capital market update february 22, 2010 marc louargand, ph.d., cre co-director university of...

Capital Market Update

February 22, 2010

Marc Louargand, Ph.D., CRECo-Director

University of Connecticut School of Business Center for Real Estate and Urban Economic Studies

University of Connecticut School of BusinessCenter for Real Estate and Urban Economic Studies

• The root(s) of the problem• The scale of the problem• The CMBS and Bank Portfolios• Borrowers and Lending• Transactions and Pricing• When will demand return?• Some bright spots• Capital market outlook

A Brief Tour of the Capital Market


CMBS: The Root of the Problem

Shutters on the BeachSanta Monica, CA


• Developed as a198 room Park Hyatt begun in 1989• Acquired in bankruptcy in 1992 by Edward Thompson

& Goldman Sachs, completed in 1993• Appraised in 2004 for $128 million, $646,464 per key• 2004: $60 million A-Note, $32 million B-Note and $20

million Mezzanine piece - $10 million used for rooms re-do

• 2005: $113.9 million A-Note,$6.3 million junior trust note, $104.8 million B-Note. Total $265 million

• Appraised at $320 million - $978,543 per key

Shutters on the Beach


Casa del Mar


• New loans secured by Shutters’ 198 rooms and Casa del Mar – 129 rooms next door

• 2007: $310 million A-Note, $72 million Mezz piece• Appraised at $450 million - $1,376,147 per key• As of August, 2009 TTM DSCR = 0.88• 0.88 DSCR implies $15,004,000 EBIT/327 rooms or

$45,883 per key or a 3.33% cap rate on 2007 valuation

Shutters on the Beach


• Who’s not guilty?• Borrowers pumped values and withdrew multiples of

real equity• Valuers cooperated, relying on recent sales• Rating agencies cooperated and were conflicted• Lenders relied on junior lenders who relied on

lenders• Treasuries flooded us with liquidity• Reference rates fell dramatically• Risk was free because the buyers weren’t taking any

Who’s Guilty Here?


2003 2004 2005 2006 2007 2008 2009Q20

200

400

600

800

1,000

1,200

525.5 595.1

723.7

855.1

1,062.3 1,065.2 1,066.0

Multi-Family and Commercial Mortgages Outstanding from Agencies, GSE's and ABS Issuers

$ B

illi

on

s

Federal Reserve; Saltash Partners LLC

The Scale of the Problem: RMBS & CMBS?


2003 2004 2005 2006 2007 2008 2009Q20

500

1,000

1,500

2,000

2,500

1,2981,435

1,612

1,7851,933

2,078 2,078

Total Multi-family and Commercial Mortgages in Bank Port-folio Excluding GSE/Agency/ABS

$ B

illio

ns

Federal Reserve; Saltash Partners LLC

The Scale of the Problem: the Bank Portfolio


Banking Sector Response: Tighten

19901991

19911992

19921993

19931994

19941995

19951996

19961997

19971998

19981999

19992000

20002001

20012002

20022003

20032004

20042005

20052006

20062007

20072008

20082009

20092010

-40

-20

0

20

40

60

80

100

FRB Senior Loan Officer Opinion Survey: Net Percentage of Domestic Respondents Tightening Standards for Commercial Real Estate

LoansMeltdown

Was anyonepaying attention?

AsianLiquidityCrisis

Long TermCapital

Management

2000 Recessionand 9/11

Recessionrecovery


19951995

19961996

19971997

19981998

19991999

20002000

20012001

20022002

20032003

20042004

20052005

20062006

20072007

20082008

20092009

-80

-60

-40

-20

0

20

40

60

FRB Senior Loan Officer Opinion Survey: Net Percentage of Domestic Respondents Reporting Stronger Demand for Commercial Real Es-

tate Loans

Job recoveryWill drive real estate again

Borrowers Back in the Market ?

Quick recoveryBecause it was a Non-real estateproblem

Extended recoveryMatched job recovery


J '01 A J O J '02 A J O J '03 A J O J '04 A J O J '05 A J O J '06 A J O J '07 A J O J '08 A J O J '09 A J O0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

Core Equity Risk Premium as% of T-Rate (Cap Rate - T-Rate)/T-Rate

Real Capital Analytics; Saltash Partners LLC

Were Cap Rates too Low or too High?


Transactions and Pricing

2001 2002 2003 2004 2005 2006 2007 2008 2009$0

$100,000,000,000

$200,000,000,000

$300,000,000,000

$400,000,000,000

$500,000,000,000

$600,000,000,000

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

U.S. Transaction Volume and Average Cap RateTotal Sales Volume Avg Cap Rate

Real Capital Analytics

Implies 19%-20%Value decline


2001 2002 2003 2004 2005 2006 2007 2008 2009

-40.00%

-30.00%

-20.00%

-10.00%

0.00%

10.00%

20.00%

30.00%

NCREIF ODCE Total Return

NCREIF

-36.8%Change includingIncome return

Overshoot?

Recent Core Property Returns


When Will Demand Return?

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 3390%

91%

92%

93%

94%

95%

96%

97%

98%

99%

100%

98.6%

98.0%

Recent Post-Recession Employment Recovery1990 2001 2008

Months to Recover Peak Employment

33 48

This is now the sharpestemployment declinein the modern era

Bureau of Labor Statistics; Saltash Partners LLCEstablishment Data

January, 2010 (p)93.8% of peak

24 months and counting

Signs of a bottom?


1970

1970

1971

1972

1972

1973

1974

1974

1975

1976

1976

1977

1978

1978

1979

1980

1980

1981

1982

1982

1983

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1988

1989

1990

1990

1991

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1994

1995

1996

1996

1997

1998

1998

1999

2000

2000

2001

2002

2002

2003

2004

2004

2005

2006

2006

2007

2008

2008

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

HH-Establishment as % of HH

Jan. '73-May '75Apr. '80 - Aug. '83 Jun. '85 - Jun. '86

Jan. '91 - Jul. '92

Oct. '99 - Nov. '03

Feb. '70 - Nov. '71

Household Share grows in Recession

NBER Business Cycle Trough

Watch for the “Household Yawn”


• New York 105,000 • Fairfield County 17,800• New Haven 2,500• Hartford 9,800 • Includes Financial/Insurance Service,

Information, Real Estate, Professional Technical Services and Administrative Support

• * existing supply at 90% occupancy

Office Jobs Needed to Regain a Robust Market*


• Job Loss is slowing, likely turning positive now or soon

• Deep cuts may have caused capacity constraint– Caterpillar called back 600 workers last week– Other recalls announced

• Office employment is a much bigger part of the economy than it was in the past

Bright Spots


• $100 - $200 billion raised to buy distressed assets and mortgages

• Multiple “Blank Check” IPO’s registered with SEC

• Weak transactions flow continues $44 billion in 2009 down from $500 billion in 2007

• REITs have lowered debt burden to 60%• A familiar refrain…………………………………………

Massive Blind Pools on the Sidelines


• Too much money chasing too few deals!

• Bidders are already reaching• So far only the FDIC is offering huge

bargains• The floor is in, let the fun begin!

A Familiar Refrain


• Needs requirement is 1.2 to 1.5 million units per year• Completions have fallen to 380,000 annual pace in

2009• Unsold inventory of new homes down to 6 month

supply (some say 7)• Pending Sales Index of existing homes up 11% in U.S.

year over year, Northeast up 15%• Many CT towns showing YoY price increases Central

CT more so than Fairfield County

Housing Shortfall is around the Corner


Connecticut Housing Picture is Mixed

WEST-HARTFO

RD

MADISO

N

HAMDEN

HARTFORD

STAMFO

RD

DARIEN

MO

NRO

E

TORRIN

GTON

WESTPO

RT

TOLLAN

D

BETHEL

VERNO

N

NO

RWALK

LEDYARD

GREENW

ICH

GROTO

N

FAIRFIELD

NEW

-CANAAN

NEW

TOW

N

DANBURY

NEW

-MILFO

RD

NEW

-FAIRFIELD

-25

-20

-15

-10

-5

0

Continuing pain in many areasnotably Fairfield County

Center for Real Estate, UCONN

2009 Q3 (preliminary) Constant Quality Home Price Change Percent (High Series)


0

1

2

3

4

5

6

7

8

9

7.91 7.9 7.86

6.1

5.25 5.154.7 4.67

4.423.88

2.842.58 2.57

2.09 1.94 1.84 1.711.46

1.040.720000000000001

2009 Q3 (preliminary)Constant Quality Home Price Change Percent (High Series)

Central Connecticut showing positive signs

Center for Real Estate, UCONN

Connecticut Housing Picture is Mixed


Look for Housing Market Changes

19731974

19751976

19771978

19791980

19811982

19831984

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

0

500

1,000

1,500

2,000

2,500

3,000

1,725 sq.ft.3.0 persons

2,570 sq.ft.2.6 persons

New Single Family Homes Built for Sale: Average Square Feet

72% growth per person

Census Bureau

Post-Recession Periods


• Units will be smaller as in previous recoveries• Size will be reduced further for aging Boomers• The “Small House” movement will encourage more small

houses• The Green revolution and interest in sustainable

development will increase construction activity• The “New Urbanism” (now 30+ years old) will continue to

focus on inner cities, especially those with colleges in their downtowns

• Replacement/New style construction will be higher than in the past cycles

Look for Housing Market Changes


Capital Market Outlook

4 week 1 year 5 year 7 year 10 year 2o year 30 year0.00

1.00

2.00

3.00

4.00

5.00

6.00

200120022006200720082009

History doesn’t repeat itself,but it does rhyme


• Fed has raised the Federal Funds rate• Fed has signaled higher rates in the future• Banking system is coming under increased oversight

and regulation• Commercial mortgages are seen as the primary

problem by regulators• Good banks will be working out bad bank loans

– Marco Community Bank failure –FDIC Loss sharing arrangement is back but doesn’t save the agency much

• Real estate will be in the doghouse for a while



• Back to Blocking and Tackling• Basic value underwriting

– Current rents– Current occupancies– conservative LTV’s and DCR’s– Modest growth assumptions

• Recourse loans at higher levels• Keeping tenants happy• Practicing basic real estate• Channel 1994


capital market update february 22, 2010 marc louargand, ph.d., cre co-director university of...

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