National News Outlets Cite MIT/CRE Indexes: Subprime Troubles Affecting Commercial Sector
With their latest release, market indexes developed by the MIT Center for Real Estate are showing that the woes of the beleaguered subprime market have reached real estate's commercial sector. These findings have been reported by national news outlets that include:
Boston Globe, 11/14/07
Dallas Morning News, 11/15/07
Boston Herald, 11/18/07
Wall Street Journal, 11/19/07
Seeking Alpha, 11/19/07
Chicago Tribute, 11/21/07
US Commercial Real Estate Value Falls
By Chris Reidy
Boston Globe
November 14, 2007
The value of US commercial real estate owned by big pension funds fell 2.5 percent in the third quarter, the first quarterly downturn since the third quarter of 2003, according to an index produced by the MIT Center for Real Estate.
The drop may not only spell the end of a five-year rally during which commercial real estate prices effectively doubled, but it also may signal that weakness in the housing market is spilling over into commercial real estate, said the MIT Center, which added that the last time that prices fell more than 2.5 percent was in the fourth quarter of 2001, when prices fell 3.9 percent following the terrorist attacks of 9/11.
Commenting on the index for the third quarter of 2007, MIT center director David Geltner said in a statement, "The fall in our index is the first solid, quantitative evidence that the subprime mortgage debacle, which hit the broader capital markets in August, may be spreading to the commercial property markets."
Commercial Real Estate the Flip Side of Residential — for Now
But the market shows signs of slowing with the U.S. economy
By Steve Brown
The Dallas Morning News
November 15, 2007
LAS VEGAS – While the housing market suffers through one of the worst downturns in decades, the commercial property sector is thriving in many markets.
But economists see some signs of moderation in the commercial property business. And a slowdown in the U.S. economy could put the brakes on commercial building.
"Commercial typically follows the national economy," said Lawrence Yun, chief economist of the National Association of Realtors, at the industry's conference this week in Las Vegas.
To fill office buildings and warehouses, the economy needs to be strong.
That's certainly been the case in North Texas and other U.S. markets.
Dallas-Fort Worth leads the country in job creation, and office and warehouse construction are booming.
Residential sales, however, have dipped in the last year.
"There are clearly different factors that drive residential and commercial," Mr. Yun said. "When the residential market took off, the commercial market was in a slump."
Now the tables are turned.
But Mr. Yun said leading indicators for the commercial property market are cooling as the U.S. economy loses steam.
"The economy is expanding, but not as strongly as before," he said. "Some economists are actually forecasting for economic recession."
Traditionally when that happens, demand for commercial property slows.
A report released Wednesday by the MIT Center for Real Estate suggests that the commercial property market may already be in transition.
Commercial real estate prices in the third quarter showed their first drop in four years – down 2.5 percent.
"The fall in our index is the first solid, quantitative evidence that the subprime mortgage debacle, which hit the broader capital markets in August, may be spreading to the commercial property markets," MIT Center for Real Estate director David Geltner said in a prepared statement.
MIT suggested in its report that the new data signal the end of commercial real estate's five-year boom.
Another new report from McGraw-Hill Construction predicts that commercial construction spending next year will fall 6 percent from 2007's record level. Even so, nationwide commercial building will total almost $19 billion.
Although employment growth in Dallas-Fort Worth is still high, the rate of job gains has fallen more than 25 percent from earlier in the year, based on the latest annualized employment statistics.
Still, Mr. Yun said markets including Dallas, Phoenix, Austin and Salt Lake City may fare better than the national average in commercial real estate because of their job growth.
Cities that are losing employment are already in trouble, the analysts said
"When you are bleeding jobs, there is no good real estate market," economist John Tuccillo said. "People don't buy houses, and they don't need places to work."
Real estate agents say that in some markets, they have relied on commercial property to fill the void left when the housing market slowed.
"If it weren't for commercial, we'd all be starving to death," said Florida Realtor George Wilson.
But tighter lending standards are starting to have an effect.
"The credit crunch definitely impacted the residential market, and it appears to be impacting the commercial market as well," Mr. Yun said.
Southern California property broker Stan Mullin said there has been a "complete repricing" of the industrial real estate market because of the credit crunch.
"We are being retraded on every single transaction we are working on today," said Mr. Mullin, recent president of the Society of Industrial and Office Realtors. "Half of the lenders are out of the market."
And those lenders still making commercial mortgages want more upfront money, he said.
"We are talking about an awful lot of equity that is being required today that wasn't in the past," Mr. Mullin said.
Commercial property foreclosures are also edging up.
Mr. Yun said commercial loan delinquencies "began to rise fairly sharply in the last three quarters. It's still below the 2001 level but is a little bit of a concern."
In some markets, the price that investors are willing to pay for commercial buildings is out of whack with rental returns, Mr. Yun said.
"People are questioning if there is a bubble in the commercial space," he said. "Some people are saying this is not sustainable."
A big positive for the commercial property investment sector may be the weakness of the dollar. "The dollar is weak, so foreign investment in U.S. commercial real estate is growing," Mr. Yun said.
Foreign investment in U.S. commercial real estate is forecast to reach $50 billion this year. That's up from less than $40 billion in 2005.
Office Building Values Sink; MIT Index Says Subprime Mess Hits Commercial Sector
By Scott van Voorhis
Boston Herald
November 18, 2007
The commercial real estate market, until recently a bright spot in an increasingly gloomy economy, may be headed for trouble, according to a key MIT index of property values.
The value of office tower and other commercial real estate owned by major pension funds dropped 2.5 percent in the third quarter, according to the Transaction Based Index.
That is the biggest drop since commercial building values plunged in the fourth quarter of 2001 amid a recession in the aftermath of the Sept. 11 terrorist attacks. The drop is tied to the widening credit crunch brought on by the subprime market collapse, according to researchers at the MIT Center for Real Estate.
With loans more difficult to get, sales of office towers and buildings have begun to slow while developers complain that financing new projects is also much more difficult.
"The fall in our index is the first solid, quantitative evidence that the subprime mortgage debacle, which hit the broader capital in markets, may be spreading to the commercial property markets," said David Geltner, director of the MIT Center for Real Estate.
The drop in property values comes after a spectacular rise in commercial values, especially marquee towers. It is a boom that saw State Street's new headquarters sell for more than $700 million and the Hancock tower fetch close to $1 billion.
But real estate executives have been watching for more than a year for signs that tower and commercial property prices are coming back to earth. In another sign of the times, investors in some recent downtown office building sales, have become much more cautious, executives said.
"These are all cyclical things," said Larry DiCara, a top Boston lawyer and real estate expert. "The market comes and it goes, it's up and it's down. It's not a panic situation."
Commercial Property Is Now Under Pressure
By Peter Grant
Wall Street Journal Online
November 19, 2007
The value of commercial real estate, which nearly doubled in the past seven years, is now starting to decline due to the credit crunch, according to a report released yesterday by Moodys Investors Service. [Moody uses a transactions-based index whose methodology was developed at the MIT Center for Real Estate. -MIT/CRE Ed.]
The report found that the value of commercial property declined 1.2% in September from the previous month. Particularly hard hit were apartments in the West and office property in most states other than California.
The report is an early sign that the commercial-property sector is being dragged down by the growing reluctance of lenders to extend credit for anything related to real estate, which in turn could create a new drag on the economy and additional problems for investors. Declining commercial-property values could lead to an increase in default rates on commercial real-estate loans and on commercial mortgage-backed securities.
No one is predicting that defaults in the commercial sector will come close to rivaling those in the housing sector. The default rate for commercial mortgage-backed securities is about 0.4%, compared with a 20% default rate for subprime, or high-risk, home loans, the hardest hit segment of the residential mortgage market. And commercial rents in many markets continue to rise.
Tad Philipp, a Moodys managing director, says he wouldnt be surprised to see the commercial-mortgage default rate double or triple, but he notes that still wont be "alarming" because historically the default rate is about 1%.
Still, the latest trends "might represent the inflection point in commercial real estate values given the ongoing liquidity crunch," the report states. Commercial-property values are primarily being hurt by the increasing cost and declining availability of financing. Given the higher cost of debt, buyers need to pay less to get the return on equity they want.
Even a slight decline in values could make it difficult for property owners to refinance their mortgages, especially if they have been paying only interest on their existing debt and not paying down principal. Such interest-only mortgages have become increasingly popular.
Defaults also would likely increase if the economy slumps and drives down commercial rents. Already there are signs of slowing in some markets. Available sublease space swelled to 77 million square feet in the third quarter from 73 million square feet nationwide in the second quarter, the first national increase in five years, according to Grubb & Ellis Co.
Mr. Philipp predicts there will be "more downs than ups" in coming months.
The decline in property values reported by Moodys comes after years of sharp increases. In July, for example, investors paid $510 million, or a record $1,600 per square foot, for the 33-story office tower at 450 Park Ave. in Manhattan.
Some surveys indicate prices are still rising. For example, commercial property appreciated 2.2% in value in the third quarter, according to an index published by the National Council of Real Estate Investment Fiduciaries. NCREIF looks at appraised value while Moodys bases its values on actual sales, according to Moodys executives.
Other research firms have found sales volume to be clearly declining. Real Capital Analytics said in an October report that the credit crunch derailed a number of transactions in the third quarter of this year, and that sales volume for office buildings dropped below $8.5 billion in September, compared with an average of $11.5 billion in the Septembers of 2005 and 2006.
Jennifer S. Forsyth contributed to this article.
Commercial Property Values Declining — MIT, Moody's
By the Editors
Seeking Alpha
November 19, 2007
Commercial real estate values are finally beginning to decline as a result of the credit crunch, according to two new reports. The MIT Center for Real Estate's quarterly transaction-based index [TBI], which reflects the value of commercial property owned by pension funds, dropped 2.5% in Q3 2007. The decline — the index's sharpest downturn since Q4 2001 and first drop since Q3 2003 — could herald the end of the sector's five-year rally. "The fall in our index is the first solid, quantitative evidence that the subprime mortgage debacle, which hit the broader capital markets in August, may be spreading to the commercial property markets," said David Geltner, Director of the MIT Center. Meanwhile, a report to be released Monday by Moody's Investors Service shows a 1.2% decline in the value of commercial property in September from August. The two reports suggest that despite the rarity of default in commercial real estate, lenders are reluctant at present to grant credit to any form of real estate. If the value of commercial property slides, the default rate on commercial real estate loans and commercial mortgage-backed securities could rise. The latter has a default rate of 0.4% versus a 20% default rate for subprime loans. Moody's MD Tad Philipp notes that even if the commercial-mortgage default rate triples, it would still not be "alarming." Nonetheless, the change in value direction could "represent the inflection point in commercial real estate values given the ongoing liquidity crunch," according to the Moody's report.
Commercial Property Prices Down, Index Shows
By Susan Desenhouse
Chicago Tribune
November 21, 2007
While most of the worry about real estate values has centered on residential sale prices, a dip in commercial property prices nationwide is registering on a new index that issued its first report Monday.
On average, prices that investors paid for all types of commercial property fell 1.2 percent in September, according to Moody's/Real Commercial Property Price index, which is based on actual sale prices rather than the much-measured assessed values.
"This is the first full month of data since the acceleration of the liquidity crisis, and we saw a downturn in prices as the economy slowed, the availability of capital decreased and the cost of capital increased," said Sally Gordon, a senior vice president at Moody's Investors Service.
Over the next year, "we'll see a net decline in values," Gordon said.
But prices are coming off a high point that will provide a cushion if the downturn continues.
Therefore, Gordon added, "We are not saying that commercial real estate will be the next subprime," referring to mortgages given to those with a weak credit history.
The extent of price declines varies by location and property type, according to the index, which was created by Moody's, the real estate sale research firm Real Capital Analytics and the Massachusetts Institute of Technology's Center for Real Estate.
If the economy continues to slow or goes into a recession, "that will dampen the demand for space, occupancy may decline, and that would make it difficult for landlords to have pricing power so rent increases will slow or decline," said Gordon, noting that Moody's is not making any economic forecast at this time.
For most properties, decreased income flow puts downward pressure on values and sale prices.
In September, office sale prices fell 0.5 percent, and multifamily apartment properties dropped 1.0 percent.
On the other hand, prices of industrial property rose 3.0 percent, and retail real estate was up 2.6 percent, according to this index.
"In most markets around the country, leasing is holding up, but after a huge surge in the asset [sale] market that reached a frenzy during the first half of the year, we're backing off the peak," said David Geltner, director of MIT's real estate center.
In his opinion, "the situation isn't as dangerous as it was in the late 1980s and early 1990s," he said.
Back then, several lenders failed under the weight of non-performing real estate loans.
But overall, "Chicago is a weak spot," Geltner said.
For instance, over the last few months office building sale prices have declined throughout the metropolitan market by 17 percent, said Dan Fasulo, a managing director at Real Capital Analytics.
With a metropolitan vacancy rate of 15.2 percent, Chicago ranks 40th out of 57 markets Real Capital surveyed, noted Fasulo.
"Overall, Chicago is underperforming," he said.
INDUSTRIAL VACANCIES: For the metropolitan area industrial market, the vacancy rate hit a low of 8.6 percent in the third quarter, according to the Association of Industrial Real Estate Brokers, based in Rosemont.
However, a recent broker survey found that 78 percent of association members expect vacancies to hold steady or increase during the remainder of this year and in 2008.
"User demand is soft, and there is an oversupply of new construction," said John Joyce, a senior director with Cushman & Wakefield Illinois Inc.
"For the first time in several years," he said, "tenants in the market now have the advantage."
