Capital Markets’ Distress Mingles with Hints of Improvement

Signs of growth in distressed properties are mixing with evidence that the U.S. and global real estate markets are starting to stabilize, according to a recent analysis by Jones Lang LaSalle Inc. The issue of distressed assets in the United States presents a contradictory picture. Loan defaults are at an 11-year high, and lenders and borrowers face the daunting prospect of refinancing commercial real estate loans valued at $1.3 trillion over the next four years. By April, the unpaid balance of CMBS loans in special servicing hit $24.5 billion, a total 10 times as high as it was in March 2007. Yet commercial real estate foreclosures totaled a surprisingly low $65 million in April–the latest indication that the level of distressed asset sales is much less than predicted by many experts. Jones Lang LaSalle’ analysts suggest that programs like the federal government’ s Term Asset-Backed Securities Loan Facility are encouraging private investors to buy bank whole loans and securities. That, in turn, is giving banks reason to move more on forced sales and foreclosures. Meanwhile, the decision to expand TALF to include new CMBS issues has helped to tighten spreads on AAA-rated CMBS to the 700 basis-point range. Other trends also suggest that the real estate capital markets are getting on more solid ground. In early May, the Libor-OIS spread dropped to 75 basis points, a nine-month low. The spread between what the U.S. Treasury pays for three-month borrowing and what banks pay reached 77 basis points last month. As recently as last October, the TED spread was 464 basis points. While some benchmark spreads continue to shrink, the value of REITs is increasing. Since the end of February, REIT market values have gained 60 percent, bouncing back from a dismal six-month stretch during which values slid 80 percent. Rising investor confidence has helped REITs jump $10.6 billion in the public market so far in 2009, a total that already approaches last year’s. In markets outside the U.S., transaction activity remains relatively low, but Jones Lang LaSalle offers some deals and trends to watch. “All eyes are on Aviva Investors’ proposed sale of an £800 million diversified portfolio of 47 U.K. properties,” the report notes. “It could provide a good indication of the strength of domestic and foreign buyers’ interest in the market as well as a pricing barometer.” Forced asset sales by private equity funds are increasing transaction volume in Asia. Nippon Life Insurance Co. is under contract for the $1.2 billion acquisition of American International Group Inc.’s Japanese headquarters. And in China, economic stimulus policies appear to be boosting the number of deals. By the end of April, the amount of space trading hands reached 176 million square meters, a 17.5 percent increase compared to the same period of 2008.