Commercial Real Estate: Is this 2009 or is this 1991?

The impending doom that is being reported by the media about commercial real estate has reached a near crescendo in recent months. In an ironic twist, I've received many calls from potential joint venture partners clamoring for investment opportunities. Although the market is "awash" with fresh capital to be put to work, there is actually a shortage of acquisition opportunities in today's commercial real estate market.

This shortage is surprising as most participants were expecting an avalanche of foreclosed property. In fact, lenders are not engaging in wholesale selling of their toxic loan assets as predicted. In addition, most lenders are not foreclosing on larger assets, even if their loans have matured, and even if their underlying real estate values are "under water". The humorous phrases of the day that size up the situation are "extend and pretend" and "delay and pray". The lack of foreclosures can be traced directly to the relaxation of the "mark to market" accounting rules that require a lender to write down the value of their assets based upon recent comparable sales and/or recent appraisals of the underlying real estate.

In contrast to current banking rules, the rules in the early 90's were very strict. Banks had to obtain a current appraisal, writing down their assets to a percentage of that value. At that time, far more banks were shut down by the government and their assets were placed into the RTC for aggressive disposal. Through September of 2009, approximately 89 banks had failed. In contrast, in 1989 alone, regulators took control of 534 banks. Overall, during the S&L crisis of the late 1980's and the early 1990's, over 1,000 financial institutions failed.

Another factor limiting foreclosures is that bank stock prices have recovered enormously, with many banks taking in large chunks of cash by issuing billions in new stock and bonds. And, with rates from the Fed at near zero, banks are minting money every day. They are borrowing from the Fed at near zero interest and they are lending it out at historically wide spreads. With these new profits rolling in, the major banks believe that they can take their time with respect to writing off real estate loan losses.

In addition to lax bank accounting, there are several other interesting factors at work that explain why prices haven't fallen as hard as may have been expected. These are as follows:

1) RATES: The Fed has placed a floor under cap rates by lowering interest rates to near zero. Investors now see higher yielding real estate as a solid alternative to 1% money market rates.

2) REIT RECOVERY: REIT stock prices, along with the broader market, have made a startling recovery in recent months. Like the banks, many REITS have replenished their balance sheets with fresh cash from new stock issuance. Some of the money that the REITS have raised through stock issuance has been applied to pay off maturing loans and some of this new cash is beginning to look for new acquisitions. REITs are also competing with billions of dollars of uncommitted private capital.

3) FOREIGN LENDERS & IPO's: A series of new mortgage REITS have recently gone public bringing new liquidity to the market. In addition, new mortgage issuance is coming from foreign lenders that are eager to take market share. For example, SL Green recently completed a large loan on a New York Office building (100 Park Avenue) utilizing a consortium of foreign lenders.

4) TALF: The Fed's TALF program is also assisting with new liquidity. This program has an enormous potential for jump starting the securitization market. REITS are proceeding to tap the TALF, which may add to their liquidity - at extremely low interest rates.

5) THE DOLLAR: The cheap dollar is making the U.S. one the most attractive places in the world for foreign investment. This fall, Germany conducted its largest institutional real estate investor conference called Expo. The demand at that conference for U.S. real estate was shocking. German funds took in cash at a rate that caused them to shut down fund-raising because they were concerned about not being able to invest the cash quickly enough. One fund, Deka, just acquired a D.C. office building at a 6.3% cap.

6) LESS SPECUALTIVE BUILDING: Finally, we did not see as much speculative construction during the mid-2000's as we did in the late 1980's (as a percentage of the total footage), so the market is not under the same pressure from over-building that it was in the early 1990's.

So where do we go from here, and what should investors do? Given all of the factors I've enumerated herein, and assuming the U.S. economy continues to recover, it is very possible that we may not see a collapse in commercial real estate prices like we saw in the early 1990's. Markets usually don't follow 'conventional wisdom'. And while everyone is predicting a collapse in commercial real estate prices, I am beginning to think we may see the reverse; 'bid-ask' spreads may begin to close to the upside.

There is no progress in life without risk-taking. It may be that the biggest mistake for investors to avoid right now is to do nothing at all.

Although prices have not fallen nearly as much as many real estate professionals have been expecting, base interest levels have continued to fall to near record lows. If seller financing can be obtained, and as the TALF begins to thaw the frozen mortgage market, buyers may be able to obtain long term fixed rate debt at near record lows. If inflation begins to accelerate, low fixed rate financing could prove to be extremely lucrative in the future as rents begin to rise with inflation. The low rates can go a long way to ameliorate the perceived lack of bargains.

Feldman Equities focuses on the less visible opportunities, perhaps the not-so-pretty office buildings, where there is a lot of vacancy. These properties, offer great value and growth potential if the correct turnaround strategy is utilized. Currently, we're focused on acquiring distressed office buildings in Manhattan, Florida and New York.

Because of our background in construction and development, we take a bricks-and-mortar approach to buying assets. While many players over-compete to buy trophies at or above replacement cost, we prefer "value-added" acquisitions that require significant redevelopment. Our policy is that the total cost of the purchase and redevelopment costs must come in well below replacement cost.

A "hands-on" approach to turning around distressed assets, combined with deep bricks and mortar capability, have earned Feldman Equities a national reputation with investors for being ahead of the market, and for producing above normal investor returns. We believe that the year is 2009 and not some other time - and that the time to act is now.

Larry Feldman
President/CEO
Feldman Equities, Inc.
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