Some folks made a fortune after the S&L, buying up commercial property for a song, tidying it up, holding it for a few years and then cashing out.
Will history repeat itself?
It’s a tough call; plenty of people lost their shirts this time around trying to catch the falling knife.
Then again, anyone who was in the game in London six to nine months ago did very well. A good example of a transaction that turned some heads was the purchase of Canary Wharf’s landmark building (the former HQ for Bear Stearns) which was just sold for £208 million even though it was valued at £170 million last June. But it was a pretty narrow window focused on premium end (“quality prevails”) and dominated by foreign money. But still there are mutterings of a “Dead-Cat-Bounce”.
The other issue is that real estate is always a local business, and to play as an outsider you need to be with someone who can (a) source the deals (no one sells anything at a loss unless they are forced to), (b) knows the difference between a deal and a lemon (c) knows when to pull the trigger – the windows can be short.
The problem right now is that many of the folks that know the business who didn’t do a fire-sale in 2007 are (reluctant) sellers, not buyers; and they are feeling rather sorry for themselves. The ones that actually saw it coming, and offloaded, are a rare breed.
This time it’s different
The S&L was caused by over-building. That’s a project financing issue and there the vulnerability for the developer is in the first five years after completion. Making it through until the DSCR is solid so the thing can be sold-on as investment grade is tricky if you hit the market at the same time as everyone else.
Traditionally, once there are predictable long-term revenues it’s a simple play on the cap-rate, whether you go with a sale or securitize.
But for that to happen it helps if there is a securitization industry, which currently, there isn’t. In 2007 about $250 billion of commercial backed securities (CMBS) were written in the USA (source Thompson Reuters). Nowadays that’s a big fat zero.
The chances of that industry re-booting without some major structural changes, like any time soon, are slim. The sellers are sticking to their guns going with the mushroom-growing principles that worked so well in the past:
“Pay a rating agency to slap a nice AAA rating on the thing, keep the buyers in the dark, and feed them bullshit”.
And now, as was explained very well by Gary Greenberg, the traditional buyers of the toxic junk are all on strike.
Apart from of course the Fed who bought over a trillion dollars of “waste” over the past year, and no one knows what they bought, or how much they paid - except that it was probably too much. That might have saved some skins but it did nothing to force through the reality check that the sellers are going to have to face one of these days.
On top of that the various “forbearance” programs to save the “Too Big to Fail” from the pain of paying for their own stupidity, by letting them extend and pretend, is holding up the day of reckoning.
So when is the time to step out into the spotlight and try your luck at catching falling knives?
This is a chart of the Moody’s US Commercial Real Estate Index (annualised and re-worked so 2003 is 100%) with an estimation of the “Other Than Market Value” of the market as a whole expressed in terms of the Moody’s Index.
click to enlarge
Notes:
The historical trajectory of the (pink) line for “Other Than Market Value” (OMV), which represents what some people call “Fair Value” and is an estimate of where the market should be if it was not in what International Valuation Standards and George Soros calls “disequilibrium”, was calculated from the aggregate market data presented in the “Congressional Oversight Panel regarding Commercial Real Estate Losses and the Risk to Financial Stability” (.pdf here), using the average annual 30-Year Treasury yield as a benchmark cap-rate.
That was calibrated by making the assumption (which could be wrong) that commercial property prices are bottoming.
The historical (red) “Market Mispricing Estimate” line was worked out by dividing the Moody’s Index by the estimated OMV (and taking away one so that 0% = no mispricing). The forward line was estimated from (a) the assumption that the mispricing under the OMV will be equal to the previous mispricing over, and (b) that the period of time the market was over-priced was about five years, so the period of time for all the “malinvestments” to get washed out of the system will also be about five years.
That line was then used to generate the forecast of the Moody’s Index, with the following assumptions.
A: 2010 will see a further rise in vacancy and softening of prices. That will stabilize in 2011 and things will start to improve on that front in 2012.
B: The 30-Year yield will drift up towards 5.5% over the next three years (i.e. it won’t shoot up to 7% or 8% which some people think it might (I don’t)).
Based on that analysis my view is that it’s starting to be the time to look at investing in commercial property in the USA or some variant of that (like buying up the debt).
The bet there is:
1: The US taxpayer (and/or the folks buying US debt) are going to get a bit tired of paying for other peoples' mistakes and so the “extend-and-pretend” fairy-tale will come to an end and decent properties are going to start to get sold at market clearing prices.
2: Long-Term US Treasury yields are not going to skyrocket. Some people say they are, which will depress the OMV line, and prices. My view is that they won’t go up a lot, but I’m pretty much in a minority.
3: The US economy will slowly start to heal (and they won’t go to war with anyone, just for the moment).
One thing that would help both the healing of the US economy and the commercial property market would be if the securitization industry starts to re-boot (hopefully this time around not manufacturing AAA rated melamine tainted milk).
There is little sign of that happening and no sign that the government or the regulators understand how important this is, or even that they understand how securitization is supposed to work. But one of these days they might figure it out. Chance is a fine thing.
Whenever that starts to happen it’s likely CMBS will be the first to come out of hibernation because those are the cleanest deals and they are the easiest for the buyers to do their own due diligence on.
And having been burnt by the rating agencies saying “Oh, that was just an opinion… you should have done your own due diligence”, all the buyers are going to be doing that. It’s going to be a long time before you get anyone buying into that market with their eyes closed.
Disclosure: Blumberg Capital Partners
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