The Lost Year
Dec 1, 2008 12:00 PM, By Elaine Misonzhnik
Those in the retail real estate industry who hoped a market recovery would come swiftly and painlessly in the early stages of 2009 are going to disappointed. Instead, 2009 is looking very much like it will be a lost year for the sector with investment sales volume down, fundamentals continuing to weaken and no sign of recovery until the fourth quarter at the earliest. Even the most bullish forecasters advise industry pros to hunker down and muddle through 2009 and then hope a turnaround takes hold in 2010.
Real estate Pollyannas insisted for much of 2008 that the credit crunch would pass, that plenty of cash-flush buyers sitting on the sidelines were waiting to pounce and that property fundamentals would not erode much. The wave of buying never materialized and throughout the year store closings accelerated and the credit crisis deepened. Now it's looking like those cash-rich buyers may sit out 2009 as well. Worse, they may turn their backs on retail altogether and opt to invest elsewhere, such as infrastructure.
The stark reality is that the credit crunch is no longer the only culprit for depressed sales volumes. Retailers are hurting and that's damaging existing properties where vacancy rates are rising and its stopping the construction of new projects in their tracks.
So with the freewheeling days of 2006 and 2007 unlikely to reemerge, the industry is likely to face a continued shakeout. Property values could continue to fall. And cap rates — once thought to have undergone a secular change resulting in risk-free lower levels in the 6, 5 and even 4 percent range — seem to be on the way up. In the third quarter of 2008, cap rates for retail properties stood at 6.8 percent, according to New York City-based Real Capital Analytics. To spur more investment activity, that number will likely have to move into the 8 percent to 10 percent range, experts say. Cap rates across all sectors will need to move up 150 basis points to 200 basis points, to a range of 7.5 percent to 8.5 percent for acquisitions to start making sense again, according to ULI's “Emerging Trends Report.” Cap rates on class-B and class-C properties might see increases of up to 300 basis points.
Overall, commercial property values could decrease 30 percent to 40 percent peak to trough, according to JPMorgan research. Since the beginning of the downturn in 2007, retail property values have already fallen between 10 percent and 20 percent, according to research from brokerage firm Cushman & Wakefield.
As a result, the retail real estate sector is not likely to see a lot of acquisition activity next year, according to Stephannie Mower, head of the capital markets group in the Dallas office of Cushman & Wakefield. She expects more transactions will start taking place in the third and fourth quarters of 2009, as a greater number of loans come to maturity and landlords face increasing pressure to sell. “The cash buyers are certainly out there, but because of what's occurred in the stock market everyone is thinking that prices will continue to go down and everyone wants to make sure that [they are] at an absolute bottom,” Mower notes. “By the second quarter of 2009, you'll see [acquisition activity] pick up quite a bit. But I think we will not see a real recovery for another 12 to 18 months.”
Suzanne Mulvee, a senior real estate economist with Boston-based Property & Portfolio Research (PPR), takes a similar view, noting that transaction volume will not start picking up until late 2009, with many closings taking place in 2010. The September bankruptcy of Lehman Brothers didn't help matters. After the Lehman news broke, commercial mortgage originations, already down to a trickle, came to a complete halt, says Andrew Oliver, executive vice president and principal with Cushman & Wakefield Sonnenblick Goldman, a global real estate financial services firm. Wall Street is now out of commission, commercial banks are either dealing with their own solvency issues or are at a complete loss about how to value real estate properties and insurance providers have already exceeded their real estate allocations for 2008. Those issues aren't likely to go away at least until the third quarter of 2009, according to Oliver, limiting the amount of money available for new acquisitions next year.
Right now, portfolio lenders are focusing on smaller deals, $25 million and under, while money for transactions worth more than $50 million is virtually impossible to come by. To line up, say, $250 million in financing once required working with two or three banks. Now it means dealing with a consortium of 10 or more. What's more, market experts expect that underwriting criteria will continue to be stringent, particularly on retail properties, which are perceived to pose the most risk. In October, the retail sector experienced the greatest increase in the 60-day CMBS loan delinquency rate out of all commercial property types, by 9 basis points, to 0.40 percent, according to JPMorgan. Delinquencies for all sectors rose 5 basis points, to 0.51 percent. As of Nov. 10, the overall commercial mortgage-backed securities (CMBS) delinquency rate for retail was at 0.68 percent, according to JPMorgan analyst Alan L. Todd and he expects it to range between 1.5 percent and 2.0 percent next year.
