Monday, January 7, 2008

Pie in the Sky Optimism?

This outlook on Commercial Real Estate from Grubb & Ellis Co. and Jones Lang LaSalle Inc reminds me of the optimism that residential brokers were displaying a year ago, when they predicted "a slight downturn" in the Housing Market.

Commercial Real Estate Outlook


Jay Walker said...

To be fair Eric, I don't think its quite the same. Here, the rents aren't likely to fall off a cliff - yes, a recession will hurt, but it's not like the commercial market was creating space in a tizzy to tenants who couldn't afford to pay, based on unsustainable rates. Which is essentially what happened in the residential sub-prime mess.

Obviously, any impairment on re-financing credit has the potential to produce some type of blow-up in the commercial market, but there are probably a lot of international pension and institutional funds who'd consider stepping up with more US commercial realty purchases, for slightly higher cap rates.

While it might not be great, I don't think it's the buffalo off the cliff scenario, like the residential market will look like.

My 2 cents.

Jay Walker
Confused Capitalist

Eric J. Fox said...

There are some common themes between the two:

1) Lax underwriting standards.
2) Securitization of loans to third parties.
3) Rise of IO and Option ARM loans.
4) Falling demand as economy contracts.

And here are some ones unique to CRE:

1) Optimistic assumptions on cash flow growth.
2) Rising capitalization rates.

Eric J. Fox said...

The URL's didn't come through correct. Here they are again:

Eric J. Fox said...

Jay Walker said...

Yes, some of the themes look the same, but the impact is quite different. Think about it this way: would any of those things mattered much in the residential market, if it hadn't been for, ultimately, the inability of the mortgagor to pay?

I say no, not really. It's the defaults that start the "thin edge of the wedge" and then a momentum develops which is exacerbated by other factors.

Again, the strength of the commercial tenant is different. While the recession coming or here might hurt this market, I don't think #1, #2 or #3 is really going to have much impact. A CDO on a reasonable commercial tenant is a whole lot more secure, in my mind anyway, than a CDO on a marginal income homeowner.

In terms of the second set - "optimistic assumptions on cash-flow" might produce muted future gains, but don't usually trash the market today. Secondly, rising cap rates have the effect of lowering the market, but how much the cap rates move up, and how long it takes to get there, are two open questions in my mind.

All-in-all, I think the CRE market will hold up relatively well - and that's not something I said about the residential market. From the start of my blog in Feb/06, I thought that market looked like nothing but trouble.

Not saying there's not going to be some fall-out in this market - but unless the recession is severe, I think it's going to be relatively muted.

Jay Walker
Confused Capitalist

Eric J. Fox said...

Jay....I hope you are right.