Good news is often in how you read it. Today’s headlines beg you to believe the next bank collapse is imminent, tend to sensationalize the huge amounts of capital raised to keep financial institutions alive, and emphasize the distress of the general population. Behind the red ink, however, the financial industry is continuing to de-leverage balance sheets and slowly strengthen themselves and, consequently, the market.

This de-leveraging of real estate and the related, real-estate investments will continue to be the prevailing theme for 2008. While the investment banks pursued increasing returns utilizing aggressive debt strategies over the past several years, they have now been forced to add equity to their balance sheets, either by foreign investment or by accessing inexpensive debt from the government. Regional and community banks have also been forced to add liquidity to their balance sheets through reserves, as even the private, real-estate investor seeking to purchase a drug store has been forced to provide more equity in a transaction. Everyone needs more liquidity, and pending a strengthening economy and return to liquidity in the asset-backed securities market, there will continue to be an extended period of low relative volatility in the credit market, and it seems the industry will embody a “wait and see” attitude.

Of course, good news has not been prevalent in the commercial real estate arena recently, as it has been so significantly scarred by the lack of available credit, and by large amounts of equity seemingly waiting on the sidelines for another investor to make the first move.

Glaring evidence of this fact appears in the 2008Q1 statistic that commercial real estate investment was down 70 percent, and is on pace to fall below 2004 overall numbers¹. This anemic deal flow is magnified by the lack of debt available for investors. Evidence: The total CMBS market contributed approximately $230 billion in debt (U.S.) in 2007; and this year CMBS issuance is virtually nonexistent, with first half of 2008 (U.S.) issuance a mere $13.4 billion². Resulting underwriting is continuing the deleveraging theme as higher coverage ratios, wider spreads, and more stringent standards by lenders have increased the average equity requirement to approximately 30-40 percent for most property types.

Recent good news, however, is that investment grade tranches of some CMBS pools are beginning to clear the market and spreads have decreased by up to 100 basis points to offer coupon rates in a low percentage range. Confidence in the overall CMBS market will be slow to return, however the second half of 2008 is expected to improve somewhat with CMBS volume anticipated to gather steam as several Wall Street firms begin to make new loans. While insurance companies simply don’t have the need or ability to fill the $200 billion gap in the market, their 2008 originations are projected to be approximately $50 billion - down slightly from $56.6 billion³ in 2007. Agencies are working to fill some of the void in the multi-family sector and expect a 20 percent increase in origination over 2007 volume. Making the largest difference in market liquidity, however, has been the regional, community and foreign banks that have contributed more than 60 percent of the loan volume in the first quarter of 2008. Much of this has been property level, but corporate level investment has also been fueled by the currency exchange.

Other factors also point the way to greener pastures: the REIT bond market has shown signs of life; there are a couple of CDO facilities testing the market; and there are large funds being established for the purpose of purchasing some of the debt that has been dragging down bank balance sheets.

The overall economy continues to struggle with dismal consumer confidence, an ongoing single-family-home crisis, skyrocketing oil prices and increasing inflation in the price of everyday essentials. While it is virtually impossible to stifle concerns surrounding financial institution instability and economic fundamentals surrounding a continued recessionary spiral, CMBS spreads are still expected to tighten. As CMBS lending gains momentum, the bid/ask delta in commercial real estate narrows resulting in more product clearing the market. So as the continued deleveraging of investors will lead to a return of debt to the market, the return of credit and the accumulation of “wait and see” equity should pave the way to an improved second half of 2008. SLDT

1 Real Capital Analytics, 2008.
2 Mortgage Bankers Association, 2008.
3 Commercial Mortgage Alert May 9, 2008.