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ULI/PwC: Commercial Markets to Hit Bottom in 2010

Wisniowski, Charles
Economists from the Urban Land Institute, Washington, D.C, and PricewaterhouseCoopers, New York, forecast more pain in 2010.

ULI Senior Resident Fellow for Real Estate Finance Stephen Blank said in a webcast last week that no matter how bad one thinks the environment for commercial real estate will be, it’s liable to be much, much worse—unless, that is, you’ve got cash. For those who don't, commercial real estate sector will hit bottom next year, suffering a surge of painful writedowns, defaults and workouts.

“Housing hit bottom in 2009. Now we expect the commercial real estate markets to bottom out in 2010”  Blank said. “Incredibly, this industry collapse is going to be worse than the early 1990s and the worst that we’ve suffered since the Great Depression.”

The report outlines a scenario in which massive government infusions finally build up loss reserves in financial institutions to levels allowing them to foreclose or strike deals with many over-leveraged borrowers. In turn, banks will start to dispose of real estate owned properties and government regulators will package and sell more bad loans and real estate assets acquired in takeovers of increasing numbers of failed community and regional banks.

Consequently, the report predicts that transaction markets will begin to thaw and value declines ultimately will average more than 40 percent off mid-2007 pricing peaks.

Blank said forget about any kind of meaningful commercial resurgence until late 2011 or 2012 thanks to a lackluster economic recovery and problematic job growth. But Blank and PwC Consultant Jonathan Miller cited a significant bright spot to the otherwise dismal scene next year for investors--provided their purchases are strictly cash and carry.

“On the investment side, you have to deal with cash. There’s no other choice because there’s really not much, if any, debt available. So cash investors will be in a very good position to take [advantage of] cyclical lows,” Miller said. “But don’t rush. A lot of the first deals will be the worst stuff. Those are the investments that won’t come back quickly.”

The report predicts that debt markets will remain severely compromised. Resuscitated banks will increase lending slowly, employing strict underwriting standards and requiring significant equity stakes from borrowers.

Miller said to expect moribund commercial mortgage-backed securities markets to remain entangled in complex workouts of failed multi-tranched structures with mounting levels of troubled loans maturing through 2015. “Restoring confidence in a revamped CMBS model becomes a major pri­ority for the government and financial industry, but a quick fix is unlikely,” he said.

The report said rents and occupancies will likely continue to fall well into 2010, hurting already weakened owners struggling with financing issues. It predicts retail and office properties will take the biggest hits as debt-burdened consumers continue to rein in shopping and companies delay rehiring while looking to shave occupancy costs and improve productivity.

“Once hiring increases, apartments should rebound more quickly than other sectors thanks to pent-up demand from the expanding population of young adults—20-somethings get tired of living with parents and doubling or even tripling up with roommates,” the report said.

Miller predicted 2010 will be an “unavoidable bloodbath for a multitude of ‘zombie’ borrowers, investors and lenders” as the market and lenders decide who is the fittest to survive.

“Getting through 2010 will be the test for who can survive,” said Miller. “Whoever’s left standing will be in a great position.”