Lately you may read a lot about small nuggets of turnarounds, a “reaching the bottom” in some sectors, and the stock market spent several days last week above 8,000. Yet, the next big fallout seems to CMBS and the commercial real estate markets. Over and over articles are printed about the pending disasters that are sure to strike commercial real estate, a plunging of values, and how so many owner operators are facing disastrous balloon payments, due dates and aspects of foreclosure on properties that are otherwise performing at or close to proforma.
Upon closer inspection, you may discover that all or most of these articles and predictions of death and pestilence are penned by those players who bought properties in the last three to four years, paid cap rates in the 6% cap range at negative leverage (from an interest rate standpoint) at very high Loan to value positions, or perhaps even levered up with mezzanine and secondary participation pieces.
We are facing a simple repricing of the market and of values. This is being exacerbated not so much as from occupancies, though they are certainly down somewhat, but rather by financing markets; the lending community’s unwillingness to continue to go to 80% and more of loan to value or at a 1.0 debt coverage ratio. So those acquisitions at aggressive purchase prices financed with short term debt that does not fully amortize, (or self liquidate) will be distressed, troubled, or in today’s parlance become “special assets”.
Ever heard of “live by the sword, die by the sword”? The sword today is debt. The wise swordsman chooses his foil wisely; one that is light enough to be whipped smartly and without burden to surgically excise returns from the market to his benefit. The unwise swordsman perhaps just reaches for the largest blade he can lift, one that may in fact be too unwieldy for him to effectively utilize for survival in true combat, and in the confusion and fog of war, sometimes he may succumb to falling upon it himself.
Too many of the investment market participants have been feeding gluttonously on debt and are addicted to it. Wall Street and hedge funds have been enablers of these acquisition hounds and developers, chasing fees and some kind of return, any return. As these practitioners lose these deals to foreclosure, do not weep for them. Free enterprise is efficient. Weep for their children, but not for them.
Article written by Bruce A. Davis, Senior Partner of Bryant Commercial Real Estate Partners, LLC and member of Market Solutions Group