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This Miserable Run Can Still Be Undone

Seasoned commercial real estate professionals can relate to Jonathan Bartlett when he offers this observation: “I'm beginning to think that at these conferences they ought to start taking belts and shoelaces at check-in because it's extraordinarily depressing to hear these economists get up and tell us over and over again how bad things are.”

For their part the economists would probably advise Bartlett, a vice president with real estate advisory firm Robert Charles Lesser & Co. (RCLCO), in Washington, D.C., not to shoot the messenger. Bartlett's humorous remark during a recent keynote address at the Southeast Apartment Markets Conference in Atlanta speaks to the battle fatigue and frustration professionals across property types have experienced in the past two years.

Complicating our efforts to make sense of it all are new buzzwords and fuzzy metaphors to describe the state of the industry. What used to be known as a cycle is now being called a “reset”. We're also being told that we're in the second inning of a nine-inning game when it comes to recovery for commercial real estate, though how the game unfolds is anyone's guess.

I have a simpler assessment of the situation. First, the twin effects of a recession and credit crunch have wreaked havoc on overleveraged borrowers who bought at the top of the market. Second, the drop in real estate fundamentals has been so fast and deep that future year-over-year comparisons of key indicators will likely show that we reached the bottom more quickly than we originally thought. How long the industry bumps along the bottom depends on demand for space, which ties back to the pace of job creation. Some things never change.

Showing resilience

It's hard to imagine that the vital signs of the U.S. hotel market, for example, over the next few quarters could be any worse than we observed in the wake of Lehman Brothers filing for bankruptcy, the near collapse of the financial system and millions of layoffs in Corporate America.

“We were astonished with what happened in the fourth quarter of last year,” recalls Patrick Feltes, senior vice president with GE Capital Solutions, Franchise Finance, who works out of the Phoenix office. “The standard catch phrase in our business was ‘off the cliff’ when it came to looking at revenue per available room, average daily rate and occupancy. We were seeing drops anywhere from 10% to 20% in the fourth quarter of last year compared with the same period a year earlier.”

Not surprisingly, GE Franchise Finance, which specializes in lending on limited-service hotel product in the midscale segment with an average loan size of $7 million to $8 million, decided at that point to pull back on loan originations. Like any smart lender, GE adapted quickly to changing conditions.

The decline in hotel property sales transactions year-over-year has been even more dramatic. According to Real Capital Analytics, sales of U.S. hotels $5 million and higher totaled $11 billion during the first three quarters of 2008 compared with only $2.6 billion during the first three quarters of 2009. That's a whopping 76% decline. The number of hotel transactions also dropped from 458 to 109 during the same period.

Such a huge decline in the sales volume means that going forward the year-over-year comparisons will likely become more favorable, particularly if more distressed hotels come to market in 2010 as many industry experts believe will be the case.

Political wildcard?

It's clear that a lot of banks have commercial real estate assets on their balance sheets that aren't worth nearly as much as the money lent on them, says Chris Macke, CEO of Chicago-based General Equity Real Estate. He believes that the Obama administration is wrestling with the issue of whether to have the examiners get tough with the banks prior to the mid-term congressional elections in 2010 by forcing them to clean up their balance sheets now.

“Watch that,” urges Macke, “because if they [the Obama administration] start having serious approval issues and you start hearing about a huge possible change in Congress in the 2010 mid-term elections, they are going to get a lot more aggressive about cleaning up the banks.”

And that might allow us to pull back from the cliff.

Contact Editor Matt Valley at [email protected].

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