Written by (and shared by permission of) David Murray 11/6/2009
Recently I attended a meeting of the Kansas City Chapter of Society of Industrial and Office Realtors (SIOR). Our chapter asked the Federal Reserve Bank of KC to give us its take on the credit markets, as it pertains to the Commercial Real Estate Market (Industrial, Commercial, Office and multifamily lending). Mr. Chuck Morris, VP and Economist for the KC Region presented a program that detailed every down turn in the economy from 1929 to date. Mr. Morris holds an undergraduate, graduate, and PhD in Economics from the University of California.
For over one and a half hours, Mr. Morris presented a very detailed presentation that covered many facets of our economy. Below, I have summarized and paraphrased what I heard in the meeting:
1. Commercial real estate funding comes primarily from the following sources: Commercial banks 45%, Commercial Mortgage-Backed Securities (CMBS) 26%, Insurance Companies 9%, others 21%. The mortgage-backed securities are currently the most problematic method of funding, due to the fact that there is no CMBS market at this time. The main concern with respect to this market is where are the replacement funds going to come from when the pool of these mortgages comes due in 2011 and 2012. In the 4th Quarter of 2007, these mortgages accounted for $60 Billion in leading! By 1st Quarter of 2008, that number was nearly $0, and now that number is negative. The absence of this type of financing has added to the market’s liquidity problems. I asked Mr. Morris what the Fed has planned to do, and he replied that this problem is currently being discussed, but there is no plan of action so far. It is my belief that this is a serious issue for the future of the financial markets, especially in the markets that were overheated, i.e. Florida, Las Vegas, Phoenix, CA, etc. While this type of funding is spread nation-wide, I do not think Springfield has anywhere near 26% of it’s lending coming from these troublesome sources. By their nature CMBS are usually associated with large-scale projects, of which Springfield only has a few. However, some of this debt is in fact present in our local market in the form of apartments and a few commercial developments. Since few of our eggs, are in the CMBS basket, I am hopeful our commercial banks will fill in the gaps as needed.
2. Current demand for loans is very weak as compared to past recessions, and thus loan growth is flat. This is stemming from the fact that the borrowers who drive loan growth are suffering from low earnings or losses.
3. Weak loan demand, however, is not causing banks to decrease the rates of interest to their borrowers. This does seem odd because the spread that the Banks are paying for deposits, versus what they are charging in interest rates, are very high compared to historical data. Morris was pressed on this issue, and he responded that every bank makes its own decision about the rate of interest charged. He surmised that the over exposure of past lending practices are reflected in the banks’ efforts to comply with FDIC regulations and liquidity issues.
4. Property sales volumes have declined nation-wide. For sales of $5m or more, sales in 2001 were $76.5B, a terrible year due to 9-11. Each following year, sales volume improved to a high of $421.2B in 2007. In 2008 sales fell to $132B, which was caused by the mortgage collapse in the 3rd quarter. Thru August 2009 sales were $23.0m estimated to be $34.5B for all of 08) or a mere 8% of 2007 numbers.
5. Morris believes we have bottomed out, due to the signs of growth the economy is showing. The reason for the economic turnaround is primarily Monetary Policy by the Fed. It takes time for this process to work as we are all painfully aware of. I asked Morris if some Fiscal Policy similar to what was used in the 80′s were to be enacted, would that be helpful in stimulating business? (In the eighties when faced with high interest rates, tax law changes that allowed depreciation on structures to be shortened and investment tax credits were used to spur investment in buildings, plants and equipment) Morris acknowledged that those changes did help during the 80′s, but being a Monetary Policy specialist he would not speculate on my question.
6. What is next? Morris stated that in the last 10 recessions, housing is the best indicator of a turn around. The average time from the bottom to the beginning of the turnaround is 12 months for housing, 24 months for durable goods, services and 36 months for commercial real estate. These numbers apply to the nation as a whole and as we all know real estate values are very much determined by local markets. In the 1980′s Southwest Missouri stumbled (Due to the Resolution Trust Corporation (RTC) days), but we never did face the severe declines of some other regions. Our region possesses the same assets as it did in the past, and thus I do not believe that it will take as long to return to a more normal market here at home as it will in some other areas of our country.
7. Mortgages will return once normal amortization takes place. As loans are paid down, interest income falls and the only way for institutions to recapture that lost income is to loan money. When institutions focus on earnings the loans will return.
8. Real Estate is still a good long term investment. As we all know there is only so much land available, and this scarcity insures that with proper planning and management, real estate will continue to provide for good returns over the long term. Some of today’s problems are caused by a few attempting to make a liquid asset out of an ill liquid tract of real estate. Real Estate never has, nor will it ever be, liquid in the true definition of the word. Much has been said about mark to market accounting with respect to the stock market, but similar tactics are being used by some financial institutions, and this is arbitrarily forcing larger percentages of equity into transactions that do not merit such penalty. Just because some assets have issues, it is unwise to penalize the entire market, which, unfortunately, is exactly what has happened. Soon, once the dust has settled and a little time as passed, the market will return, a bit smarter and wiser.