Commercial Real Estate (CRE): The Slow-Mo Cliff-Dive Gathers Speed
by ilene - November 17th, 2010 4:02 pm
Commercial Real Estate (CRE): The Slow-Mo Cliff-Dive Gathers Speed
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Courtesy of Charles Hugh Smith, Of Two Minds
Commercial real estate is in a structural cliff-dive, currently in slow-motion but soon to gather momentum.
With all the hub-bub about the foreclosure crisis in residential real estate, commercial real estate (CRE) has fallen off the radar screen of crises. Don’t worry, it’s still careening off the cliff; the fall is just in slow motion.
No need for a fancy report to see the signs of decay in CRE. Signs of the ongoing CRE meltdown are everywhere--empty storefronts, mall shops and vacant office complexes abound.
The causes are all too familiar: lending standards went out the window, banks loaned too much, buyers paid too much, lousy deals were avidly securitized, cash flow projections entered Fantasyland and unhealthy speculation fed widespread fraud.
Since boom-and-bust cycles of overbuilding and retrenchment are endemic to commercial real estate, it’s tempting to view this as just another post-expansion trough. Since prices have already slipped a staggering 40% from the 2006 peak, those calling this the bottom of the current cycle have some history on their side.
But beneath what appears to be a standard-issue retrenchment--a glut of inventory to work through, lenders avoiding risk instead of embracing it, and so on--structural changes in the U.S. economy are changing the CRE landscape for good--and not in a positive direction.
A long-term structural decline in CRE is not just a real estate industry concern. With some $1.7 trillion in CRE loans needing to be refinanced in the next few years, a continuing decline in CRE values could push the still-fragile banking system into a new crisis and the economy back into recession as early as next year.
The extremes reached in the boom were certainly epic: investors paid $800,000 per resort hotel room and over $500 per square foot for Class A office space, numbers which no terrestrial cash flow could possibly justify. Retail centers sprouted alongside every new exurb subdivision.
By this logic, an unprecedented boom requires an equally unprecedented bust to work through the excesses in price, debt and risk. So far so good, but there is an anecdotal body of evidence which suggests that profound systemic changes are taking place in the U.S. economy which will structurally reduce the demand for commercial real estate--not for a few years, but permanently.
1. A significant portion of CRE…
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Asset Inflation/Deflation: The Fed’s QE2 vs. $15 Trillion in Losses
by ilene - November 3rd, 2010 11:52 am
Asset Inflation/Deflation: The Fed’s QE2 vs. $15 Trillion in Losses
Courtesy of Charles Hugh Smith, Of Two Minds
Given that the economy faces $15 trillion in writedowns in collateral and credit, the Fed’s $2 trillion dollars in new credit/liquidity is insufficient to trigger either inflation or another speculative bubble.
"Don’t fight the Fed" is supposed to be a strong argument for being bullish on the U.S. economy and stocks. We all know the Federal Reserve is about to unleash a torrent of money into the financial markets via its QE2 (quantitative easing) campaign of buying Treasury bonds directly and pulling various other monetary levers to open the liquidity gates.
But before we succumb to the excitement that accompanies the unleashing of the Fed’s supernatural powers, perhaps we should look at some numbers first.
Size of U.S. economy: $14 trillion. Probable size of QE2: $1 trillion. That means QE2 is perhaps 7% of GDP. Even a whopping $2 trillion QE would equal about 14% of GDP.
In contrast, by some measures China opened the floodgates of credit to the tune of fully 35% of their GDP to combat the contraction caused by the global financial meltdown in late 2008: China’s Creative Accounting.
How much collateral and credit will be destroyed as the U.S. economy rolls over into recession/depression in 2011-14? Based on the latest (September 17, 2010) Fed Flow of Funds, here is my back-of-the-envelope estimates of losses yet to be booked in assets (collateral) and credit (debt):
1. Residential real estate: current value, $18.8 trillion. Estimated value in 2014: $13.8 trillion, i.e. a decline of $5 trillion or 26%. If all impaired mortgages are written down or sold for fair market value, I am guessing the full $5 trillion will need to be written off by somebody, somewhere.
My 26% estimate is conservative; according to the Case-Shiller Index chart, a decline of 40% would be required to return the index to the year-2000 level.
2. Commercial real estate (CRE): The Flow of Funds only reports "nonfarm nonfinancial corporate business" so the CRE number of $6.5 trillion is a few trillion light (that is, we need to add in CRE owned by financial corporations). I am estimating writedowns of $3 trillion--a number others have also guesstimated.
Empty malls, empty office parks, empty warehouses, empty retail: they’re all worth essentially zero. The cost of bulldozing them is higher than their auction value.…
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The Morality of Chinese Growth
by ilene - October 2nd, 2010 2:07 pm
The Morality of Chinese Growth
Courtesy of John Mauldin at Investors’ Insights
Oil at $125 a Barrel, Gasoline at $5
David Rosenberg and Capacity Utilization
Gary Shilling: Commercial Real Estate and Employment
The Morality of Chinese Growth
Another Birthday? What Happened to My Year?
Athens and the Barefoot Ranch
This week I am at a conference in Houston. I must confess that I don’t attend many of the sessions at most conferences where I speak. But today, the guys at Streettalk Advisors have such a great lineup that I am there for every session. But it’s Friday and I need to write. The solution? This week you get a "best of" letter. The best ideas I’ve heard and the best charts I’ve seen at this conference. Then we close with two short but very thoughtful essays from Charles Gave and Arthur Kroeber of GaveKal on "The Morality of Chinese Growth." Lots of charts and something to make you think. Should be a good letter.
Oil at $125 a Barrel, Gasoline at $5
John Hofmeister is the former president of Shell Oil and now CEO of the public-policy group Citizens for Affordable Energy. He paints a very stark (even bleak, as he gets further into the speech) picture of the future of energy production in the US unless we change our current policies. First, because of the after effects of the moratorium. It is his belief that the drilling moratorium will effectively still be in place until at least the middle of 2012. There won’t even be new rules until the end of 2011, and then the lawsuits start.
Gulf oil production will be down by up to 1 million barrels a day. Imported oil is now 67% of oil usage but will go to 75% by 2012. He thinks crude oil will be up to $125 and gasoline between $4-$5 at the pump. And it will only get worse.
He describes the problem with the electricity from coal production. The average coal plant is 38 years old, with a planned-for life of 50 years. Our energy production capability is rapidly aging, and we are not updating it fast enough.
He argues that the fight between the right and the left has given us 37 years without a realistic energy policy, as policy gets driven by two-year political cycles but good energy planning takes decades. There…
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Preserve and Protect: Mapping The Tipping Points
by ilene - August 21st, 2010 1:50 pm
Preserve and Protect: Mapping The Tipping Points
Courtesy of Gordon T Long of Tipping Points
The economic news has turned decidedly negative globally and a sense of ‘quiet before the storm’ permeates the financial headlines. Arcane subjects such as a Hindenburg Omen now make mainline news. The retail investor continues to flee the equity markets and in concert with the institutional players relentlessly pile into the perceived safety of yield instruments, though they are outrageously expensive by any proven measure. Like trying to buy a pump during a storm flood, people are apparently willing to pay any price. As a sailor, it feels like the ominous period where the crew is fastening down the hatches and preparing for the squall that is clearly on the horizon. Few crew mates are talgking as everyone is checking preparations for any eventuality. Are you prepared?
What if this is not a squall but a tropical storm, or even a hurricane? Unlike sailors, the financial markets do not have the forecasting technology for protection against such a possibility. Good sailors before today’s technology advancements avoided this possibility through the use of almanacs, shrewd observation of the climate and common sense. It appears to this old salt that all three are missing in today’s financial community.
Looking through the misty haze though, I can see the following clearly looming on the horizon.
Since President Nixon took the US off the Gold standard in 1971, the increase in global fiat currency has been nothing short of breath taking. It has grown unchecked and inevitably has become unhinged from world industrial production and the historical creators of real tangible wealth.
Do you believe trees grow to the sky?
Or, is it you believe you are smart enough to get out before this graph crashes?
Apparent synthetic wealth has artificially and temporarily been created through the production of paper. Whether Federal Reserve IOU notes (the dollar) or guaranteed certificates of confiscation (treasury notes & bonds), it needs to never be forgotten that these are paper. It is not wealth. It is someone else’s obligation to deliver that wealth to the holder of the paper based on what that paper is felt to be worth when the obligation is required to be surrendered. It must never be forgotten that fiat paper is only a counter party obligation to deliver. Will they?…
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Are Bank Stocks Such a Good Buy?
by ilene - August 18th, 2010 11:37 pm
Are Bank Stocks Such a Good Buy?
Courtesy of Yves Smith at Naked Capitalistm
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A fund manager who will go unnamed mentioned to me that he is putting clients into bank stocks because they are trading at or below book value.
Now of course, individual stocks can and do always outperform the outlook for their sector, so there are no doubt particular banks whose stocks are cheap right now. But there are good reasons to question the notion that banks in general, and money center banks in particular, are a bargain.
First and perhaps most fundamental is the notion that bank equity is a readily-measured number, and that book value is therefore a useful metric. In general, even in companies in make-and-sell businesses, balance sheet items are subject to artful reporting. Notice, for instance, how every four or five years most big public companies take a writeoff that they classify as extraordinary, and equity shills dutifully exclude it from their calculation. In most cases, the writeoff is an admission that past earnings were overstated, but seldom is anyone bothered by what this says about the integrity of that company’s accounting or the acumen of its management.
Bank earnings, even under the best circumstances, involve a great deal of artwork, and most of all in the very big banks with large dealer operations. As Steve Waldman pointed out,
Bank capital cannot be measured. Think about that until you really get it. “Large complex financial institutions” report leverage ratios and “tier one” capital and all kinds of aromatic stuff. But those numbers are meaningless. For any large complex financial institution levered at the House-proposed limit of 15×, a reasonable confidence interval surrounding its estimate of bank capital would be greater than 100% of the reported value. In English, we cannot distinguish “well capitalized” from insolvent banks, even in good times, and regardless of their formal statements.
Lehman is a case-in-point. On September 10, 2008, Lehman reported 11% “tier one” capital and very
…
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Shadow Office Space “Leased but Empty” Haunts Commercial Real Estate
by ilene - July 23rd, 2010 3:07 pm
Shadow Office Space "Leased but Empty" Haunts Commercial Real Estate
Courtesy of Mish
Shadow housing supply, foreclosed but not on the market as well as sellers who want out but cannot get out is one of the factors weighing on residential real estate. Similar supply issues weigh heavily on commercial real estate.
Office vacancies are widely reported, but few gave factored in the shadow supply, downsized companies with more leased space than they need, holding on to it hoping thing get better, or stuck in long-term leases with more space than they want or need.
Minneapolis StarTribune article Shadow space haunts office market takes a good look at this very issue.
That section of empty cubicles, the conference rooms collecting cast-off office furniture … for employees, they’re dreary reminders of layoffs, consolidations and shelved expansion plans.
To real estate professionals, it’s "shadow" office space — space that’s leased or owned but largely empty and not officially listed anywhere as vacant. And brokers are fretting about the buildup of unprecedented amounts of it around the Twin Cities. All that idle square footage will likely prolong the recovery of the area’s hard-hit office sector, already struggling with high vacancy rates. Slow demand for new space will likely mean a dearth of new construction, and all the jobs and building material sales that go with it.
NorthMarq’s semiannual Compass Report, due out today, shows that the direct office vacancy rate in the Twin Cities has hit 19.9 percent — a 19-year high, by NorthMarq’s numbers. Fold in the space tenants are trying to sublease, and the rate jumps to 22.8 percent — the highest since NorthMarq began tracking sublease space in 1995.
McCarthy and other brokers estimate that 75 percent of companies don’t use about 10 percent of their space. By that measure, there would be about 5 million square feet of shadow space across the seven-county metro area — enough to push the real office vacancy rate from 19.9 percent to above 25 percent and perhaps closer to 30.
The amount and scope is unlike anything he’s seen in nearly 20 years in the business, he said. "It’s across all types of buildings," McCarthy said. "It’s just sitting there." It’s a national problem, he said.
National Problem
Subleasing is not easy because of the glut of vacant properties, because walling off sections is impractical or impossible…
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What Bond Bubble?
by ilene - July 7th, 2010 12:16 pm
What Bond Bubble?
Courtesy of Rom Badilla of Bondsquawk.com
Interest rates have rallied tremendously in recent months as concerns of an economic slowdown and the potential for a double dip weigh on the minds of both Wall Street and Main Street. Since early April, which marks the recent high in rates, the long-end of the curve has rallied significantly. The yield on the 10-Year U.S. Treasury has declined more than 100 basis points to 2.97 percent during that time frame.
That type of change usually takes many months, if not years, to accomplish. The average implied volatility of both interest rate swaptions and options on Treasuries over the last 10 years is around 100-120 basis points on an annualized basis. Hence, the move to where we are now is quite significant.
Admittedly, part of the decline is attributed to a flight to quality due to fears of contagion from Greece and the European debt crisis. However, the last leg of the drop in yields was due to signs of a slowing economy and declining price pressures. If it were a continuation of the flight-to-quality trade, we would have seen the dollar appreciate as was the case earlier when the Euro approached parity as sovereign risk escalated. Lately with the recent string of weak domestic economic data, the dollar has declined 1.7 percent from June 21 while the 10-Year rallied 26 basis points and pushed below 3 percent.
If there’s any argument that there is a bond bubble, keep in mind that there needs to be an imbalance, i.e. a shift in outlook toward lower rates. Basically, the majority of the world needs to be on one side of the boat, where tipping over is a possibility and the imbalance is ultimately rectified. Right now, we are far from that.
According to Bloomberg’s economic and interest rate survey, market participants still expect higher rates to materialize with the Federal Reserve raising rates in early 2011. In additions, forecasters expect the 10-Year to increase 40 basis points to 3.37 percent by the end of the Third Quarter.
Bloomberg Economic Forecasts
Rate hawks and bond vigilantes are still advocating for higher rates as the U.S. grapples with both perceived higher inflationary expectations fueled by future economic growth and higher fiscal deficits. To be honest, after packing on the calories by downing countless hotdogs and…
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Commercial Foreclosures Pick up Speed; Cash-Strapped Landlords let Evictions Lag; Rent Control Idea Straight from the Loony Bin
by ilene - May 24th, 2010 2:59 pm
Commercial Foreclosures Pick up Speed; Cash-Strapped Landlords let Evictions Lag; Rent Control Idea Straight from the Loony Bin
Courtesy of Mish
Here is a pair of interesting articles from the Arizona Republic regarding an increase in commercial foreclosures and a slowing number of evictions in apartment complexes.
Please consider Commercial foreclosures pick up speed
Mesa Financial Plaza, the 17-story office tower that lights up the night sky with a neon-blue silhouette, has been noticed for trustee sale.
The $40.6 million default is just one of many that are starting to drop in the Valley. The number of defaults for loans of more than $20 million is increasing rapidly for all product types, including office, industrial, retail and large apartment complexes.
Chris Toci, executive director of the capital markets group at Cushman & Wakefield of Arizona Inc., said Phoenix is at the front end of a major crash.
Cash-strapped landlords let evictions lag
One might that that evictions would be rising due to lack of payment but that’s not the case in the Phoenix area as Cash-strapped landlords let evictions lag
Fewer tenants are being evicted from apartments across the Valley, but the decline is more about the dismal state of landlord finances than tenants paying their rent on time.
In the latest fallout from the recession and housing crisis, growing numbers of apartment-complex owners are in serious financial trouble or foreclosure.
Lawyers, a tenant advocate and a commercial real-estate broker point to a variety of factors. Overbuilding in recent years saturated the market with apartments just as homebuilders
and investors added hundreds of single-family dwellings to the rental mix.Many owners bought large complexes at the market’s peak and then saw values plummet. Forced to cut rents to keep units occupied, they have been left without enough income to pay debts and keep up maintenance. People leaving the state have only added to high vacancy rates.
And although the recession has left many renters unable to pay each month, apartment owners don’t have the money or inclination to boot them.
Andrew Hull, a Phoenix attorney who represents landlords and property managers, said his eviction caseload has declined about 20 percent this year.
For some of his clients, vacancy rates have skyrocketed, and half of the units in their large complexes are empty. Those in bankruptcy don’t have the money to hire attorneys for evictions, Hull
…
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One Tenth of US Banks Now on FDIC’s “Problem” List
by ilene - May 21st, 2010 3:32 am
One Tenth of US Banks Now on FDIC’s "Problem" List
Courtesy of Jr. Deputy Accountant
A total of 775 banks, or one-tenth of all U.S. banks, were on the Federal Deposit Insurance Corp.’s list of "problem" institutions in the first quarter, as bad loans in the commercial real-estate market weighed on bank balance sheets.
Poor loan performance in other sectors also continued to hurt banks, with the total number of loans at least three months past due climbing for the 16th consecutive quarter, FDIC officials said in a briefing on Thursday.
"The banking system still has many problems to work through, and we cannot ignore the possibility of more financial market volatility," FDIC Chairman Sheila Bair said.
There were 702 on the FDIC’s "problem" bank list at the end of 2009 and 252 at the end of 2008.
Looks like Bank Fail Friday is on for the foreseeable future!
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Have The Commercial Real Estate Stocks Bounced Too Far In February?
by Chart School - March 1st, 2010 2:23 pm
Have The Commercial Real Estate Stocks Bounced Too Far In February? (NYSE:SPG), (NYSE:VNO), (NYSE:IY)
By Nicholas Santiago at InTheMoneyStocks
In late December 2009, one of the clues that the major stock indexes were going to decline in the month of January 2010 was the commercial real estate stocks. Leading commercial real estate stocks such as Vornado Realty Trust (NYSE:VNO), and Simon Property Group (NYSE:SPG) headed the rally in 2009 and forshadowed the decline January 2010.
Many traders and investors have thought throughout 2009 that commercial real estate was going to be the next shoe to drop on the stock market. However, that was not the case in 2009 as these stocks not only held up well, but, actually outperformed. In late December 2009 these stocks started to show weakness. The ishares Dow Jones Real Estate ETF (NYSE:IYR), which is a basket of many different real estate companies rolled over at the same time and confirmed that the January decline was industry specific and not company specific.
Now we are back at interesting levels again for most of these commercial real estate stocks. Currently the February move higher has been nothing short of impressive for commercial real estate and the overall stock indexes. However, it has lacked several factors for a sustaining rally. Many of these stocks in this commercial real estate group are trading below their daily 50 moving average. This is something that many institutional traders watch very closely. Then the volume on this rally in February has been somewhat on the weak side. This is also another sign that many institutional traders will take note of. The last factor that we have noticed is that this industry group is now trading into good retracement levels which will usually serve as good resistance area.
These stocks and this sector have been excellent stock market barometers over the past year. The commercial real estate sector is now nearing a very important level. If these stocks start to fall soon the overall market may not be too far behind. Today these stocks are behaving just fine, however, this type of action could change on a dime and might be worth monitoring.
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
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