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LuckyOne

The Commercial Real Estate Avalanche .....

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I am involved in a commercial real estate (CRE) project overseas.

It is in deep trouble. Rents are falling, occupancy is lower than expected and the loans are due in early autumn.

The initial structures were incredibly aggressive. The equity was a mere sliver at around 7.25%. Falling rents and rising cap rates mean that they are now in negative equity to the tune of around 35% of the initial debt.

From a personal perspective, the negative equity is not an issue as the recourse for the loans is not to me and I am only going to lose my initial equity which is money that I always understood was at extreme risk due to the highly leveraged nature of the structure and was part of the high risk / high potential return part of my portfolio.

I am among the many here who are somewhat flummoxed by the pace of the meltdown. I think that projects like these that were started around the peak of the bubble are only starting to blow up now. I looked at quite a few similar projects (and only chose one thankfully) and they were all structured similarly.

Unless there is some form of CRE loan modification program which is implemented within weeks rather than months, there is going to be an avalance of bad CRE deals hitting banks' income statements and balance sheets.

The next leg lower is about to begin.

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What do you think about CRE in this country? I've pretty much called the bottom here (prices have fallen 45% from peak) and I'm starting to see my commercial clients doing deals again.

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What do you think about CRE in this country? I've pretty much called the bottom here (prices have fallen 45% from peak) and I'm starting to see my commercial clients doing deals again.

I did think CRE was close to bottom in the UK then I looked at the yields on the big REITs: 4.5% on Hammerson to 6.3% on LandSecs

The ishares UK Property ETF is yielding about 5% that seemed - well rubbish to me

Rents are still falling, especially in retail.... so I'm none to keen to jump in now

I was thinking I'd want to see yeields at 7-8% before it looked attractive, what am I missing?

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I did think CRE was close to bottom in the UK then I looked at the yields on the big REITs: 4.5% on Hammerson to 6.3% on LandSecs

The ishares UK Property ETF is yielding about 5% that seemed - well rubbish to me

Rents are still falling, especially in retail.... so I'm none to keen to jump in now

I was thinking I'd want to see yeields at 7-8% before it looked attractive, what am I missing?

You might not be missing anything but my view is that if you're looking to buy then you can probably negotiate some pretty tasty deals at the moment.

IMHO looking for a yield of 7-8% right now might be a bit ambitious - I would have more of an eye to the future.

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What do you think about CRE in this country? I've pretty much called the bottom here (prices have fallen 45% from peak) and I'm starting to see my commercial clients doing deals again.

Now that there is so much supply, tenants need to make fewer compromises than they did two or three years ago.

I think that you have to be extremely selective about location. Properties in established areas are probably very close to the bottom. Proporties in marginal locations are probably going lower still.

I am still really confused by the divide between commercial and residential. Commercial is where people work to earn the money to buy residential. I don't understand how the former can be down 50% while the latter is only down 25%.

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I'm in CRE Investment in the UK. It is a two tier market.

Defensive properties - i.e. in prime locations of Central London and 15 year plus income to well capitalised tenants - the markets bounced considerably. 100 basis points or more. Semms like a rush to defensive assets and no thought of the short to medium term rental / void risks.

Short term income - still subdued, the risks outweigh the benefits. Industrial estates can be picked up for an initial yield of between 9 and 12.5% depending on their quality.

There is a severe lack of supply. If the banks begin to forclose the market should drop back and with the rcent loan write offs that could be soon.

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Now that there is so much supply, tenants need to make fewer compromises than they did two or three years ago.

I think that you have to be extremely selective about location. Properties in established areas are probably very close to the bottom. Proporties in marginal locations are probably going lower still.

I am still really confused by the divide between commercial and residential. Commercial is where people work to earn the money to buy residential. I don't understand how the former can be down 50% while the latter is only down 25%.

I think the problem with CRE (particularly in certain locations) is that there was already an overhang of supply when the recession started which caused prices to fall quickly. Businesses downsizing and going bust also means the demand side has collapsed.

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I did think CRE was close to bottom in the UK then I looked at the yields on the big REITs: 4.5% on Hammerson to 6.3% on LandSecs

The ishares UK Property ETF is yielding about 5% that seemed - well rubbish to me

Rents are still falling, especially in retail.... so I'm none to keen to jump in now

I was thinking I'd want to see yeields at 7-8% before it looked attractive, what am I missing?

I always worry that rental income lags property prices. In a declining market, yields can be flattered by the lag in voids / rent decreases etc.

This market is still based on expected capital appreciation versus the US market which is all about income. The risky part of my portfolio needs some additional assets and I will be looking to the States rather than here in November and February.

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I am involved in a commercial real estate (CRE) project overseas.

It is in deep trouble. Rents are falling, occupancy is lower than expected and the loans are due in early autumn.

The initial structures were incredibly aggressive. The equity was a mere sliver at around 7.25%. Falling rents and rising cap rates mean that they are now in negative equity to the tune of around 35% of the initial debt.

From a personal perspective, the negative equity is not an issue as the recourse for the loans is not to me and I am only going to lose my initial equity which is money that I always understood was at extreme risk due to the highly leveraged nature of the structure and was part of the high risk / high potential return part of my portfolio.

I am among the many here who are somewhat flummoxed by the pace of the meltdown. I think that projects like these that were started around the peak of the bubble are only starting to blow up now. I looked at quite a few similar projects (and only chose one thankfully) and they were all structured similarly.

Unless there is some form of CRE loan modification program which is implemented within weeks rather than months, there is going to be an avalance of bad CRE deals hitting banks' income statements and balance sheets.

The next leg lower is about to begin.

Which country have you invested in?

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Now that there is so much supply, tenants need to make fewer compromises than they did two or three years ago.

I think that you have to be extremely selective about location. Properties in established areas are probably very close to the bottom. Proporties in marginal locations are probably going lower still.

I am still really confused by the divide between commercial and residential. Commercial is where people work to earn the money to buy residential. I don't understand how the former can be down 50% while the latter is only down 25%.

Commercial was more dependent on overseas money

Residential prices are stickier, because prices are more based on historic data and less on current measures like rent and yield back up by hard comparables

I expect residential and commerical losses to become closer ovwer time tho ;)

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I always worry that rental income lags property prices. In a declining market, yields can be flattered by the lag in voids / rent decreases etc.

This market is still based on expected capital appreciation versus the US market which is all about income. The risky part of my portfolio needs some additional assets and I will be looking to the States rather than here in November and February.

Interesting, I had ruled out US commercial real estate as it had dropped less than the UK - what am I missing?

Whats the typical yeild on big US REITS now?

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I am still really confused by the divide between commercial and residential. Commercial is where people work to earn the money to buy residential. I don't understand how the former can be down 50% while the latter is only down 25%.

there was no 'A Retail Outlet in the Sun', 'Commercial Property Ladder' etc?

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You might not be missing anything but my view is that if you're looking to buy then you can probably negotiate some pretty tasty deals at the moment.

IMHO looking for a yield of 7-8% right now might be a bit ambitious - I would have more of an eye to the future.

no disrepect intended, but you are sounding like an estate agent...good yields, time to buy, missing out.

Money and lending is needed. both are tight.

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I did think CRE was close to bottom in the UK then I looked at the yields on the big REITs: 4.5% on Hammerson to 6.3% on LandSecs

The ishares UK Property ETF is yielding about 5% that seemed - well rubbish to me

Rents are still falling, especially in retail.... so I'm none to keen to jump in now

I was thinking I'd want to see yeields at 7-8% before it looked attractive, what am I missing?

Do REITS actually have any equity at all? 40% falls alone will wipe out equity value, without even considering leverage ratio

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UK property unit trusts seem to be bottoming so I have started to put modest sums in. Aviva and Ignis have nice funds with decent portfolios of London/Southern England properties. The yields are around 6%, and there is the potential for future capital growth.

Property is a nice inflation hedge as well :P .

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Property is a nice inflation hedge as well :P .

Sure about that?

IIRC property fell massively in real terms during the 1970's inflationary period.

i.e. 10ish% HPI vs 25% inflation.

It helped -but not that much

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UK property unit trusts seem to be bottoming so I have started to put modest sums in. Aviva and Ignis have nice funds with decent portfolios of London/Southern England properties. The yields are around 6%, and there is the potential for future capital growth.

Property is a nice inflation hedge as well :P .

I was thinking similarly, however, I'm a bit concerned about rents falling and I don't see capital growth in the short-medium term

Therefore I decided I wanted 7-8% income to justify the investment, looked the majors - 5%....

You can get 6-7% on corporate bonds with better security and similar possible capital growth potential

(Guess it depends on your inflation outlook) ;)

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Which country have you invested in?

The mid-Atlantic states in the US.

Population growth, demographics and land prices made it the only part of the US that was a sensible risk / reward trade-off at the time (2005/2006).

This project will fold. The ones that I looked at in California, Florida, Texas, Arizona and Nevada are going to implode much worse than this one has which makes me think that the size of the problem for banks is going to be massive.

It is worth noting that the banks involved in this relative backwater were American (the less risky portion of the debt) and European (the more risky portion of the debt).

The impact of the implosion of the CRE market in the US is not going to be limited to the US.

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no disrepect intended, but you are sounding like an estate agent...good yields, time to buy, missing out.

Money and lending is needed. both are tight.

No offence taken ;) I just think that if you are a cash rich investor (and a number of my clients are) then where do you put your money? Gilts? Corporate Debt? Shares? Residential Property? Commodities? There are risks with all of them. IMHO (and probably because it's my area of specialism) the commercial property market now represents as good an investment as anything else out there but as others have pointed out, you still need to be selective.

Edit: rubbish punctuation

Edited by Willy Weasel

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I am still really confused by the divide between commercial and residential. Commercial is where people work to earn the money to buy residential. I don't understand how the former can be down 50% while the latter is only down 25%.

Partly I think it's a case of commercial players being willing to take a rational business decision and sell at a loss. Residential is more emotion driven so owners are tempted to hold out for the market to improve and behave less rationally in the short term.

What this means is that resi is a slower more drawn out crash wheras commercial is a short sharp shock.

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No offence taken ;) I just think that if you are a cash rich investor (and a number of my clients are) then where do you put your money? Gilts? Corporate Debt? Shares? Residential Property? Commodities? There are risks with all of them. IMHO (and probably because it's my area of specialism) the commercial property market now represents as good an investment as anything else out there but as others have pointed out, you still need to be selective.

Edit: rubbish punctuation

yes thats the $m question

the only answer i can come up with is a lil bit of everything, kept very liquid, and a lot of cash in various currencies

the main problem I have in buying physical property is that it just aint liquid

(hence my very high return criteria I guess)

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Sure about that?

IIRC property fell massively in real terms during the 1970's inflationary period.

i.e. 10ish% HPI vs 25% inflation.

It helped -but not that much

Not if my mum and dad's experience is anything to go by; bought a house in 72 for £8k; dad lost job so had to sell QUICK in 82; sold for £38k. In the same period wages more than doubled too but still, thats 450% in 10 years.

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yes thats the $m question

the only answer i can come up with is a lil bit of everything, kept very liquid, and a lot of cash in various currencies

the main problem I have in buying physical property is that it just aint liquid

(hence my very high return criteria I guess)

What I think this means is you aren't cash rich enough!

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yes thats the $m question

the only answer i can come up with is a lil bit of everything, kept very liquid, and a lot of cash in various currencies

the main problem I have in buying physical property is that it just aint liquid

(hence my very high return criteria I guess)

Liquidity is an interesting question.

My view is that you have to accept a discounted expected return in exchange for liquidity.

A part of any portfolio needs to be liquid to cover expenses, portfolio rebalancing / reallocation etc but that a part of a portfolio need not be liquid which boosts overall portfolio returns relative to a completely liquid portfolio.

The more money that you have (to Bagsos's point), the less liquidity you need and the higher returns that you will earn. Just another reason why the rich get richer.

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