False Optimism or Cold Reality who do you believe?

Implications: The media is ripe with economic bad news as it relates to both residential and commercial real estate. There is no doubt the market in DC/Metro has slowed which was predicted by this writer long before the summer credit crunch. What is now happening which in some ways is understandable by the major market players is their putting a happy face on the current market for commercial real estate investment sales as well as leasing activity. Its one thing to be an eternal optimist and another to be in denial about the current situation and what looks like a negative future unfolding for not just the real estate markets but the National economy in particular. Every recession over the last 50 years has followed a housing slump. Only two exceptions in the 1950's and 1960's did a recession not occur and that was due to Federal Defense spending (Korean & Vietnam Wars). That is not happening this time around. The Federal Reserve obviously has voted on the negative side.

Analysis: I find it almost humorous that the same market players in commercial real estate who were pushing the Bull market are now singing a different song....from yesterday's WSJ Article...
"In the last couple of years, they were providing 10-year interest-only loans where borrowers never had to pay principal," said Scott Rechler, chief executive and chairman of RexCorp Realty LLC. "Those types of investments may run into problems when the loans come due in the next three to five years," he said. The market, he said, "has shifted back to requiring principal and having to demonstrate that you have the cash to cover debt service."Developers face tighter underwriting conditions amid early signs that a correction in the commercial real-estate market is underway" What a departure from just 6 months ago. The market players are suggesting the underlying market fundamentals are in excellent shape.

What is surprising is that most experienced players in commercial real estate know the commercial real estate market does not respond to movements in economic conditions quickly. Commercial real estate usually is the last industry segment affected by a slowdown and the last to come out it when things pick-up.

So why are the major market players especially the brokerage community acting as if all the troubles are over. Everything is great, the Federal Reserve cut its main rate and there is plenty of credit available. Office buildings are still at very low vacancy levels so why worry. There is plenty of credit statement is true, but it is much more costly which in turn puts downward pressure on commercial real estate pricing. Its not how much its how much per month as the saying goes. The same way low interest rates provided the fuel for the compression of cap rates over the last 2-3 years the reverse is true when credit becomes more expensive. Its not just the rates but the terms by which the lender is willing to place a loan. These same players are now saying how a market correction is needed and its a good thing. OK that may be but were these same people ignoring loans that were offered with higher underwriting standards? The answer is yes of course, but now they look forward to the correction. They are trying to have it both ways.

As a friend of mine likes to say "Its reality" and to be overly optimistic is doing a disservice.

The big pension funds and life insurance equity buyers are thrilled this correction has finally arrived. Not only do they have far less competition on the buy side the property pricing is headed lower. On top of that borrowers have become the pension fund/Life companies new best friend. Why, because the CMBS market is in turmoil and you can't find a sponsor. Does that bode well for the overall industry?

You also have the pending issue of "IF" there is a major economic slow down what happens to all those properties  which were bought in the last 2-3 years with the slack loan underwriting? The what happens is those owners will be in trouble as they bought those properties at such thin returns they have no cushion on their downside risk.

You now have a confluence of economic circumstances such as record high gas prices, a major housing slump which has far reaching effects on so many related industries, you have a debt crisis which is still in the midst of unfolding, rising unemployment, just the fact that over 120,000 financial service jobs have been eliminated in the past 3 months,
an election year which typically makes companies delay economic decisions, cut backs in Federal Spending, and less consumer spending.  

What does this add up to? It certainly does not add up to being in denial. What are or will these major commercial real estate players, in particular the brokers advising their clients?

If they are in denial their clients will be hurt by their false optimism, and you will have a similar scenario that has happened in the residential sector which is lack of confidence in the people that run the industry.

Let's be realistic and take our collective heads out of the sand.

Remember there is a saying in the banking business which can apply across the board for all industry types..."Bad business decisions are often made during good times"