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Déjà vu or Vujà dé ?

Citi 2011 Mid-Winter Financial Institution Treasury Management Symposium. Writing the Next Chapter for R.E. Déjà vu or Vujà dé ?. K.C. Conway, MAI, CRE Executive Managing Director, R.E. Analytics Colliers International KC.Conway@Colliers.com.

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Déjà vu or Vujà dé ?

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  1. Citi 2011 Mid-Winter Financial Institution Treasury Management Symposium Writing the Next Chapter for R.E. Déjà vu or Vujà dé? K.C. Conway, MAI, CRE Executive Managing Director, R.E. Analytics Colliers International KC.Conway@Colliers.com

  2. USPIGS Vs the BRICs - Fighting Debt Vs Growth(US, Portugal, Ireland, Greece & Spain) Vs (Brazil, Russia, India & China)

  3. What we have been doing this past decade has implications for real estate in the decade ahead.

  4. Let’s start with some perspective on what happened. Vujà dé: We haven’t seen a decade of negative growth America’s Lost Decade of Growth Implication: Less construction lending; More focus on Perm and ReFi loans

  5. What kind of job growth do we need each monthIf we produced 170,000 jobs/month, it would take until 2H 2014 Employment has fallen by roughly 7.6 million since the onset of the recession During the previous expansion, job gains averaged 170,000/mo. With such growth, the U.S. would not attain its pre-recession employment peak until mid-2014. Cumulative Change Since December 2007 Latest Month July 2010 Source: Bureau of Labor Statistics

  6. Can the FED manage the debt, high unemployment and inflation? Vujà dé … The FED has never seen this situation before? Does the Bernanke FED know how to manage the start of inflation from an already elevated level of unemployment? Implication: Interest Rates and whether 10-Yr Treasury will stay <4% in 2H ‘10?

  7. The 2011 Appraisal Challenge: Cap Rate justification“Band of Investment” Cap Rate technique… Pre-2007Post 2010 / Today Required Equity 20% Required Equity 30% or less? Need to know: Need to know: EQUITY IRR 10% Equity IRR Back in “teens” + Allowable Debt 80% Allowable Debt 70% or higher? Use Mtg Constant 6.42% Use Mtg Constant Need to know: Need to know: 1. Interest Rate (5%) 1. Interest Rate What will 10-Yr Tr be? 2. Loan Amort. (30 yrs) 2. Loan Amort. Going back up Indicated Cap Rate:Indicated Cap Rate: Equity (.20*.10) Equity (.30* ?) + Debt (.80* .0642) Debt (.70* ?) Indicated Cap Rate: 7.14% Indicated Cap rate: Assume <% 10-Yr Q.How did we get to 4%-6% Cap Rates? Q.Where are comps for today’s deals <7% Cap? A. The market over-reacted. Leverage >80%? A. Band of Inv like this may be needed to explain

  8. How large is the US CRE debt problem? This part is also Vujà dé … never seen it this large. • #1: US Financial Institutions • 50% / $1.6 Trillion • #2: CMBS • 20% / $640 billion • • half that of US Banks • Q. What was the total out-standing CRE debt in 1998? • $800 billion • We did not quadruple the physical amount of US • Real Estate in 12 years. • This crisis is an OVERLEVERAGE event. • Three Stats to keep in mind: • Fed Balance Sheet: $2.45 Trillion • 2012-2015: $10 Trillion other debt due • Unfunded Entitlements: $80 Trillion

  9. CRE Concentration in banks is another Vujà dé … It is different by size of Institution; and it amplifies why a “one-size fits all” regulatory response is problematic. Why R.E. construction is so material to the Community & small regional banks Why the mortgage “putbacks” are so material to the large banks What will be a QRM?

  10. BREAKING NEWS Fed releases outline for who will be deemed a “Systemically Important F.I.” (85%/$50b/BHC) Bank Regulation:KC’s theory on the regulation life cycleWill we get Déjà vu or Vujà dé ? FIRREA Vs. Dodd-Frank = Life Co, Private Equity & FBO advantage Traditionally, we get…. What we need to be doing to get risk management and regulation to be effective is think… • None…Some…to a TON…and then DONE • We went from: • no new Interagency Appraisal Guidance 1994-2010…to… • CRE Concentration and Loan Workout Guidance…to… • Dodd-Frank, new IAG, and… lots more to come until we are DONE in 2012. Think DYNAMIC vs “Incident Responsive.” ALLL (Allowance for Lease & Loan Losses) is forward looking, but we drive RISK via a rear window approach (What has been our loss experience Vs what it might be via Sensitivity Analyses).

  11. A DYNAMIC approach to RISK and Regulation… We need to understand that CRE investment is DYNAMIC – not static All sources of contamination need to be analyzed! Investors (blindly buying mortgages based on Rating Agency ratings. Investors and speculators looking to increase their wealth harvest. Wall Street & Securitization Congress (just increase home ownership) & Bank Regulators. Rating Agencies supposedly keeping an eye on everything Appraisers just looking at values from the surface fishing for “comps” to support any value. Credit or equity impaired borrowers seeking the American dream of home ownership Predatory lenders and “non-bank” subprime lenders with no oversight.

  12. There is a geographic bifurcation…Office example:(An interesting office leasing story for Denver) Absorption and Sales are occurring primarily in the large, core-MSAs; and not yet in the tertiary markets.

  13. Home Foreclosures:We are not done. The problem is concentrated in 10 states PreForeclosure, thru REO activity is resuming in aftermath of the “robo-signing” moratoriums. State court rulings (OH, MA, UT, FL) will dictate bank losses. Not looking good for the top banks with large MBS exposure. Source: Realty Trac – YE 2010 report

  14. How accurate are property records?The Salt Lake Tribune – by Tom Harvey – First Published Jan 15 2011

  15. CMBS CRE Performance Vs Life Company CRE…

  16. CMBS CRE performance by Property Type…

  17. Life Company CRE performing contrary to CMBS… Note: The “Overall” return is being fueled by both “Income” and “Price” appreciation return. It isn’t just a change in Cap Rate story.

  18. I will conclude with my pro/con CRE list…and a ? What makes me “pro” commercial real estate? • Capital is returning to R.E. ($45 billion Life Co; $70 billion REITs, & $50 b CMBS) •GDP is growing; US exports just hit an all-time record of $5.5 trillion; etc. •Principle of “Substitution” – You can buy at a fraction of cost to build. A Cost Approach to test NOI/Cap Rate conclusion against % of Replacement Cost What worries me about commercial real estate? •Interest Rate Risk: The Federal Reserve’s monetary policy, QE2 and bias toward “extend” strategies for the banks that seem all too familiar to Japan. 3.65% 10-Yr Tr •Rising Oil and commodity prices that will fuel inflation and are already adversely impacting earnings reported by discount retailers - high transportation costs eating up their margins. Cotton, Corn, Wheat, Copper, Steel, Cement, Rare-Earth minerals •The bifurcation in commercial real estate being misread leading to a new round of problems (already seeing sub 6% Cap Rates on MF and a re-start of new construction that is not yet warranted). •Looming State and Municipal debt crisis yet to play out. •Cap Rate Compression and Cap Rate justification to reviewers

  19. Audience Poll Question: Will CRE come back in Harmony with the market in 2011? orWill CRE be sold-off for a Song by the banks and CMBS Servicers?

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