Bruce Norris is joined this week by the Senior Resident Fellow of Finance for
the Urban Land Institute, Stephen Blank.
Bruce asked about the ULI Emerging Trends report and how long it’s been around.
Stephen says it’s been around for 30 years and has always been national in
scope. The report has gone through different partnerships but the report is now
a joint venture between the Urban Land Institute and Price Waterhouse Cooper.
The report interviews 100s of people in the real estate business and compiles
their opinions. Interviewees include developers, private and public owners,
advisors, institutional investors, service providers and lenders.
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Stephen says the people that were interviewed in 2007
actually said they were expecting 2008 to be difficult. Emerging Trends is
unique because of the process and the one-on-one interview process. These
interviews tend to be very frank in nature. There is one writer and three
editors to help put the report together. The real estate industry has been very
supportive in being involved in this report.
Bruce asks Stephen where the blame is in his opinion. Stephen says there was a
period of unparalleled liquidity. With that liquidity came an increasing need
for income-producing assets and increased competition to lend money so interest
rates were forced to low levels. Increased liquidity increased leverage pushing
down rates of return.
The subprime market was unregulated and obviously became an issue. Mortgage
bankers took these loans and then passed them on to Wall Street. Some argue the
models that were used were too old and relied to heavily on ratings. There was a
failure to do due diligence and it’s created a big mess. People ended up day
trading condos.
Bruce says there’s been some confusion between investor and speculator. Now,
we’ve assured ourselves the downturn because the investors are limited to the
number of loans. Investors can’t 1031 exchange and investors can’t buy rentals
due to limits put in place by lending institutions. Purchase prices are being
driven down even further because of this issue and the government isn’t
addressing it at this time.
Bruce asks if Stephen thinks the residential problem will move to commercial and
if it will be as severe. Stephen says he doesn’t think they’re related and that
an economic downturn needs to happen. Commercial is a lagging indicator.
Residential could cause a downturn in the economy which would then spill over to
commercial. Stephen says we didn’t build as much so we’re not going to have over
supply meeting under demand like the last down market. Only some areas like Las
Vegas and Florida will have issues because of over building.
Bruce asks if he sees commercial lenders taking back a glut of properties in the
coming years. Stephen sees sharp increases in foreclosures for loans adjusting
in 2009-2010. The loan-to-value ratios are going to be an issue unless their
income has increased a great deal. Bruce and Stephen discuss if lenders could
leave a loan in place to avoid taking back a building, also known as performing
non-performing loans. The debt is still being paid. Lenders, if they can, would
rather nurse these along until the market improves. Not all lenders can do that
unfortunately.
Bruce asks if commercial lenders did the same kind of stated income programs
that we saw in residential. Stephen says that as competition increased, banks
started looking at other factors to base loan amounts on. Reserves were lowered.
If the markets had continued to go up, the property could afford this new
method. In a decline, it’s an issue.
Stephen sees cap rates going up. 15-20% price decline could occur because the
cap rates are changing. Not as much personal guarantees are on commercial.
Moving forward from now, more lenders are requiring personal guarantees.
Historically loans had an amortization with ten year term assuming a 25 year
amortization period. In ten years you would historically amortize 12-13% of the
loan which added protection for the lender, even if prices declined. As the
market was more competitive, amortization period was eliminated and the loans
were interest only. As these are refinanced, no equity exists.
Bruce asks about unemployment and commercial. Stephen says it will be an issue
and vacancies will increase. Declining lease rates will also be an issue.
Stephen says REITs are not originators of loans but purchase already existing
debt. They may originate mezzanine loans but are not conventional lenders. REITs
are owners of income producing properties. Primary lenders are commercial banks
(40% of markets), insurance companies (20% of market), and commercial
mortgage-backed securities (40% of market). Stephen says that the mortgage
backed system is on life support. Insurance agencies are a major source now but
it’s taking more time and they have the pick of the market.
For more information on the Urban Land Institute, visit
www.uli.org .
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