Thoughts on the Commercial Real Estate Crisis; Simon's Results; Friendly's New Format (Tuesday's News & Notes)

The torrent of retail real estate and commercial real estate stories and posts has suddenly died down a bit. There are still seemingly a few stories a day proclaiming that commercial real estate is the "next shoe to drop." I've grown weary of linking those here.

The numbers have been grim. The latest example is the collapsing Massachusetts Institute of Technology Center for Real Estate (MIT/CRE) index. Still, the chorus has grown way too loud. Seeking Alpha even argues that the record price drops represent good news for the sector. We may have hit bottom, which means prices may begin to rise. Prices are down now about 40 percent from 2007 peaks. I don't think that stable assets will fall much further than that. Distressed assets will fetch fire sale prices. But that is to be expected. And, frankly, that will be part of the industry's recovery. Some buyers coming in and scoring assets on the cheap will enjoy some lovely returns.

There is no way all the debt coming due in the next few years will be refinanced. But, again, that needs to play out. Worthy borrowers should be able to get debt. However, it's clear that some very unworthy deals were getting done in the latter stages of the boom. Those need to blow up in order for a recovery to occur. This is one reason I'm lukewarm on the notion that the government needs to step in and offer more aid to the commercial real estate sector or needs to go to lengths to get the securitization machine started again. Banks that made bad loans need to recognize losses. Borrowers that shouldn't have gotten financing need to default. Will expansion of TALF and other measures that have been discussed end up aiding the worthy or the unworthy?

For instance, commercial real estate loans are going bad at a very fast rate according to this chart. Loans are going bad. They're going bad because vacancies are rising and incomes from properties aren't enough to meet interest payments. In other words, there's a real reason loans are going bad. It's not about liquidity. It's about the recession. The argument for bailouts has centered on the notion that commercial real estate is a victim of the credit crunch.

The idea being put out there is that worthy borrowers can't get loans because liquidity isn't flowing. But even if there were no credit crunch would banks be refinancing loans on failing properties? I don't think that sounds like such a great idea. Worthy borrowers should be able to get loans. But the fact is there just an awful lot of loans that should be going bad. Not everything should be getting refinanced. Doing that only will prolong this crisis for the sector. The sooner that bad assets and unqualified owners are weeded out, the better it's going to be for the survivors.

Llenrock blog, incidentally, has an interesting theory as to why there seems to be a standstill on the refinancing front--and it may not just be due to a lack of liquidity. I'll quote them here:

The reason this is interesting to the world of commercial real estate, is that currently, the credit markets are frozen because nobody is certain of the potential outcomes of their decisions. Ideally, with that information, players in this “game” can assess the outcomes of different choices, weighing the options of others into the assessments of their own choice. In this game, as in all game theory, the only concern of each individual player is maximizing his own payoff, without any concern for the other player's payoff. With that in mind, let's see if we can apply it to what is currently going on in the world of commercial real estate finance.

The post goes on to speculate that both sides are trying to maximize their results. Banks don't want to modify loans if they don't have to. Borrowers want to try and get a better deal. The result is a standstill because neither side is blinking just yet. It's another interesting thing to think about in the current situation.

Those are just some of my thoughts on a relatively slow day. Anyway, here are some news and notes from the past two days on retail and commercial real estate.

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