Let’s lose the double talk and face reality...or who is Kidding Who?

Implications: Why do so many keep relying on the same so called experts, those whose opinions are solely based on self interest and who seem to not be looking at the real picture that is right in front of them. Why do professionals in the real estate industry et al, appear to keep ignoring how negatively impacted commercial real estate will become? Why do we keep asking for the advice of those whose actions have helped create the current mess we find ourselves? Isn’t doing that a sure ticket to more serious problems? The blame game isn’t productive, however, sometimes its needed so the same mistakes aren’t repeated and we know who not to listen to going forward.  

Analysis:  The time for accountability is now...from the rating agencies and the Federal Reserve, to the Wall St. bankers and the vast majority of commercial real estate companies both brokerage and investment owners and developers to be asked the hard questions.    


Let’s start with the following statement in the referenced article... “The market has totally changed,'' said Howard L. Michaels, chairman of New York-based Carlton Advisory Services Inc., which helped Macklowe refinance the GM Building in January 2004. ``He paid an appropriate price at the time he bought the properties (sic meaning the EOP $7 billion worth of buildings). It was a major score for him. And it was unforeseeable by him or any body else that the market would change so drastically.'' True the market has totally changed, that is the only correct part of the statement. To say the current events were “unforeseeable” is a total punt. All the signs were there if one cared to look. These warning signs were not hidden, and the mere fact that Macklowe was buying from Blackstone who was simultaneously closing with Equity Office should have told Mr. Macklowe and his banker that the market has finally peaked. How in good conscience could the lender make such a loan with Macklowe putting up only $50 million in equity that equals 007% equity in the deal!? You want to talk about sub-prime; here you have the commercial version of that. And you want the man who helped finance Mr. Macklowe’s acquisition of the GM building’s opinion? Does anybody actually believe you will get a straight answer? He may be able to get away with this answer regarding Macklowe’s purchase of the GM Building in 2004, but not the latter.  


Thank goodness the article at least has some counter balance...” Office building prices have come down from their peak in the third quarter of 2007, said Sam Chandan, chief economist for Reis Inc., a New York real estate data provider. By the end of the year, the falling prices had returned most of the gains that followed Macklowe's purchase, he said. “Just as much of an issue for Macklowe is the lack of lenders willing to fund such large deals”, said David Tobin, a principal at Mission Capital Advisors LLC in New York, which advised on $5 billion of property sales last year. ”There is simply no expanding demand for $150-per-square- foot office space in New York City,'' Tobin said. ``All of this excess in the real estate markets has been fueled by financing and the financing isn't coming back for a long, long time.'' And yet there are those industry experts that keep declaring how great the market fundamentals are!  


You’ll even see below one article that at least calls out the former Treasury Secretary Rubin now Citigroup's director and executive committee chair a hypocrite.  


As this writer has been saying over and over, you kill the housing market you will have a major economic problem, you kill the credit markets it becomes an even deeper recession. So what that vacancy rates are low now...the so called fundamentals of the commercial real estate market. Commercial real estate statistics are and have always been lagging economic indicators. It takes time for problems to catch up with the commercial real estate market.    


When companies start layoffs they usually do not renew leases or shutter their space and put it up for sublease. Subleases as anyone in commercial real estate will tell you will put downward pressure on rental rates. So much for the lofty rental increase projections these pundits used in buying and selling.

And when rents decrease, and tenants decide to keep their space, and they have a pending lease renewal, guess what happens? Their renewal rent will go down no matter what their option to renew says.

The pundits will say not so fast because of the lack of space...well look around in most major markets and you will see an abundance of new construction.   


There will have been built Nationally going into 2008, 128 million square feet of new mostly speculative (two thirds vacant) office construction. And if you look at the current state of office absorption, it will take a couple of years to work down that vacant inventory. Those developers will be dropping rental prices fairly soon, especially when their lender begins knocking on their door for their loan payment or loan payoff and their vacancy rates haven't changed.


If you look at one of  the articles referenced below, which quoted the Comptroller of the Currency, you will see a frightening statement, whereby many community based banks are overly exposed to commercial real estate loans and many have way too much exposure to construction loans...This on top of the Wall St Banking’s CDO/CMBS mess. Local banks are traditionally on the front lines of construction loans. By the way, it was in early 2006 that this was first brought up by then Federal Reserve Governor Susan Bies.  


Bankers are now going beyond the fear of lending on just real estate, they’ve moved onto the other types of business loans and personal loans, whereby we will see shortly an almost complete freeze on lending. Only those with stellar credit will get loans....and those are the few that need loans the least. So much for future business expansion.
No business expansion hurts absorption rates, which will be reflected in higher vacancy rates. But the pundits say the fundamentals are too strong.  


Good luck to all those investment buyers who bought with the aggressive debt and fantasy rent expectations or are so highly leveraged that the smallest vacancy will put their cash flow under water. Or those buyers which used short term debt, banking on re-selling the property quickly (Macklowe example). Sometimes the best investments are the ones you didn’t buy. Or as one intelligent banker said to me, “many bad business decisions are made during good times”. Boy is that ever true today.    


The two articles that best convey the point of the analysis are the last two. “Good Fundamentals Buoy Real Estate Execs” & “Robert Rubin: What meltdown?”  


The “Good Fundamental’s” is a group’s opinion that refuses for reasons of self interest to admit to the negative influences of what is currently going in the economy, and the real estate sector in particular. They choose not to see the negative impact which the on-going ever deepening and spreading credit fiasco is creating.  


Their “opinion” is what is going on presently and what is about to still unfold, can’t affect the great fundamentals that commercial real estate is expressing. You still hear a few voices saying how there is plenty of liquidity in the system, if so why is Mr. Macklowe about to give back 7 buildings?   Their primary rationale is the lack of overbuilding...because that is what the last commercial real estate disaster was caused by... they also don’t acknowledge the lenders laxity in underwriting and the great amount of capital that was being pushed into commercial real estate at that time as well....Sound familiar.    


No two recessions are a like, there may be some common underlying reasons such as a housing slump, but the dynamics of what started it and how it plays out are always different. But to say the fundamentals won’t deteriorate is absurd and detrimental to their clients and the public at large.   


These are the same folks that were selling investment properties based on pro-forma (projections) income models that reflected major increases in rental rates and showing how by using overly aggressive financing one could obtain highly leveraged returns.   Only one problem, they had not inputted an exit strategy which is business school 1.01, nor had they inputted downside risk. They were under the false illusion that the economy only goes in one direction. Their response will be...”well everyone was doing it...why shouldn’t I/we take advantage of the market?” The answer is what is now being played out in commercial real estate, the profits are short lived and in the end you lose more than you gained.  


Everyone looks like a genius when times are good, but those of us, called contrarians, saw an entirely different picture. We saw greed and get profits now mentality rule over long term stable interests. The attitude was and still is unfortunately, the hell with the long run, what’s in it for me now. And yet we still go back and look to do business with the same folks that got us into this mess.  

Moody’s just came out and said that the securitized marketplace is too complicated to properly assess risk...and does anyone think that wasn’t the case over the past several years? Of course it was and that is why so many intelligent people will get burned that should have known better, such as pension funds. Why Moody’s hadn’t admitted to these complexities while they were taking money from the very people they were rating is no secret.  


At least I can sleep at night knowing I gave my clients sound advice and insight. I heeded all the warning signs which have been posted for the last 3 years, as did many of my clients.  


Will business come to a halt, well it almost did in the 4thQ 2007. The CMBS market certainly has in January, which is unheard of until now. Being an optimist is a wonderful thing, and yes this writer believes this too shall pass, but until then, why not deal with reality and figure out the best route to navigate through it and not remain in a state of denial as I have said on many occasions.  


Here are some headlines just from the past week...I could write an analysis on each one. The point is to illustrate how things REALLY are and how much worse it will probably get in the near future. You can try and blame the media...in this case facts are just that facts.   


And so the commercial real estate pundits actually believe the industry will be able to withstand this blistering assault on the economy....How purposely naive.    

Services 'Collapse' Batters Stocks http://online.wsj.com/article/SB120221211278943985.html?mod=djemalertMARKET .... The manufacturing sector has looked troubled for two years, added Michael Metz, chief investment strategist at Oppenheimer, but services, which account for a bigger slice of economic activity, "have held up the economy. If services contract, there is no question a recession is ahead, or maybe we're in it."    


Moody's says it's hard to evaluate the risk in complex mortgage securities Forbes Magazine February 11th Issue  


Commercial Property Woes Hit Pension Funds: Report A new report finds the recent fall in commercial real estate values is beginning to affect the bottom lines of the nation's big pension funds. http://www.cnbc.com/id/23009899/from/ET/  


Lending woes will lead to big drop in commercial property values
http://www.FinancialWeek.com/apps/pbcs.dll/article?AID=2008321136649    


IMF head in shock fiscal warning http://www.ft.com/cms/s/106230b0-cd29-11dc-9b2b-000077b07658.html  


Economy nearly stalled in last quarter of 2007 http://www.ft.com/cms/s/106230b0-cd29-11dc-9b2b-000077b07658.html http://www.msnbc.msn.com/id/22912358/    


CMBS era of issuance grinds to halt in January http://www.reuters.com/article/ousiv/idUSN2959188020080130?pageNumber=2&virtualBrandChannel=0&sp=true  


More Subprime Pain in Store UBS Write-Downs, Insurer Downgrades Point to More Unraveling http://online.wsj.com/article/SB120174693398030853.html?mod=djemheard    


U.S. employers slashed payrolls in January Unexpected decline of 17,000 is the first payrolls drop since 2003 http://www.msnbc.msn.com/id/22948894/  


Regulator warns banks could fail if CRE market crumbles http://news.yahoo.com/s/usnw/20080131/pl_usnw/comptroller_dugan_expresses_concern_about_commercial_real_estate_concentrations



Smaller Lenders feeling squeezed by Credit Crunch http://online.wsj.com/article_email/SB120208450891739315-lMyQjAxMDI4MDAyNDAwODQ0Wj.html    


Home Mortgage Mayhem Seeps into Office Sector http://money.cnn.com/news/newsfeeds/articles/newstex/IBD-0001-22512385.htm  


Potential collapse of bond insurers threatens economy http://www.cnbc.com/id/15840232?video=632200049    


Robert Rubin: What meltdown? In a talk on Wednesday, the Citigroup director said the current financial upheaval is just cyclical. And none of the blame that there was to assign went to Wall Street. "All part of a cycle of periodic excess leading to periodic disruption." Mr. Rubin placed the blame for the economic woes not on major American financial players but on the electorate, the government and politicians http://money.cnn.com/2008/01/31/news/economy/rubin_benner.fortune/index.htm    



Good Fundamentals Buoy Real Estate Execs http://www.cpnonline.com/cpn/content_display/business-specialties/investments/e3idd28bbde51ed5ac9c15c8dfe9f0f1493