SAN DIEGO — “It’s all in the jobs,” veteran mortgage banker Jack Cohen said unhesitatingly when asked to identify the biggest issue facing the commercial real estate industry and the U.S. economy. To Cohen, it’s a simple formula: jobs and people fill space, occupied space generates rent, rent fuels net operating income, and NOI drives property values.
The CEO of Chicago-based Cohen Financial made clear during Monday’s opening session of the Mortgage Bankers Association’s Commercial Real Estate Finance and Multifamily Convention & Expo that without substantial job growth, the industry will move sideways.
“A year ago there was a piece of data floating around by economists that basically said that the number of employed people in January 2010 exactly equaled the number of people employed in January 2000. Except during that period of time, we probably built 15% to 20% more office space. Then retail and industrial followed,” said Cohen during the panel discussion at the Manchester Grand Hyatt.
“Now Moody’s has put out a report that says values on real estate today are about what they were 10 years ago,” added Cohen, referring to the Moody’s/REAL Commercial Property Price Index (CPPI). In fact, values are 41.6% below the peak of October 2007, according to Moody’s January report.
It doesn’t help matters that the U.S. economy generated only 36,000 nonfarm payroll jobs in January, well below the 150,000 monthly jobs needed just to keep up with the population growth. However, the U.S. economy added 909,000 nonfarm payroll jobs in 2010, according to the U.S. Bureau of Labor Statistics.
Cohen also has a message for struggling borrowers and lenders who are trying to escape the inevitable. “For our collective business, the issue is that the [financial] loss is finally accepted and taken, and no longer avoided.” In other words, the write-downs must occur before the property markets can hit the reset button, he said.
Timothy Gallagher, a managing director with New York-based Morgan Stanley who works in the securitized products group, said his biggest concern is the impact an exogenous event could have on investor confidence. “A month ago no one was talking about Egypt. Today it’s the headline on every newspaper and every website,” pointed out Gallagher, referring to the civil unrest that’s erupted there.
But why would a mortgage banker in Phoenix, for example, care about political instability in a country halfway around the world? “Well, there are a lot of scenarios that you could paint where depending on what the U.S. response is to Egypt and how that plays out, that could have a material effect on anything from [interest] rates to war.”
While there are a lot of potential potholes that could derail the economic recovery, up to now that hasn’t happened, Gallagher said. U.S. GDP grew at an annual rate of 3.2% in the fourth quarter of 2010. The problem is that the crisis in Egypt coupled with Europe’s sovereign debt problems could lead to volatility in the capital markets, warned Gallagher. “Until the uncertainty lessens, we’re going to be in a tougher macro environment as these things just continue to be out there and not get resolved.”
E.J. Burke, executive vice president and group head of Cleveland-based KeyBank Real Estate Capital, expressed concern about the potential for municipal bond defaults. In December, famed financial analyst Meredith Whitney warned that as many as 100 U.S. cities face default on their municipal bonds. “We think of ourselves largely as a community bank,” said Burke, “and local and state governments in virtually every one of our districts are having a hard time balancing budgets.”
The commercial real estate industry continues to deleverage. With property valuations still way down from their peak and revenues only marginally better in many cases, the loan workouts continue to pile up. How far along in the workout cycle is the industry?
“I think that we’re maybe a little more than halfway through the workouts and the deleveraging that has to occur,” said Diana Reid, executive vice president with PNC Real Estate/Midland Loan Services.
But it’s not going to happen overnight because the workouts occur in a methodical fashion — asset by asset, borrower by borrower.
“The trend we’re seeing is that borrowers are able to get the equity to make a paydown to right-size their leverage with banks,” says Reid, who is based in Pittsburgh. “Banks and others are more willing and realistic about what kind of write-down to take.”
Meanwhile, the credit quality statistics at most commercial banks are improving, Reid emphasized. “Even in CMBS, the flow into special servicing is about the same as the flow out, as opposed to the accelerated pace it had been before.”
In the commercial mortgage-backed securities arena, the total volume of loans in special servicing is $88.4 billion, according to Trepp LLC, representing 13.4% of all CMBS.
Pay particularly close attention to the pace of bank closures, urged Reid. When a bank is closed, the assets are transferred to the acquiring bank and the workouts begin on the nonperforming loans. According to the Federal Deposit Insurance Corp., 157 banks failed in 2010, up from 140 in 2009.
Show attendance was up this year. The Mortgage Bankers Association reports that there were 2,324 registrants for this year’s conference in San Diego compared with 1,885 registrants for the 2010 conference held in Las Vegas. That is a 23% increase.