Commercial Real Estate: From Bad to Worse
Veteran property investor Tom Barrack expects a refinancing crunch over the next few years to cause misery. Two years after the credit markets began to freeze up, a crisis looms in the $3 trillion commercial real estate market. Investors who need new funding find themselves without any willing lenders while fundamentals like rising vacancy rates and plunging rents worsen.
California billionaire Tom Barrack sees opportunity in the wreckage. The chief executive of Los Angeles-based Colony Capital, who made tidy profits by buying up soured up real estate debt during the S&L crisis, talked with Forbes about the troubled commercial real estate market and the broader economy.
What's going on in commercial real estate?
Barrack: It's bad and it's getting worse at the moment. The $700 billion commercial mortgage-backed securities (CMBS) market still has no new money for buyers or refinancing. About a third of that is due at the end of 2010 and 2011 and the majority between 2010 and 2012. So you have $750 billion in refinancing needed over the next 24 months and you don't have one lender.
Why is it so hard to get new funding?
Partly because new equity is needed from the owner to provide any loan because the underlying real estate is 30%-50% less valuable than it was at the time of origination. Where is that going to come from? Everybody's tapped out. All the real estate guys have gone from G4's to electric golf carts. The object of the drill for everyone in commercial real estate--and this is everyone in the world--is just get to the other side of Death Valley. If you can make it to the other side of Death Valley, there's hope. But even when the economy does start to roll out, commercial real estate takes a while behind the tail of that economy to catch up.
Is TALF driving the secondary market?
Absolutely. Smart investors are saying, hey look, you need to be where TALF is. That's gonna be where the liquidity is. That's where it comes back first. That's gonna be the security.
Is that creating a bubble in TALF-eligible Triple A bonds?
Is the CMBS market more complex than the residential mortgage-backed securities market?
Yes. You have a multitude of tenants and you have a multitude of income streams and thousands of varying properties. You have to be a nuclear physicist to understand the architecture of what happens in the event of default on these deals. It's all untested.
Where is the opportunity for smart investors right now?
The new equity in real estate is buying and restructuring debt. The rescue business is the business of the moment. So if someone is about to buckle you offer to take them out of their misery? Yeah, but it's not happening like that because you need to get to a point where they submit. Bankruptcy is an elixir in some ways, allowing a good company to go forward with a new balance sheet. You do have FDIC auctions to dissolve banks and private treaty transactions, which are happening slower than people anticipated, but they're coming down the path.
Are we headed into an inflationary period?
It seems to me the short-term battle is deflation and the long-term battle is inflation. The Fed is dumping trillions and trillions of stimulus dollars into a delevering economy and the price you pay on the other side of this is rampant inflation. When you look at the yield curve, which I think is at one of the highest spreads it's been at since 1962, it agrees with that.
Can you discuss the upside of inflation?
As commodities increase, replacement properties ramp up. But if you have a fixed-rate mortgage, or fixed cost in your real estate, unlike with a fixed-income component, that income adjusts automatically to the inflationary pressure. Investors have always looked to real estate as a fixed-income alternative with a built in hedge to inflation.
What about the downside?
On a long-term basis, we're printing debt. With that pressure on the dollar, even though the dollar is the tallest midget in the circus, there is no alternative for the dollar at the moment, the dollar will weaken. You said there's a sucker's rally in stocks right now.
The multiples that these stocks are selling at are the highest in history on current revenue. Everybody says you have to forget the current revenue, so I look at it and say, "That's a novel thought because for 40 years we were taught that all you look at is current and future revenues."
Can you talk about the new intersection between government and business?
The government train is coming, don't try to stop it, lay down in front of it and go with it. Now we're going to make money by creating value by solving problems and bringing real things to the table. It has to be more transparent, more open and less profitable. Hand-in-hand with the government is how you have to do it.
What's your outlook for the American economy?
When we shift all our energy from all the whining and crying and entitlement of what the past was, we're going to figure it out. American ingenuity and entrepreneurism is the best of brand everywhere in the world. The good news is nobody made a mistake, everybody's net worth got wiped out together on a no-fault basis. We all got marked to market together.
Maurna Desmond, 07.14.09, 06:47 PM EDT , Forbes.com
SpacePlace.net ~ The Commercial Real Estate industry's definitive source for searching, listing and connecting to commercial real estate properties, professionals, and market information.
California billionaire Tom Barrack sees opportunity in the wreckage. The chief executive of Los Angeles-based Colony Capital, who made tidy profits by buying up soured up real estate debt during the S&L crisis, talked with Forbes about the troubled commercial real estate market and the broader economy.
What's going on in commercial real estate?
Barrack: It's bad and it's getting worse at the moment. The $700 billion commercial mortgage-backed securities (CMBS) market still has no new money for buyers or refinancing. About a third of that is due at the end of 2010 and 2011 and the majority between 2010 and 2012. So you have $750 billion in refinancing needed over the next 24 months and you don't have one lender.
Why is it so hard to get new funding?
Partly because new equity is needed from the owner to provide any loan because the underlying real estate is 30%-50% less valuable than it was at the time of origination. Where is that going to come from? Everybody's tapped out. All the real estate guys have gone from G4's to electric golf carts. The object of the drill for everyone in commercial real estate--and this is everyone in the world--is just get to the other side of Death Valley. If you can make it to the other side of Death Valley, there's hope. But even when the economy does start to roll out, commercial real estate takes a while behind the tail of that economy to catch up.
Is TALF driving the secondary market?
Absolutely. Smart investors are saying, hey look, you need to be where TALF is. That's gonna be where the liquidity is. That's where it comes back first. That's gonna be the security.
Is that creating a bubble in TALF-eligible Triple A bonds?
Is the CMBS market more complex than the residential mortgage-backed securities market?
Yes. You have a multitude of tenants and you have a multitude of income streams and thousands of varying properties. You have to be a nuclear physicist to understand the architecture of what happens in the event of default on these deals. It's all untested.
Where is the opportunity for smart investors right now?
The new equity in real estate is buying and restructuring debt. The rescue business is the business of the moment. So if someone is about to buckle you offer to take them out of their misery? Yeah, but it's not happening like that because you need to get to a point where they submit. Bankruptcy is an elixir in some ways, allowing a good company to go forward with a new balance sheet. You do have FDIC auctions to dissolve banks and private treaty transactions, which are happening slower than people anticipated, but they're coming down the path.
Are we headed into an inflationary period?
It seems to me the short-term battle is deflation and the long-term battle is inflation. The Fed is dumping trillions and trillions of stimulus dollars into a delevering economy and the price you pay on the other side of this is rampant inflation. When you look at the yield curve, which I think is at one of the highest spreads it's been at since 1962, it agrees with that.
Can you discuss the upside of inflation?
As commodities increase, replacement properties ramp up. But if you have a fixed-rate mortgage, or fixed cost in your real estate, unlike with a fixed-income component, that income adjusts automatically to the inflationary pressure. Investors have always looked to real estate as a fixed-income alternative with a built in hedge to inflation.
What about the downside?
On a long-term basis, we're printing debt. With that pressure on the dollar, even though the dollar is the tallest midget in the circus, there is no alternative for the dollar at the moment, the dollar will weaken. You said there's a sucker's rally in stocks right now.
The multiples that these stocks are selling at are the highest in history on current revenue. Everybody says you have to forget the current revenue, so I look at it and say, "That's a novel thought because for 40 years we were taught that all you look at is current and future revenues."
Can you talk about the new intersection between government and business?
The government train is coming, don't try to stop it, lay down in front of it and go with it. Now we're going to make money by creating value by solving problems and bringing real things to the table. It has to be more transparent, more open and less profitable. Hand-in-hand with the government is how you have to do it.
What's your outlook for the American economy?
When we shift all our energy from all the whining and crying and entitlement of what the past was, we're going to figure it out. American ingenuity and entrepreneurism is the best of brand everywhere in the world. The good news is nobody made a mistake, everybody's net worth got wiped out together on a no-fault basis. We all got marked to market together.
Maurna Desmond, 07.14.09, 06:47 PM EDT , Forbes.com
SpacePlace.net ~ The Commercial Real Estate industry's definitive source for searching, listing and connecting to commercial real estate properties, professionals, and market information.
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