The evidence of weakening commercial real estate is now crystal clear. Deterioration first showed up in the tranches of Commercial Mortgage Backed Credit Default Swap Benchmark CMBX Indices. I talked about this in Commercial Real Estate Heads South.
Since then additional evidence has turned up. For example, the MIT Center for Real Estate is reporting it Third Quarter 2007 Transactions-Based Index (TBI), and the results are not pretty.
CRE Transactions-Based Index (TBI) 2007 Quarter 3
Results for the 3rd quarter of 2007 are highlighted by a negative 2.5% capital return for the properties sold in the NCREIF database. This is the first negative quarterly price change in the TBI since the third quarter of 2003, when prices fell 2.4 percent.
The investment total returns for all properties also registered a decline of 1.7 percent.
BusinessWeek notes that prices haven’t declined as steeply since the fourth quarter of 2001, when they dropped 3.9% after the 9/11 terrorist attacks.
“The fall in our index is the first solid, quantitative evidence that the subprime mortgage debacle, which hit the broader capital markets in August, may be spreading to the commercial property markets,” David Geltner, the center’s director, said in a release accompanying the index report.
Moody’s/REAL Commercial Property Price Index CPPI Drops
Moody’s is reporting Credit woes hit US commercial real estate.
U.S. commercial real estate values fell 1.2 percent in September as the credit crunch took a toll, and more declines could be in store, Moody’s Investors Service said on Monday. September’s drop is based on the first full month of data since the credit crunch picked up steam in August and could mark a turning point in the once strong commercial real estate market, Moody’s said in a report.
While the Moody’s/REAL Commercial Property Price Index, or CPPI, monthly aggregate index across all property types fell from August to September, the index is still up by about 12 percent compared with the same period last year and over 16 percent over the last two years.
Given the current capital market environment, one-quarter blips in prices are probably not isolated, Moody’s said. Moody’s monthly commercial property price index is based on repeat sales of the same assets at different times.
The number of transactions also dipped 20 percent in September and by 30 percent from a peak in June, Moody’s said. For the third quarter, commercial real estate prices increased 0.9 percent, but office prices dropped 0.5 percent and apartments by 1 percent, Moody’s said.
My Comment: The problem with this methodology is that it does not recognize gains quick enough on the lay up or losses quick enough on the way down. Losses are much larger than reported here. The direction is what’s important and that direction is down.
Moody’s report could be an early sign that the commercial property sector is being affected by the increasing reluctance of lenders to offer credit to anything that is real-estate related. A drop in prices of commercial property could eventually result in an increase in default rates on commercial real estate loans and on commercial mortgage-backed securities, which have so far been relatively low.
Commercial borrowers are more sophisticated than residential borrowers and therefore less likely to be surprised by rising loan terms and payments, while the generally strong commercial property market is also a mitigating factor, Moody’s said.
My Comment: Talk of mitigating factors is pure nonsense. We heard the exact same arguments when residential real estate initially headed south.
As for “commercial borrowers being more sophisticated”, that sophistication led to enormous leverage, speculation, and sources of funds not generally available to residential borrowers, and the impacts of that have yet to be felt on bank lending. Punishment is coming and it will be enormous.
The Blackstone and 666 Fifth Avenue deals should be proof. I talked about those deals in Commercial Real Estate Black Hole.
Tight Oil And Weak Commercial Real Estate
Joe Duarte is right there with me with Nasty Trend Ahead For Commercial Real Estate.
According to the Wall Street Journal, Moody’s Investor’s Service has concluded that “The value of commercial real estate, which nearly doubled in the past seven years, is now starting to decline due to the credit crunch.”
The details suggest that trouble is spread throughout the U.S. as “the value of commercial property declined 1.2% in September from the previous month. Particularly hard hit were apartments in the West and office property in most states other than California.”
The Journal notes that interest only mortgages have been increasingly popular in commercial real estate, creating the potential for more trouble down the line.
More interesting is this: “Already there are signs of slowing in some markets. Available sublease space swelled to 77 million square feet in the third quarter from 73 million square feet nationwide in the second quarter, the first national increase in five years, according to Grubb & Ellis Co.”
Let’s see, commercial real estate is on the verge of a decline after a seven year bull market, and global oil production has peaked.
What’s most significant is this, commercial real estate is the last holdout bull market sector in real estate to feel the pinch of the subprime mortgage related credit crunch, but its top has arrived just as the oil industry is telling us that prices are about to stay high for the extended future.
When you add the fact that China’s government has told banks to stop lending money, you just have to wonder what’s around the corner.
Mike Shedlock / Mish
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