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Friday, January 25, 2008 10:51 PM

Commercial Real Estate Crash Underway

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The Financial Times is reporting Squeeze halts sales in office property.

US office property sales fell by the largest amount since the September 11 2001 terror attacks in the final three months of last year, raising fears that commercial real estate is heading for a meltdown.

The volume of office space sold in the final quarter of 2007 fell 42 per cent to $26.5bn, compared with the same period in 2006, according to data released on Friday by Real Capital Analytics, a real estate data company. Sales of property portfolios fell to $5bn, after logging $105bn in the first three quarters.

My Comment: First transactions plunge. The property values plunge. This is going to play out just like residential.

"What's happening now is a capital markets event," said Dan Fasulo, managing director at RCA.

Spreads on CMBX, an index that tracks commercial mortgage backed securities, have recently suggested that default rates are expected to reach three times historical levels. But analysts say commercial property is not expected to suffer the same slump as housing because it has not experienced such high levels of overbuilding.

My Comment: What analysts are they talking to? Commercial real estate overexpansion in the face of a consumer led recession is monumental.

However, if the US economy experiences a deep recession, commercial property is considered to be at risk. Demand for space is largely driven by the health of the business environment.

"The wildcard is whether or not the US falls into a recession.

My Comment: The wildcard is whether or not we have a depression. We are already in a recession.

What's causing the market to hold up is the high level of occupancy and high level of rent," said Mr Fasulo. "Unless [there is a recession] you are not going to see a [major] deterioration."

My Comment: The market is crumbling as I type. Vacancies will soar. Banks are going to be stuck with overvalued commercial real estate for years. Too many projects were built on too optimistic lease rates and occupancy rates.
Commercial Real Estate Bond Yields Soar

Bloomberg is reporting Commercial Mortgage-Bond Yield Spreads Rise Most Ever.
The extra yield over benchmark Treasuries that investors demand to own top-rated commercial mortgage-backed securities rose this week by the most ever, according to a Morgan Stanley index.

The average spread over similar-maturity Treasuries for AAA rated 10-year securities jumped 32 percent to 244 basis points, the index shows. The extra yield over 10-year swap rates, a more commonly used benchmark, rose 48 percent to a record 185 basis points, the biggest increase since October 1998 amid the collapse of Long Term Capital Management LP and Russia's debt default.

[For More on Long Term Capital Management LTCM please see Genius Fails Again.]

Commercial-mortgage bonds rated BBB-, the lowest investment-grade, traded at a record average yield spread over Treasuries of 1,309 basis points this week, up 24 percent from last week, according to data from New York-based Morgan Stanley. Over swap rates, the spread rose 25 percent to a record 1,250 basis points.

Analysts including Darrell Wheeler at Citigroup Inc. in New York blame speculative investors such as hedge funds that are placing bets on commercial mortgage-bond defaults with so-called Markit CMBX index contracts for the rising CMBS spreads.
Citigroup Bet The Farm On Musical Chairs

Blaming the hedge funds and shorts like Darrell Wheeler is doing is beyond lame. If Citigroup want to point fingers, it should look into a mirror first, then point.

Chuck Prince: No End Soon to Buyout Boom: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing".

Citigroup bet the farm on mortgage backed nonsense, SIV nonsense, and other nonsense in the foolish belief they would find a chair when the music stopped. They didn't. So Chuck Price danced out the door, golden parachute intact as his reward for wrecking the company.

Now Citigroup is dancing like mad, pointing fingers in the wrong direction, and needing to raise more capital every day. Citigroup will not survive in its present form. The end to its capital impairments are nowhere near in sight.

Bernanke Thwarted By Commercial Mortgage Rates

Bloomberg is reporting Bernanke's Easing Thwarted by Surging Commercial Mortgage Rates.
Federal Reserve Chairman Ben S. Bernanke is proving powerless to prevent a deteriorating commercial real estate market.

While the yield on 10-year Treasury notes fell 1.43 percentage points in the past three months to the lowest since 2003 following four interest rate cuts, the cost of borrowing for apartment buildings, offices, retail properties and hotels climbed as much as 1.25 percentage points, according to David McLain, principal and chief investment officer of Palisades Financial LLC, a private equity firm in Fort Lee, New Jersey.

"The market is locked up right now because there's a huge overhang of leveraged assets of every type, development deals that won't meet projections made last year when things were rosy," said David Tobin, a principal at New York-based Mission Capital Advisors LLC, which was involved in $5 billion of asset sales last year. "It will end just like the residential housing market."

Bernanke's easing hasn't stopped the $3.2 trillion commercial market from starting a slide that mirrors the housing decline, where prices have dropped for the first time since the Great Depression. U.S. commercial property prices probably will fall 10 percent in 2008 from last year's peak after rising 60 percent since 2002, said Dan Fasulo, director of market analysis at New York-based research firm Real Capital Analytics Inc.

Delinquencies of securitized commercial mortgages may quadruple in the next 18 months to almost 4 percent, said Kenneth Rosen, an economist at University of California, Berkeley, who runs a real estate hedge fund. About 70 percent of commercial mortgages are pooled into commercial mortgage-backed securities that are sold to investors, Rosen said.

In Japan, land prices rose last year for the first time since 1991 and sales of commercial mortgage-backed securities probably increased 18 percent, said Douglas Smith, managing director of commercial real estate at Deutsche Bank.

"Japan is the only functioning market globally for CMBS," Smith said last month. In the U.S., "not many deals are being done and the European market is essentially shut down."
Markit CMBX Index

Here are the Markit CMBX Indices for those wanting to keep score. Up is down (that is a rising chart shows increased likelihood of default). Here is one such chart.

CMBS Ratings
  • “AAA” means a rating of AAA (if rated by Fitch or S&P) or Aaa (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
  • “AA” means a rating of AA (if rated by Fitch or S&P) or Aa2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
  • “A” means a rating of A (if rated by Fitch or S&P) or A2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
  • “BBB” means a rating of BBB (if rated by Fitch or S&P) or Baa2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
  • “BBB-” means a rating of BBB- (if rated by Fitch or S&P) or Baa3 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
  • “BB” means a rating of BB (if rated by Fitch or S&P) or Ba2 (if rated by Moody’s) by any two of Fitch, Moody’s or S&P.
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