The Lost Year
Dec 1, 2008 12:00 PM, By Elaine Misonzhnik
This ongoing difficulty in obtaining financing, coupled with a grim prognosis for the retail sector, will help prolong the transaction stalemate in retail investment sales. Already in the third quarter of 2008, retail property sales, at $3.4 billion, were down 80 percent compared to the same period in 2007, reports Real Capital Analytics. Year-to-date sales volume, at $16.1 billion, has been off 71 percent compared to last year, and the number of properties sold, at 1,330, down 60 percent. The firm estimates that the total volume of transactions in 2008 will total a little more than $20.7 billion. The last time retail sales volume was at this level was in 2002, which saw activity worth $26.8 billion. Next year, we might see similar figures, says Fasulo.
As a result of all this, Bernard J. Haddigan, managing director of the national retail group with Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based brokerage firm, projects retail deal volume next year might not go much higher than $17 billion. Dan Fasulo, managing director with Real Capital Analytics, thinks it could be a little higher, projecting the total might reach 2002's level of $27 billion. Either way, the projections are a big drop from the industry peak of $71.6 billion in 2007.
Lagging indicators
Because retail real estate statistics tend to lag behind general economic indicators, retail center owners have so far avoided feeling the brunt of the pain from the massive drop-off in consumer spending, according to Joel Bloomer, an analyst with Morningstar. Over the next several months, however, they will face increasing pressure from rising vacancy rates, falling rent levels and a difficult refinancing market.
In fact, on Oct. 22, Morningstar raised its uncertainty ratings, which measure the margin of safety around the fair value of a stock, to high from medium for a number of companies in the retail REIT universe, including Kimco Realty Corp., Macerich Co. and PREIT, citing possible losses in revenue because of consumer spending and the financing environment. Then, on Oct. 31, Goldman Sachs' REIT team issued a note advising investors to avoid any company with high leverage or a large development pipeline. The advisory was based on the calculation that cap rates for commercial properties will come back to the long-term average of 9.3 percent, rising 260 basis points above the current average of 6.7 percent.
The scary thing is that REITs, as embattled as they've become having seen 65 percent of their market capitalization evaporate since February 2007, are in better shape than private real estate companies, experts say. REITs tend to have long-standing relationships with lenders and most have avoided closing too many high-leverage acquisitions during the latest up cycle. The majority of retail REITs have also taken care of their 2008 maturities and have started work on securing financing for 2009, says Rich Moore, analyst, with RBC Capital Markets.
Smaller, privately held firms, meanwhile, may face difficulties. “Given the tight credit conditions, a lot of smaller companies will have trouble getting financing and that will limit their flexibility,” says Robert McMillan, a REIT analyst with New York City-based rating agency Standard & Poor's.
Finance first
So what's going to happen to those companies in 2009, when $34 billion in securitized debt alone will need to be refinanced? The good news is the credit markets might begin to thaw sometime after the first quarter of 2009, according to Dan E. Gorczycki, managing director in the New York City office of Savills LLC, the U.S. arm of the global real estate services firm Savills PLC. While Wall Street will likely continue to be out of commission next year, commercial banks could eventually start lending again, once the money made available through the $700 billion Troubled Assets Relief Program (TARP) works its way through the financial system. The effects of the bailout plan already started to be felt at the beginning of November, when LIBOR rates declined to 3.17 percent from 3.96 percent in October. The TED spread, which reached a peak of 4.64 on Oct. 10, had come down to 1.98 by Nov. 12. However, the effects may not be as great as some had hoped. On Nov. 12, Treasury officials announced they were shifting the focus of the program from financial institutions to consumer credit, with the remaining funding now earmarked for credit card, student loan and auto debt.
In the meantime, it could take months for the $250 billion infused into the financial system to bring true relief to the capital markets, according to David J. Lynn, managing director of research and investment strategy with real estate services firm ING Real Estate. So far, the program hasn't resulted in an increase of lending, according to Bob Bach, vice president and chief economist with Grubb & Ellis, a Santa Ana, Calif.-based real estate services firm. It might not have a sufficient impact on liquidity unless the government requests that banks spend at least a portion of the money they received to originate loans, he notes. Lynn projects that the recovery in the financial services sector won't begin in earnest until the third or fourth quarter of 2009.
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