Summer’s Thoughts from Keith Munsell

August 2, 2010 By

Home Runs:

Sales for the month of June hit an artificial 4 year high driven by the government tax credit. Congress has extended the deadline from the original June 30 until September 30 but still requiring a binding contract to have been executed by the end of April. Median price also rose slightly nationwide; here in Massachusetts we outstripped the national increase by more than double.

The local developers also seem to believe that the rise in sales and pricing may be just an anomaly as plans for local developments keep getting scaled back; e.g., the Fort Point development continues to be downsized. However, with the thinking that ‘if you build it they will come’ the state appears to be funding some of the infrastructure for the South Weymouth Naval Air Station (where I worked some 4 decades ago) with the thinking that this will help jump start the development. Maybe they should be thinking about where the demand will come from before we spend precious tax payer dollars – but maybe that is just me being skeptical.

However, the silver lining in these clouds is that the mortgage rates are at historic lows. So if you have a steady job, can afford to buy, or want to refinance, now is a great time to do so.

In sharp contrast to a rise in homeowner activity, Consumer Confidence fell to 51.0 in July, down from June which was down from May. The undercurrents of high unemployment, poor wage growth, a volatile stock market and rising imports appear to be the cause of great concern; thus my doubt about sustained growth.

Shop ‘til You Drop (Retail):

Shopping centers will face huge pressure as nationwide they appear to be overbuilt, though locally they seem to be OK (maybe our nightmare permitting process actually does have some benefits). The ills that affect the Consumer Confidence are brought to fruition in this sector. Watch for poorly located centers to close.

Overnight Guests (Hotels):

Hotels seemed to buck the downward trend both nationwide and locally as occupancy and rates have rebounded seemingly from a rise in business travel and summer vacationers. This is all good news for the hospitality industry; however, it will not bail out this over financed, under-performing sector as occupancy and room rates have not risen to the projections used to fund acquisitions and refinancing. There continues to be large debt service challenges ahead as loan to values and debt service coverage have not met expectations.

See through:

Years ago when I was visiting Houston, I heard for the first time the term ‘see throughs’ – referring to completed buildings with no tenants so you could see through entire floor plates to the other side. Nationwide we seem to be going that way, both with newly constructed and existing office buildings. The office sector continues to both shrink and play musical chairs as companies continue to upgrade their space while decreasing their rental expense and demand for space. Locally the first quarter showed negative absorption (giving more space back than taken off the market). In a 200+/- million square foot market (Boston to 495) there is almost 40 million square feet available. Like the Hotel sector, the office sector will have debt service challenges as rolling office debt needs to be refinanced at a time when rents have fallen and vacancy rates have risen and the banking sector continues its conservative ways.

Closing Thoughts:

Across all sectors, underperforming over financed properties will likely be returned to lenders. Consider as an example an office building financed three years ago at a reasonable 80% loan to value. Now values have dropped by say 40% and the borrower goes in to refinance. Well, that loan is underwater and the lender states that they will be happy to entertain a 65% loan to value based on the new value. This of course means that the borrower has to come up with equity representing 41% of the original value. Good luck.

I am still skeptical about the economy even though our corporations seem to be having a better time than in the immediate past. If one were to disaggregate their performance you might find that there is growth but not American job growth as some of those 8.5 million US jobs are probably lost forever. With approximately 15 million Americans out of work, there will continue to be stress across all sectors of the real estate economy.

Filed Under: USA Real Estate

Weekly Thoughts of Keith Munsell

May 26, 2010 By

Going ‘green’ is here to stay. The environment in which we live, work, shop and play has forever changed. This has a lasting effect on the way we design and construct buildings. Not just the materials used in construction, but how they are used, how materials are disposed of and how the environment is sustained. You see this at Russia Wharf (now called Atlantic Wharf) along Boston’s Waterfront and The Weston Corporate Center in Weston (both projects currently under construction, the latter poised to be delivered, by Boston Properties) and will see this in the Liberty Mutual Insurance expansion. The question has always been how much more will this cost, but maybe the right question is how much will this cost if we don’t do this.

The Boston local commercial markets, despite some positive news out of both the Seaport District in newly signed leases for almost 100,000 square feet and the Fenway area (near and dear to my BU heart) with the beginning of permitting for new major retailers continues to be stressed. Recently Waltham’s Bay Colony, one of Broadway Partners acquisitions in 2007 is handing the keys to the complex back to Prudential Financial.

Though there is money on the sidelines to purchase properties like Bay Colony, the question still revolves around pricing, with few data points, declining rent and increasing vacancies. As the front page of a recent Boston Business Journal article stated ‘Commercial RE: Things are less Bad’.

Congress and the general public (those that are informed) are questioning if we should, and at what price, continue with taxpayer support to prop up secondary market giants Fannie Mae and Freddie Mac. This cost may well exceed $400B. The generally accepted rational for their existence is that they make homeownership more affordable and that because they buy and then package loans they make the secondary market possible while deflecting risk from the banks to the banks and investors. Before you throw out the baby with the bath water remember that they hold, in some form, $5.5T of mortgages.

As the homeowner tax credit is about to expire at the end of June, the question is how much support has this given the housing industry? Recent new home permit applications were up, though at about 60% of their ‘normal’ level. Home prices and sales activity were up in many communities though the National median price fell by about 1%; existing home sales are approaching 85% of ‘normal’ activity. Will this continue? Despite record low interest rates I believe that the lack of credit incentive will put a damper on the resurgent housing market.

The underpinnings of my foreboding on both the commercial market and the residential market remain anemic job growth. Without an expanding employment base both the business community and the consumer will remain reticent to expand/spend. Millions of jobs lost in the recession may be gone forever. Though there has been an uptick in consumer spending, the loss of home equity and retirement funds will make this resurgence short lived.

What’s the good news, the good news is that there is less bad news than before. Things seem to be getting worse at a declining rate.

Filed Under: Commercial Real Estate

Mixed Reviews on Housing Sector

April 1, 2010 By

Employers unexpectedly cut 23,000 jobs last month as economists had predicted a job growth of some 40,000 positions.

Speaking of the unexpected, the good news is that more insured overdue mortgage holders got back on track last month than fell into default for the first time in over three years.

More good news is that factory orders rose in February, bolstered by strong demand in aircraft and machinery from overseas orders and increased business spending on capital equipment; continuing the recovery in the manufacturing sector, which had shed orders by some 25% during the recession.

Consumer spending rose for the fifth month in a row. Does this mean that the recession is over and that consumer confidence is back? Who knows? Jobs will be the key to recovery and as pointed out, the news is not good here; though less bad (if that can be considered good) than in the past. The increase in consumer spending may b e explained in part due to the growth in wealth as consumers have recouped (net worth of households) over $5.5T, reversing the trend that took away almost $17.5T since the zenith of net worth some three years ago.

Though nationally the real estate market continues to decline, most recently by .7% last month, locally, median sales prices rose by 8.4%; making this the third month in a row that prices have increased while sales volume also increased above what was seen during the same period in the prior year. However, don’t be alarmed at the dramatic rise in prices as this was a reflection of a particularly strong upper end of the market. Continued strength can be attributed to both pent up demand and more affordability as prices have come down nationwide by some 30% and 16%+ locally.

Single family home construction nationwide has fallen to just over 300,000 units, the lowest point in recent history. Homeowners continue to keep product off the market in the hopes of a recovery. These two facts have shrunk the pool of available housing and as we can remember from our freshman economics class on supply and demand if. …

While talking about single family homes an interesting factoid is that the national average size of newly built homes continues to migrate south as home sizes have fallen from just over 2,500 square feet in 2007 to about 2,350 square feet in 2009. One might surmise that this is due to cost containment, availability of conforming mortgages and being conscious of the environmentally impact of living large.

The question on everyone’s lips is whether the single family home market will continue to gain momentum. Home buyer credits are currently set to expire soon, and the federal government is pulling its support of housing through the purchase of mortgage-backed securities. So, can the housing market rebound without these two underpinnings? The government has just ended its program that purchased $1.25T (as in trillion) of mortgage-backed securities as well as about $175B of housing agency debt, a total of some $1.4T.
Mortgage rates continue to be at historic lows, but there is uncertainty in the market due to the looming removal of the buyer credit and government pullout (the underlying point here is that the private market will begin to function on its own again versus having the forced presence of government funds artificially manipulating market supply and demand forces). Because of this uncertainty I believe that mortgage rates will begin to drift upward over the coming months.

Filed Under: USA Real Estate

Munsell's Weekly Thoughts…Bank Failures to Green Building

March 10, 2010 By

The FDIC plans to auction more than $1 billion in assets seized from failed banks next month and this may require write-downs that weaken lenders nationwide. Note that 140 banks failed last year, 26 thus far in 2010, and as of December 2009, over 700 banks are on the FDIC’s watch list. You do the math.

Interestingly, retail sales are up for the third consecutive month, indicating that the worst may be over and an easing of fears about spending. Or, maybe we just can’t take it anymore and we are going to reward ourselves with new stuff; as job prospects still look bleak and personal income has actually shrunk when taking into account inflation.

On the local scene, the battle between the Mayor and the Developer regarding the former Filene’s site seems to be heating up – will be interesting to watch what develops. Can you force a developer to proceed when demand and financing are not available? Just look at values of commercial sites like 230 Congress Street, 10 Milk Street and, the XV Beacon Hotel.

According to a recent Business Week article, cash rich builders are buying land again at huge discounts in the hopes that the market for new homes will turn around soon (note homebuilding is at the lowest point since records have been kept). Of particular attraction are broken subdivisions where most of the infrastructure has been installed – someone’s problem is another’s opportunity.

Last but not least, out of Housing Zone ‘Does Green Help Sell Homes?’ the answer seems to be ‘yes’ but when you survey the major home builders, less than 1/3 are building certified green or high-performance homes and do not advertise these benefits. Is the buying public ahead of the curve on this issue?

Filed Under: Lending Markets

Uncertainty, No Motivation…Do Nothing

February 7, 2010 By

The Institute of Supply Management’s January index of non-manufacturing businesses climbed to 50.5, up from 49.8 in December – readings above 50 signal growth. Correspondingly, the Institute for Supply Management’s manufacturing index rose to 58.4, which represented the 6th straight month for expansion.  The Consumer Confidence index increased to 55.9, up from 53.6 in December 2009, and significantly up from 25.3 in February of 2009.  All great news, but…

Changing Landscape of Lending Markets

Banks nationwide stopped raising the bar for borrowers; however, they continue to tighten standards on residential real estate lending.  Most banks believe delinquencies on commercial and industrial loans will decline in 2010 – a position I strongly hope is true (but are you kidding?).  With $1.2 trillion of debt scheduled to roll between now and 2013, and given the limited ability to refinance those loans, not to mention the required huge influx of equity that is inevitably necessary to maintain loan-to-value ratios, do you think this may be problematic? 

Property funds have raised $135 billion along with an additional $30+ billion by REITs; commercial lenders now consider the norm a loan-to-value ratio in the 60% to 65% range with banks making short-term loans on a long-term repayment schedule, while life (insurance) companies are looking at longer-term loans.  Where does this leave our commercial property values? 

There is debt available for core (the best of the best) properties with little tenant rollover; however, at those lower loan-to-value ratios, capitalization rates (valuing an operating income stream) seemed to have bottomed out for those core properties.  Is this because values have reached the bottom in this class of property, or is it because all that money is burning a hole in the fund manager’s pocket.  Are the fundamentals really there? 

Say for example, you financed a project at 80% loan-to-value three years ago, that loan is probably at 110% of value and at today’s terms they might be lucky to refinance at a 65% loan-to-value; the additional money will have to come from somewhere and that is for the loans that meet the more stringent standards.

Tishman Speyer NYC Debacle

Look at Tishman Speyers’ New York debacle, the purchase of two NY apartment complexes for $5.4 billion with $100 million as their equity portion (plus other equity partners money)with loans of approximately $3.6 billion, the value of said purchase is now estimated at $1.8 billion.  And these are very smart guys.

Massachusetts & US Economic Indicators

Massachusetts’s economic activity declined for the sixth consecutive quarter at the end of last year as holiday shoppers were cautious and unemployment spiked.   In contrast, the US economy grew by 5.7% last quarter on top of a positive 2.2% the prior quarter according to the Department of Commerce.  How much of that growth was due to stimulus money and how much was inventory replacement remains to be seen – wait until this quarter to see what is reported.

Home construction figures fell to 557,000 units, still posing a significant risk to economic recovery.  In normal/good times, this figure could be expected to be over one million units of production.  However, applications for building permits rose. The National Association of Home Builders index fell to 15 last month, further indicating poor construction conditions – readings below 50 mean most respondents view the conditions as weak.

Net occupied space in Boston shrank by over 4 million square feet during 2009 (and this is better than the rest of the nation), while vacancy rates approached 20%. State home sales showed their first increase since 2004, however, median prices continue to decline (year to year). The question is how much of this was tax credit driven?  Foreclosures fell over the same period, however, the precursor to foreclosure is ‘petitions’, and despite the widely broadcast news that foreclosures were down 25% in Massachusetts, petitions are up.

Libor versus Labor Rates

LIBOR vs LABOR…the former being so low that it is keeping rates low and commercial debt affordable and maybe even repayable. LABOR on the other hand continues to shed jobs and the future for commercial space looks bleak.  If the LIBOR rate rises, the ability to pay debt and refinance will be significantly compromised. Millions of people have lost their jobs, their homes – the political influence of the financial sector secured a huge bailout and while Wall Street benefited Main Street suffered.  Massachusetts’s employment is back to the same level as two decades ago – where is growth going to come from?

So what does all this mean – conflicting information, some good news, some bad – in times of uncertainty most people/institutions sit on the sidelines and wait.

Filed Under: Lending Markets Tagged With:

Munsell's January '10 Thoughts on Real Estate

January 11, 2010 By

Boston Area 2009 commercial sales are off by approximately 90% as compared with the market peak. I expect to see more sales activity (not higher prices) only if sellers get more realistic, lenders dump properties on the market, and money sitting on the sidelines decides that  the investment makes sense from a CF prospective or that they think the market has bottomed out.

Boston-area housing sales will continue to be slow as most pent up demand for first time homebuyers was satisfied last year with fulfillment of the tax credit buyer program (thought to expire and then renewed through the Spring of 2010).  Nationwide sales, which had rebounded, fell from October to November by 16%.

Consumer borrowing continued to decline for the tenth straight month as borrowers continue to be nervous about employment and as they try to re-fund depleted investments.   Not helping was the most recent employment figures, which showed that the economy continues to shed jobs, this past month to the tune of 85,000 more jobs.

One of my favorite metrics did show signs of life as the Institute of Supply Management’s service index rose to just over 50, signifying expected growth in the service sector.

In November, business added some 52,000 temporary jobs, a forerunner of full time employment .

The Boston-area jobs outlook continues to be somewhat dim as some are projecting another 30,000 job loss.  This will depress the Consumer Confidence index as well as continue to expand the office vacancy rate already approaching 20%.  Nationwide, we have lost more than 7.2 million jobs.  The light at the end of the tunnel here is that temporary employment has grown and hours worked has stabilized; usually precursors  to permanent job growth.

Developers continue to pull out of projects, the latest in a string of pull outs is the developer for the South Station Postal Annex site in South Boston.  Could it be that lack of tenants and funding had any effect?

Deficits will try US ability to sell debt resulting in an increase in interest rates and further depressing both the housing and commercial real estate markets.

The major Banks have mostly repaid their TARP funds, although the bad news here is the community banks have not and their exposure to commercial and development real estate is a far more significant portion of their loan portfolio.

Filed Under: Commercial Real Estate

Bad & Good News for Housing Market

December 8, 2009 By

The bad news, contrary to what others state, is that I believe that housing prices will continue to decline, in part because of no job growth in the near future and the problems that the FHA is having. This decline will not be as dramatic as in the past year, but a decline never-the-less. I say this because there is no job growth and will not be for a least another year; this combined with low consumer confidence means that the consumer will be hesitant to obligate themselves to large purchases, though I do recognize some pent up demand. Having said this, I believe that home prices will continue to slide slightly. Low interest rates and government money is having the positive effect of slowing the rate of decline.

We all know about what is happening on the job front. The government tells us that the good news is that job loss is slowing – but it is job loss none-the-less. The other item not spoken about until recently is the trouble at the Federal Housing Administration (FHA).

Last week, the FHA acknowledged that its cash reserves were at levels unacceptable and in violation of the Congressional mandate of 2%. According to reports the FHA reserves were at .53%. The FHA is the agency which guarantees loans for many first time home buyers as well as refinancers. If the FHA runs into financial difficulties then the market could be negatively impacted – and it will be. The FHA insures about 30% of first time buyer purchases and about 20% of refinances, both up from about 3% just a few years ago. If the FHA is in trouble then the market is in trouble. The FHA requires as little as 3.5% as a down-payment, if the market continues to slide it does not take a rocket scientist to see that in a very short time the minimal equity in a home is wiped out and with it a major incentive to work things out. Currently about 17% of FHA loans are at least one month delinquent.

What might the FHA do ? They will probably require better credit from their borrowers; they may require a larger down-payment and may increase transaction costs to replenish their reserves. All of which mean that fewer borrowers will qualify and will diminish demand. A diminished demand will mean lower prices.

The silver lining, the good news, is that both locally and nationally the cost of home ownership is far better than in prior years. The monthly mortgage payment costs of the median priced home represents the lowest percentage of median family income in more than a decade. The Home Affordability Index is an excellent window with which to view home affordability. For example, if a median home is priced at $175,000 and the median family income is $55,000 the affordability index is 3.2. From the ‘80’s through ’07 that index approached 4 and in some locales like the Boston area it was 5 or higher. Today the national average is 3.4 and locally is 3.8. For the Boston area, always lambasted because of its high cost of housing this means that we can better compete with the rest of the nation, at least on this metric. Now we need job growth.

Filed Under: USA Real Estate

Commercial Real Estate Market to Bottom in 2012

November 23, 2009 By

After gorging on cheap capital and overleveraging in the mid-2000s, the commercial real estate market will hit bottom sometime in 2012. There will be an oncoming tsunami of defaults and foreclosures because of an inability to restructure debt along with declining occupancies and rental income.

To date, the government has propped up lenders with huge infusions of cheap taxpayer money, which has kept the institutions solvent (this highlights the concept of “extend and pretend”, which is more commonplace in today’s market), but has not had the effect of either loosening lending or correcting the problems. Eventually the banks and the Special Servicers (CMBS market) will have to jettison their portfolios, increasing the supply of available product while at the same time further depressing prices.

And the timing could not be worse, as many of the 400 or so banks on the government’s ‘watch list’ will become insolvent dumping their assets at auction prices. Add to the above equation the inability to obtain borrowed money at anywhere reasonable loan-to-value ratios and the lack of a replacement market for the moribund $200B a year CMBS market and you have the ‘perfect storm’.

Did I mention job growth – no, as there will not be any anytime in the near future? I am always intrigued by hearing about our ‘jobless recovery’ if it is in fact a recovery at all; as what recovery isn’t jobless? Doesn’t industry gain business before hiring employees and to date we have not been gaining much business. When we do, first you will see a growth in average hours worked per week, then you will see an increase in temporary employment and finally a growth in permanent jobs as business feels comfortable that their growth was not an anomaly, but truly an economic turnaround.

So what is the good news – there isn’t any.

What should investors do if interested in commercial real estate acquisitions – wait.

Filed Under: Commercial Real Estate

The Future of Commercial Real Estate

November 6, 2009 By

At the annual New England CCIM Chapter meeting in Burlington last week, I had the opportunity to present a discussion on the future of commercial real estate values.  The following executive summary attempts to provide some color to the Commercial Property’s Future presentation (37 KB PDF) that I prepared for the event.

I noted that all recoveries are really jobless as industry gains business and then hires as opposed to hiring and then hoping for more business.  Ultimately, the employment environment trickles through all sectors of commercial real estate – depressing values.

The increased savings rate, while overall good for the economy in the long run, currently takes billions of dollars out of the economy which otherwise might have been spent on consumer goods and services (70% of our economy).  This along with job loss and employee angst will keep a lid on retail sales.

A bright spot is that retailers and manufactures are keeping their inventory low and shortly will have to restock – meaning an increase in manufacturing and distribution with a positive effect in demand for warehouse space.  However, if the economy has not picked up by then this may be a short lived increased demand.

The mantra in the financial sectors has been ‘extend and pretend‘ – kick the can down the road.  If we don’t mark our borrower’s assets to market then we don’t have to recognize a decline in value and a technical default (even if they are paying) as the loan to values (LTV) are too high, the debt coverage is not there, and many of the mortgage covenants have been broken.  However, this extend and pretend behavior cannot go on forever, and when the market values are reported, commercial loans will have even more problems as borrowers will not be able to refinance existing debt and will have to either kick in more equity and/or pay down the loan.  What lenders will step into this void?

The landlord’s Catch 22 (after the Joseph Heller novel about trying to get out of the service by saying you are crazy, but if you know you are crazy then you can’t be) for those attempting to develop is that the landlord needs signed leases to get a loan, but the tenant needs the assurance that the project will go forward as evidenced by a loan in place before they are willing to commit to a project.  Which comes first the chicken or the egg?

My predictions as to value, peak to trough are for Boston: Homes -25%; Retail -40%; Industrial -40%; Office -35% and Lodging -55%.  Nationwide, I see home prices declining even further unless the administration extends the home buyer programs (which just recently made it through the Senate and House) in some form and commercial office real estate declining further due to depressed rents and economic uncertainty.  At a national level, homes -35% and office -45%, while the remainder of the segments are in line with Boston.

Filed Under: Commercial Real Estate