The Outlook for Commercial Real Estate
Presented to the Real Estate Council of Austin August 18, 2009 Dr. Mark G. Dotzour Chief Economist Real Estate Center @ Texas A&M
Today‘s Topics
• • • • • The US and global economies and jobs The Federal Reserve play book Timeline for the CRE recovery Bank lending for real estate The outlook for apartments, office, retail and industrial markets in Austin
Topic One The U.S. and global economies and the outlook for jobs
It‘s Not So Complex,
It‘s Just Big (1)
• Banks and other high-powered Wall Street firms made a lot of bad loans for houses, and commercial real estate` • They also made a lot of bad loans for businesses, credit cards, and M&A. • They lost more money than their equity • The losses are so big that the government can‘t allow banks to take them all at once
It‘s Not So Complex,
It‘s Just Big (2)
• They can‘t auction the bad assets because it would reveal the true extent of the losses. • So they have ―injected capital‖ so that the banks can amortize their losses over years.
It‘s Not So Complex,
It‘s Just Big (3)
• The Fed will keep rates low for a long time until the banks ―earn their way‖ out of the massive losses they have incurred • Savers are afraid of the market due to the high levels of risk and Madoff-style fraud • Savers buy US Treasury bonds and have created a bubble in that market driving rates low
It‘s Not So Complex,
It‘s Just Big (4)
• Businesses are hesitant to borrow for expansion right now due to manifold political risks • So banks borrow money from the Fed for free and buy Treasuries with no risk • Rates will stay low, even when the Fed decides to ―tighten‖. • They will just pay interest on reserves and the banks will loan to the Fed instead of businesses and consumer. That way, CD rates stay low for a long time.
Small Business Outlook
―Planning To Hire People In The Next Six Months‖
National Federation of Independent Business
Corporate Hiring Plans:
Next 6 Months
Q2-09
Q1-09
Q4-08
Q3-08
More Jobs 6%
7%
9%
29%
Less Jobs
49%
71%
60%
32%
Updated 7/8/08 Source: Business Roundtable
Gross Private Domestic Investment
Source: Department of Commerce
It‘s Not So Complex,
It‘s Just Big (5)
• The FDIC funds ran low, so they refilled the gas tank with another $500 billion authorization. • The FDIC is ramping up staffing to handle the volume of failed banks coming up. • Be ready for the stream of distressed assets that will be coming onto the market in the next year.
It‘s Not So Complex,
It‘s Just Big (6)
• American consumers spent more than they earned (―Fairyland dream‖) • They maxed out credit cards and HELOCS • Businesses ramped up staffing and locations to meet Fairyland demand • All levels of government ramped up spending on Fairyland revenues
It‘s Not So Complex,
It‘s Just Big (7)
• • • • • • • •
$3 gasoline started to wake the dreamers $4 gasoline jolted them back to reality Now we are back to saving some money The economy will bottom, when the savings rate levels Less spending means less stores and workers Means less sales tax revenue Means less income and property taxes Means business and government need to ―right size‖
It‘s Not So Complex,
It‘s Just Big (8)
• So the Fed and Treasury are trying to replace the postFairyland consumers • Consumers got a tax credit in 2008, but they saved it • They are trying to prop up homeowners that bought a house they couldn‘t possibly afford • They are trying to prop up businesses that need to right-size • They are trying to prop up state and local governments that need to right-size
Bernanke Comments
July 23,2009
Mr. Bernanke stressed however that in spite of glimmers of improvement in the economy, the Fed intended to keep interest rates extremely low for an “extended period”. ―I want to be clear that we have a very long haul here because, even if the economy begins to turn up in terms of production, unemployment is going to stay high for quite a while, so it‘s not going to feel like a really strong economy,‖ he said in his biannual report to Congress.
The Best Case Scenario
Favorable corporate earnings 4Q09 Stocks rise about four months prior to that Consumer confidence rises with stocks More spending results in higher profits Layoffs end by the end of the 2009 ―Jobless recovery‖ in 2010 Higher interest rates and inflation in 2010-11
The Worst Case Scenario
The securitized lending market doesn‘t reopen Bad banks and businesses propped up No price discovery for ―toxic‖ mortgages Political risk for business stays high Business / investors ―sit on their hands‖ Unemployment goes well over 10% Commodity deflation and price deflation
Key Indicators:
Personal Savings Rate
Source: Department of Commerce
Key Indicators:
Corporate Profits
(With Inventory Valuation Adjustment & Capital Consumption Adjustment)
Source: Department of Commerce
Topic Two The Federal Reserve playbook to deal with deflation
Deflation:
Making Sure ―It‖ Doesn‘t Happen Here
―I believe the risk of significant deflation…in the foreseeable future is extremely small because…‖ 1. The resilience and structural stability of the US economy - Flexible and efficient markets for labor and capital - An entrepreneurial tradition - A willingness to embrace technological and economic change
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Making Sure ―It‖ Doesn‘t Happen Here
―I believe the risk of significant deflation…in the foreseeable future is extremely small because…‖ 2. The strength of our financial system - Our banking system remains healthy and wellregulated - Firm and household balance sheets are for the most part in good shape
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Making Sure ―It‖ Doesn‘t Happen Here
―I believe the risk of significant deflation…in the foreseeable future is extremely small because…‖ 3. The Federal Reserve itself. - ―I am confident that the Fed would take whatever means necessary to prevent significant deflation‖ - The Fed and the Treasury have sufficient policy instruments to ensure that any deflation would be both mild and brief.
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Cause and Effect
Cause: A collapse of spending that causes producers to cut prices to find buyers on an ongoing basis. Effects: Recession, rising unemployment and financial stress ―Deflation of sufficient magnitude may result in the nominal interest rate declining to zero or very close to zero.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―To Boldly Go Where No Man Has Gone Before‖
―I should emphasize that my comments on this topic are necessarily speculative, as the modern Federal Reserve has never faced this situation nor has it pre-committed itself formally to any specific course of action should deflation arise.‖ ―…calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―Welcome to the Machines‖
―..the US government has a technology, called a printing press… that allows it to produce as many US dollars as it wishes at essentially no cost.‖
―We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―bring down 2-year interest rates on government securities‖
Step 1: ―… commit to holding the overnight rate at zero for some specified time.‖
Step 2: ―… make unlimited purchases of securities within two years of maturity at prices consistent with the targeted yields.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―bring down 3-6 year interest rates on government securities‖
Step 1: ―…the Fed could also attempt to cap yields….at still longer maturities, say three to six years.‖
Step 2: ―…another option would be for the Fed…to operate in the markets for agency debt (for example GNMA)‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―bring down the longest term rates on government securities‖
―…prior to the Federal Reserve-Treasury Accord of 1951, the Fed maintained a ceiling of 2.5% on long-term Treasury bonds for nearly a decade.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―bring down the rates on privately issued securities‖
―….the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including corporate bonds, CP, bank loans and mortgages) deemed eligible as collateral. ―…such a program could significantly reduce liquidity and term premiums…and lower the cost of capital to banks and the private sector..‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ ―the Fed has the authority to buy foreign government debt‖
―Potentially, this class of assets offers huge scope for Fed operations, as the quantity of foreign assets eligible for purchase by the Fed is several times the stock of US government debt.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
Deflation:
Monetary Policy at the ―Zero Bound‖ The Ultimate Trump Card
―…it‘s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation.‖ ―A striking example from US history is Franklin Roosevelt‘s 40% devaluation of the dollar against gold in 1933-34.‖ ―The devaluation and the rapid increase in money supply it permitted ended the US deflation remarkable quickly.‖
Remarks by Governor Ben S. Bernanke on Nov. 21, 2002
The Great Devaluation of 1933-34
• • • • From 1929-33, real GDP collapsed by 26.5%, and unemployment rose to 25%. From 1937-38, real GDP declined by 3.4% and unemployment rose from 14% to 19%. Between 1934 and 1937, there was a rapid recovery, where real GDP rose 9.5% per annum and unemployment fell from 25% to 14% In 1933-34 Roosevelt devalued the dollar from $20.67 to $35 per ounce. After falling at an average rate of 6.7% per year from 1930-33, the CPI rose by an average of 2.7% per year from 1934 to 1937. The stock market that had collapsed by 86.2% between September, 1929 and June, 1932 rose more than fourfold in the five years between 1932 and the peak of the next business cycle in 1937. Monetary and fiscal policy were abruptly tightened in 1936-37 with the Fed hiking reserve requirements just as tax rates increased and government spending declined in attempts to balance the budget. The economy fell into a recession while the stock market fell 54%.
Source: WSJ March 18, 2009 Michael Darda, MKM Partners
•
•
Federal Reserve ―Plan C‖
Treasury Works on 'Plan C' To Fend Off Lingering Threats Troubling Issues in Lending Could Still Disrupt Economy By David Cho and Binyamin Appelbaum Washington Post Staff Writers Wednesday, July 8, 2009 As the financial system tries to right itself after its near-collapse last fall, the Treasury Department has assembled a team to examine what could yet bring it down and has identified several trouble spots that could threaten the still-fragile lending industry. Informally known as Plan C, the internal project is focused on vexing problems such as the distressed commercial real estate markets, the high rate of delinquencies among homeowners, and the struggles of community and regional banks, said government sources familiar with the effort. Part of the mission is assessing which firms are the most vulnerable and trying to decipher what assets these companies hold and whether they pose a danger to the wider financial system. Plan C is a small-scale, relatively informal approach to a problem the administration hopes to address in the long term by empowering the Federal Reserve to oversee systemic risk. The team is also responsible for considering potential government responses, but top officials within the Obama administration are wary of rolling out initiatives that would commit massive amounts of federal resources, said other sources in close contact with
The $ and Trade Deficits
Comments of Martin Feldstein
at NABE in 2008
• In the 1980‘s, the dollar fell 30%, which led with two years delay to a 40% decline in our trade deficit as exports expanded. • We have to pay for our trade deficit in one of two ways: 1) increase exports or 2) a lower dollar. • In the 1980‘s the dollar fell a lot and inflation didn‘t change. • A lot of the trade deficit in the 1980‘s was paid for by a gift from the Japanese who recycled our $ to buy real estate at high prices, that were bought back at 50cent dollars.
China
"Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies‖ Wen Jiabao, the Chinese Right now they are stuck with $2 trillion in US Treasuries, agency paper, etc. They can't sell their dollars without really hurting the dollar, thereby forcing the renminbi to rise and hurting their own exports. But they, and much of the world, feel that the US is pursuing policies that are going to be harmful to the value of the dollar and therefore to China's largest reserve exposure.
What to do? Take those dollars and buy physical assets. Companies, natural resources, maybe real estate?
China
• Exports are down 20% • Chinese consumer spending only accounts for just 35% of their GDP. • Their stimulus package was about 1/3 GDP, equal to $4.5T in the US • Their money supply shot up 28.5% in July alone • Hang Seng up 70% in past four months
Fed Monetary Policy Keep Rates Low for a Long Time
91 Recession 2001 Recession
left rate at 3.0% for 17 months left rate at 1.0% for 12 months
2008 Recession
left rate at .25% for 8 months
(Thru July)
Where Will the Next Bubble Be?
US, Japan, China, Europe all pumping massive quantities of cheap money into the system
• • • •
China‘s stock market. U.S. Stocks Commodities US commercial real estate
Topic Three Timeline for the commercial real estate recovery
A Timeline for CRE Recovery
2009
•Prices fall as cap rates revert to 2002 levels •Occupancy falls a job layoffs continue •Rents fall as owners covet tenants •New construction continues to add new supply •Foreclosures increase as refinancing is precluded
A Timeline for CRE Recovery
2010
•Prices continue to fall as price discovery continues •Occupancy falls as firms downsize staff •Layoffs end, but downsizing continues for cost savings •Rents fall to compete for smaller tenant base •New projects started in 2007-08 are completed •No new construction projects undertaken
A Timeline for CRE Recovery
2011
•Slow job growth begins to soak up space •No new supply delivered to the market •Rent levels stabilize at lower rates •2006 vintage loans fail to refinance •Foreclosure rates decline as credit market heals •Class A space starts to fill at expense of lesser properties
A Timeline for CRE Recovery
2012
•More rapid job growth increases absorption rate •No new supply delivered to the market •Rents start to rise as space starts to fill •More foreclosures from properties bought 1H07 •Property values start to increase, anticipating positive absorption and very limited new supply.
A Timeline for CRE Recovery
2013
•More rapid job growth soaks up more space •Occupancy rate increases significantly •No new buildings delivered to the market •Prices continue to increase due to rising fundamentals and falling cap rates
Some Comps Start to Appear at 35% Price Decline
• Phoenix Apartment Portfolio – Phoenix, AZ • On January 13, 2009, the Account sold a portion of an apartment portfolio investment located in Phoenix, Arizona for approximately $20 million and realized a loss of approximately $11.7 million. The Account purchased the investment on June 23, 2006. The original investment in this property was $31.2 million. • Houston Apartment Portfolio – Houston, TX • On February 19, 2009, the Account sold a portion of an apartment portfolio investment located in Houston, Texas for approximately $8.9 million and realized a loss of approximately $5.2 million. The Account purchased the investment June 23, 2006. The original investment in this property was $13.8 million.
The Progression of Investors Returning to Commercial RE
First buyers will be high net worth investors, buying for their own account. They can afford to miss the bottom and still make good money. Cap rates will be at their highest as buyers seek opportunistic returns. Once prices stabilize at the bottom, then institutional buyers will re-enter the market. Cap rates will start to rise as ―core buyers‖ enter the market.
Private Equity War Chests
• Loan Star Funds raising two funds of $10 billion each to buy distressed real estate assets.
• Numerous funds raising capital to buy, which will put a strong floor on real estate when the bottom is determined.
Topic Four Bank lending for real estate
Fed President Lockhart on
The risk I'm watching most closely is commercial real estate. There is a heavy schedule of commercial real estate financings coming due in 2009, 2010, and 2011. The CMBS (commercial real estate mortgage-backed securities) market is very weak, and banks generally have no appetite to roll over loans on properties that have lost value in the recession. Refinancing problems will not directly affect GDP—it's commercial construction that factors into GDP—but I'm concerned problems in commercial real estate finance could adversely affect the otherwise improving banking and insurance sectors.
Source: Dennis P. Lockhart President and Chief Executive Officer, Federal Reserve Bank of Atlanta Rotary Club of Nashville July 20, 2009
Bernanke on CRE
Source: Bloomberg 7/22/09
It ―may be appropriate‖ for the government and Congress to consider ―fiscal‖ steps to support the industry, Bernanke said today. Ideas for fresh support for the market could include government guarantees for commercial mortgages, Bernanke also said today. ―As the recession‘s gotten worse in the last six months or so, we‘re seeing increased vacancy, declining rents, falling prices -- and so, more pressure on commercial real estate,‖ Bernanke said yesterday. ―We are somewhat concerned about that sector and are paying very close attention to it. We‘re taking the steps that we can through the banking system and through the securitization markets to try to address it.‖
CRE Default numbers
Through the end of June, the estimated level of troubled commercial assets had reached nearly $110 billion, RCA said. That figured includes a projection of more than $10 billion in newly defaulted mortgages in the month of June. ‖Distress is not only widespread geographically and by property type, but also by borrower type. Excess leverage is endemic to every type of investor, all of which are facing difficulties refinancing mortgages as they come due,‖ RCA said.
Source: REIT.com 7/213/09
CRE Loan Information
Fed estimates the size of the US commercial property market is $6.5 trillion about 1/3 the size of the $20 trillion residential market. Commercial property loans outstanding are estimated at $3.3 trillion (about 33% LTV) About half of these loans are held by commercial banks. About 25% of commercial property loans are securitized in CMBS. The other 25% of all commercial property loans are held by LIC and savings companies.
According to Foresight Analytics, estimates that loan losses of $250 billion could occur, causing another 700 banks to fail.
In 1993, less than 2% of banks and thrifts had CRE that was more than 5X tier one capital. Now that number has jumped to 12%, involving 800 banks/thrifts.
CRE Loan Refinance Issues
As the July issue of industry publication US Banker noted, more than $168 billion of the $204 billion in commercial mortgages coming due this year are held by banks and thrifts. That dwarfs the $19.1 billion of CMBS loans that also mature this year.
Still, Chandan tells GlobeSt.com, "one of the concerns investors are going to have is whether the evaluation of the loans, the loan quality, fully captures the potential downside." He refers to loans from 2006 or 2007 as being underwritten to perspective as opposed to current cash flows.
Bank Risk Measures
Total CRE Loans / Risk-Based Capital Red flag if greater than 300% FY06 149% 91 162 165 284 251 190 FY07 136% 93 184 166 302 284 203 FY08 153% 107 186 199 296 301 284 3/31/09 141% 104 185 195 290 272 287
Big Bend Country Panhandle Hill Country San Antonio DFW Gulf Coast Houston
Healthy Bank Re-Defined
Last month, United Community Banks, of Blairsville, Ga., acquired assets and liabilities of Southern Community Bank Yet United Community has commercial real-estate exposure equivalent to over 850% of its tangible common equity. Then there is PrivateBancorp, of Chicago, which this month acquired all the deposits and just over $900 million of assets of Founders Bank. Adjusted for a recent share issue, PrivateBancorp's commercial real estate is equivalent to 590% of its TCE.
Great Southern Bancorp, of Springfield, Mo., in March acquired certain deposits and $443 million of loans from TeamBank. Great Southern's commercial real estate, which contains a large share of construction loans, is 536% of TCE.
Source: Bloomberg News, July 13, 2009
FDIC Increase Staffing in 2009
FDIC Approves 2009 Operating Budget, Releases Third Quarter 2008 Results for the Deposit Insurance Fund December 16, 2008
The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) at an open board meeting today approved a $2.24 billion operating budget for next year. The 2009 budget represents an increase of more than $1 billion from 2008. The Board also approved an authorized 2009 FDIC staffing level of 6,269, an increase of 1,459 positions from the staffing level authorized at the beginning of 2008. The additional staff will be hired primarily to perform bank examinations and other bank supervisory activities and to address bank failures, including the management and sale of assets retained by the FDIC when a failed bank is sold.
FDIC Problem Institutions
Source: FDIC
FDIC Employees
(Including RTC before 1996)
Source: FDIC
What Does It Take to Get A Real Estate Loan in Today‘s Market?
• • • • Loan to value ratio between 50-65% Interest rates between 6.5% and 8.5% Debt coverage ratio around 1.3 Banks that have lower concentrations of real estate loans already on their books
Topic Five The outlook for apartments, office, retail and industrial markets in Austin
The Outlook for Commercial Real Estate in Austin
Fundamental Assumptions
For 2010 Forecast
• Currently, the TWC is showing the Austin job growth rate to be negative 1.5% compared to a year ago. • We estimate that the US economy will lose jobs in the next 12 months and that Austin will outperform the US.
Fundamental Assumptions
For 2010 Forecast
• Consequently we forecast Austin job growth to be unchanged over the next 12 months. We anticipate further job losses into next spring, followed by a slow turnaround to positive numbers by next summer.
• Our forecast assumes that the Austin population will grow 2% in the next 12 months.
The Local Buzz:
Industrial Market
• Owners are attempting to ―wow‖ their prospects quickly. Any prospect‘s broker is getting a lot of offers. • New shell space is very aggressive with free rent offers. • Some deals are being offered at rent that is just above the operating expenses
The Local Buzz:
Industrial Market
• Applied Materials was retaining thousands of suppliers on short-term contracts but have now decreased their suppliers by 50%. • Workforce reductions at Dell have created large blocks of vacant industrial space. • Big blocks of second-hand space plus new supply coming on line is creating severe pressure on rent.
The Local Buzz:
Industrial Market
• According to the Austin Chamber, the next big demand drivers for Austin will come from clean tech, biotech, data centers and call centers.
The Local Buzz:
Industrial Market
• In the past, the average owner wanted to sign leases for 3 to 5 years while tenants wanted 2 to 3year leases. • Today, owners are looking to sign leases for 1 to 2 years while tenants want 6-month to 1-year leases.
The Local Buzz:
Industrial Market
• Flex space involves smaller deals than in the past. • Flex landlords are doing some deals that are less than the expenses in Class B office. • Landlords are asking for more security than in the past. They are demanding more personal guarantees if the tenants want extensive TI money.
National Market Comparison:
Flex R&D
Los Angeles, CA San Diego, CA Miami/Dade Co., FL Phoenix, AZ National Avg. Austin, TX Raleigh/Durham, NC Detroit, MI Atlanta, GA
Source: CoStar
Q2 ‗09 Quoted Rents $15.77 $15.66 $14.09 $12.47 $11.15 $10.57 $ 9.73 $ 9.06 $ 8.73
National Market Comparison:
Industrial Warehouse
Q2 ‗09 Quoted Rents $9.44 $7.80 $7.52 $7.45 $6.72 $6.50 $6.11 $5.67 $5.17
San Diego, CA Los Angeles, CA Miami/Dade Co., FL Las Vegas, NV Tucson, AZ Seattle/Puget Sound, WA Austin, TX Tampa/St. Petersburg, FL National Avg.
Source: CoStar
The Local Buzz:
Retail Market
• National tenants taking a wait and see stance. • Retailers in last 12 months got cold feet and didn‘t expand or start construction that was proposed. – An example was Target who planned for 140 more stores nationwide last year and opened 40. – Wal-Mart downsized its newest Austin store from 200k SF to 100k SF. – HEB backed out of a store planned for Austin.
The Local Buzz:
Retail Market
• Rents are down 10% to 20%. • Landlords are offering higher TI of $15 - $20 per SF versus only $5 - $10 per SF in the past. • Free rent is becoming part of the negotiation.
• Strongest stress is on new strip center projects.
The Local Buzz:
Retail Market
• The good news is that good projects are still leasing up and not having to give space away. • Best news is not much new development occurring. Catching up on the demand side. • Some Austin retailers are still opportunistic but most are on the sidelines at the moment. • Mom-and-pop retailers are taking advantage of this market to negotiate lower rents. • Triple net expenses are out of hand in Austin, with property taxes alone running about $6 per SF.
The Local Buzz:
Retail Market
• Anything breaking ground in 2007 that had a construction loan will probably mature in 2010. • Bottom line is good relationships with bankers will help to get deals worked out. • Likely to see little new retail development for three years.
National Market Comparison:
Retail
Los Angeles , CA New York (Long Island) Miami/Dade Co., FL Austin, TX Chicago, IL National Avg. Atlanta, GA Dallas/Fort Worth, TX San Antonio , TX
Source: CoStar
Q2 ‗09 Quoted Rents $30.60 $28.94 $28.79 $21.82 $18.30 $17.29 $14.85 $13.23 $13.21
The Local Buzz:
Apartment Market
• Renters are still ―coupling up‖ • They are taking on roomates.
• Some are moving back home.
• Some are postponing divorce because they can‘t afford two households.
The Local Buzz:
Apartment Market
• Drop in domestic migration is creating pent-up demand for Austin housing • In 2005-06, net domestic migration was 688,000 In 2007-08, net domestic migration was 366,000 • In 2005-06 international immigration was 1 million In 2007-08 international immigration was 890,000
The Local Buzz:
Apartment Market
• What is in the construction pipeline now will be it for a while. Beyond that, you are looking at: – 2010 – 1,000 units – 2011 – zero to 500 units • Examining Austin‘s supply history back to 1992, there has only been a couple of years when annual deliveries were as low as 1,000 units.
The Local Buzz:
Apartment Market
• This will be an unprecedented decrease in supply. • There are a few thousand proposed units sitting on the shelf that could start construction in 3 to 6 months when the time is right.
The Local Buzz:
Apartment Market
• Everybody is chasing HUD money now. HUD restricts the number of projects in a certain geographic area.
• Fannie stopped doing interest-only loans recently. Freddie likely to follow suit. • Debt coverage ratios are around 125%, and the loan to value ratio is between 60-80%.
The Local Buzz:
Apartment Market
• Banks are not wanting to call their construction loans and take back the properties. The trend is to extend for one to two years and hopefully rents and occupancy will increase. The typical 3-year construction loan is being extended to a 5-year loan. • Extensions will prolong the lack of price discovery. – Banks don‘t want hard comps to show their RE portfolio is 125% LTV, so there is an advantage to no price discovery for the banks.
The Local Buzz:
Apartment Market
• Nobody knows what a project is worth or what cap rates are. – 18 months ago, Class A deals were selling at a 5 cap. – Today, deals would probably be 200 basis points higher for urban infill properties. Suburban properties were 6 to 6.5 cap then and 8 to 8.5 cap now. But no deals are getting done. – Cap rate bottomed in 2006 and 2007 at a range of 3.2% to 3.9%
The Local Buzz:
Office Market
• In the overall market, the magic occupancy number is 80%. Dip below that, and everything changes. Including sublease space, Austin is below that.
• Some rental rates actually getting executed are 20% off of asking rates for small tenants and 30 -40% off asking rates for large, credit tenants.
The Local Buzz:
Office Market
• There are many big blocks of space available. Businesses looking for 25 -100k SF currently have 54 options available. • Significant increase in vacancy in the Southwest market creates stiff competition with the Northwest and other submarkets. • Leasing broker deal books are pretty thin at this point. Not a lot of tenants prowling the streets.
The Local Buzz:
Office Market
• There is 9 million SF of vacant space in Austin. To get back to 90% occupancy, the market must absorb 6 million SF of space.
• Austin absorbs 1 -1.2 million SF of space per year in a good year. So, you are looking at 6 years to get back to equilibrium.
The Local Buzz:
Office Market
• Sublease space is up to 1.6 million SF. The question here is how much term is left. Fifty percent of sublease space has 4 years or more remaining.
• Sublease space with less than 2 years remaining is not very competitive.
The Local Buzz:
Office Market
• If you assume 250 SF of office space for each new job, it would take 24,000 new office jobs to fill up 6 million SF of vacant space.
• The construction boom will grind to a halt in the second half of 2009 and beyond. Permitted projects will be delayed.
The Local Buzz:
Office Market
• The biggest vacancies and the most aggressive landlords are in new buildings. There is a lot of pressure on Class B buildings to keep their tenants. • At this point, office rents are fluid. Do you reduce rents now to have the security of a tenant or wait for another tenant to emerge down the road?
The Local Buzz:
Office Market
• At the peak of the market, some office buildings in Austin sold at cap rates south of 5%. • As cap rates revert back to 2002-03 levels, office buildings are likely to drift north of 8%.
National Market Comparison:
Office
Miami/Dade Co., FL San Francisco, CA Los Angeles , CA San Diego, CA New York (Long Island) Seattle/Puget Sound, WA Austin, TX Las Vegas, NV National Avg.
Source: CoStar
Q2 ‗09 Quoted Rents $30.66 $30.40 $30.06 $29.45 $27.13 $27.03 $25.57 $24.45 $23.46
Time for Questions