Commercial real estate turnaround not expected soon
Dotzour, while making his outlook presentation for the 2010 commercial real estate market at the Society of Commercial Realtors breakfast Dec. 1 at Colonial Country Club in Fort Worth, said the
market’s recovery depends on corporate earnings showing improvements, unemployment numbers improving and a smattering of deals getting done to produce fair market comps for appraisers. And so far, only corporate earnings are improving some, but not enough to put a dent in the country’s unemployment numbers, he said.
“When corporate profits are up, people should stop firing people,” Dotzour said. “The problem is the … good businesses that should be hiring aren’t and the question is why? It’s because of the uncertainty. You can’t insure against uncertainty,” Dotzour said. “… The uncertainty is raising capital gains taxes, raising income taxes, changing all the health care rules, maybe they’re good, maybe they’re not, but when you don’t know what they are, business people – here’s what they do: nothing. Accumulate cash, sit on the sidelines and wait until it’s over.”
Dotzour said consumer confidence drives a domino effect in the economy: if consumer confidence is up, people buy, which drives corporate profits up. If corporate profits are up, theoretically, businesses hire more people, which slows residential foreclosure rates and fuels commercial real estate absorption, rental rates and sales prices. But without that confidence, the economy will continue to remain in a standstill.
A key indicator for commercial real estate transactions lies in comps, Dotzour said, but many large institutional banks aren’t eager to make loans because loans require comparable market analysis or comps and that could mean banks would have to recognize losses in their real estate portfolios. Even so, Dotzour said eventually, transactions will happen, comps will be made and losses must be recognized.
According to the Board of Governors of the Federal Reserve System, the percent change in the number of commercial real estate loans in 2009 compared to 2008 hit zero.
“The flood gates are going to unleash as soon as we get some comps,” he said. “As long as there are no comps, I can value [commercial real estate] at whatever I want, but as soon as I get comps, I have to mark them down. So how do I keep from marking them down? I keep the market from clearing so there are no sales. At some point, there’s going to be enough sales where [appraisers] say ‘I’m sorry pal, … I’ve got five comps right here.’ At that point, it’s going to be over and that will be the beginning of commercial real estate transactions again because the market will clear at that point and buyers will start piling in.”
Though Dotzour said the Texas market is somewhat insulated from the extreme cases of market devaluation, national investment firms – many of which are invested in Texas commercial properties – are beginning to show signs of lower comps. Blackstone, for example, marked down its real estate portfolio by 30 percent in the fourth quarter of 2008 and another 19 percent in the first quarter of 2009, Dotzour said. Goldman Sachs’ largest private equity fund invested $3.7 billion from May 2007 to August 2008 and has since written it down by $2.1 billion – a 60 percent write off.
And perhaps the most telling, Dotzour said, is Moody’s/Real CPPI, which shows property values are down 40.6 percent as of the end of August. In an analysis of Moody’s portfolio, NACREIF Property Index, an analyst firm, says Moody’s has recognized less than two thirds of the write downs on its property values to date.
“So they’re thinking minus 40 isn’t the end of the game yet,” Dotzour said. “…Somewhere in the next year, I’m going to start going all in again because I want to own commercial real estate when it’s empty when rents are low and cap rates are high and I want to own it for the next five years while buildings fill up, rents go up and cap rates go back down,” he said. “That’s when you make a lot of money.”
Dotzour equated the current market to that of the late 1980s RTC days.
“… I promise you people will make lots of money in real estate now just like they did after the RTC in the late 80s. It’s a similar type of environment. There’s money to be made - you just have to stare it in the face honestly and figure out how do I do it? I don’t do it by hiding and pretending it’s now what’s going on.”
Dotzour said the first buyers will likely be high net worth investors who will sell to institutional investors who are “too afraid to buy in the marketplace right now,” he said.
Dotzour said his timeline for a commercial real estate recovery begins with prices continuing to fall in 2010 as price discovery continues, occupancy and rents fall and construction projects started in 2007 and 2008 begin to wrap up.
“And here’s where your juices get flowing as an investor. No new construction projects undertaken,” he said of 2010. “That’s when you make money. You start buying in at the bottom when rents are still going down or maybe toward the bottom, occupancy is high, but there’s no new construction because at a certain point, the economy picks up, rent starts to pick up and there’s no new competition for a while. That’s the window where you make a lot of money and that window doesn’t happen very often in our lifetimes.”
In 2011, Dotzour said rents will likely start to rise as no new construction puts pressure on supply and property values will begin to go up anticipating positive absorption and no new supply.
In 2012, rapid job growth will hike occupancy and rent rates and lower vacancies and cap rates will start to compress again as the market starts to flow. This, he said, is the ‘all in’ point.
As for today, Dotzour said real estate professionals must continue to wait out the market, look for signs of more comps and positive corporate earnings and prepare their investors for the time to buy while trying to keep their heads above water.
“The bottom line is, this ain’t the end of the world,” Dotzour said of today’s market. “If you lose a business, that’s what happens in small businesses. It’s called a risk. It’s called free enterprise. It’s not something to be ashamed of. If you bought a property in 2006 or 2007 with a big loan on it, you made a mistake. You’re going to lose. That’s all there is to it. You’ve already lost – whether you know it or not, you have. If you’re a lender that made too many loans to people that bought properties in 2006 and 2007 with a high loan to value ratio, you made a mistake, too. You’re going to lose, too. That’s all there is to it. It’s not the end of the world.”
