lately looks to have matured into a sustainable but slow recovery. The knock-on effect for commercial real estate has been positive, as vacancies are receding and rents are poised to climb. At least generally this is true; parsing the market more finely reveals froth across some apartment markets and in certain core office nodes, and retail remains a hit-or-miss prospect. Arguably, a slow economic recovery is good for commercial real estate market fundamentals. As demand inches forward, supply is kept at bay, and lengthens the cycle. Against a backdrop of mod- est economic growth, healthier lenders remain cautious, as risks are still seen to the downside, and lending terms remain favorable Source: PPR longer. The shortcoming of a muted recovery is that it promotes only slow healing of legacy loans. Indeed, projected lifetime losses Since the market bottomed in late 2009, the recovery in CRE for the CMBS conduit universe1 are still elevated, at 7.4% for fundamentals has been steady and sure. Vacancies across of- apartment on the low end and 9.9% for hotel on the high end.2 fice, industrial, and retail markets have moved off recent peaks, Debt markets continue to suffer under the burden of loans that are but generally remain well above long-term averages. The recent coming due and unable to meet market rate refinancing terms. As dislocation in fundamentals led to an unprecedented shutdown recovery takes hold, regulators should be less complacent about in construction. In the office market, for example, net new supply extend-and-pretend strategies; they want banks to clean up loan in 2011 was just 1.4 million SF (net of teardowns); in 2012 new portfolios. In the long run, this will lead to a healthier banking supply will climb to 29 million SF, still only a fraction of the 100 system, but in the short term it will keep debt markets constrained million SF per year that had been added on average since 2000. — which may be good for market fundamentals. The lack of new construction allows better leverage of still modest demand, and vacancies should sink closer to historical averages by year-end. And although the recovery has done little to lift rents thus far, 2012 should mark a turning point. But with rent levels still well below pre-recession highs, NOI losses will persist. CRE Finance World Summer 2012 50


CRE Finance World, Summer 2012
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