Conversations on the floor at ICSC's New York National Conference and Dealmaking often involved this question: Have the government's measures to support banks and ease the rules in how commercial real estate loans are accounted for delayed the process of banks recognizing losses or are they buying time for an actual recovery in property values and fundamentals?
The answers we got to that question varied. The most pessimistic assessment is that the process is actually making things worse. In that scenario, property fundamentals, rather than stabilizing or improving, will get worse because there is no one capable minding the store. The properties that are being held in limbo will end up losing tenants and that will only make the losses worse once banks are forced to recognize them.
The more tepid view--and what most people seem to think--is that the process of recovery is only being strung along by what's happening with the banks. Properties are being held in a holding pattern and possibly being managed by the wrong people. Fundamentals are unlikely to improve in the coming months and the inevitable losses are just being delayed instead of avoided. Few expect that the bid for time will be long enough that we'll see any real recovery in property fundamentals or prices. Instead, many see the government's efforts as a Hail Mary. They feel that, in the end, the government has chosen to support financial institutions while letting everyone else hang. This will only hamper the recovery by preventing assets from getting into the hands of the most capable operators that might have a chance of doing something productive with them.
In addition, the binge of buying that everyone thought might happen in 2009 in which investors came in and grabbed armloads of assets from distressed owners is simply not happening. Many investors thought they'd be able to take good properties from indebted owners at bargain basement prices and hit internal rate of return targets of 25 percent. But those deals are not out there, according to Richard Walter, president of Faris Lee Investments. Instead, what is available are distressed properties that require some real care and investment in turning around. And the overall volume of available assets is very low. Those with cash are finding it makes more sense to just buy corporate bonds and lock in solid returns. In other cases, funds that were raised for direct investment are being reconfigured as mezzanine or preferred equity funds, according to Jonathan Brinsden, COO of the Midway Companies.
That leads to a second theme that came up a lot: Repositioning. The amount of ground-up development is bound to stay low for some time. Those with development and design expertise will instead play larger roles in helping to reposition assets. Projects where enclosed malls are partially reconfigured to add open-air components or non-retail uses may be the norm in the next couple of years. It's a trend we touched on in a recent feature. Experience will be key in a climate where shoppers are increasingly relying on the Web to research and complete purchases. You have to give them a reason to come to your property. You also have to provide uses that cannot be replicated by online shopping--restaurants, entertainment, fitness centers, non-retail uses--and environments that are pleasing. It also may mean more necessity retailers and seeing grocers in unconventional spots.