Coping with the Capital Markets

Back in early 2007, many industry observers suggested that pricing in the commercial real estate markets did not reflect traditional risk and that a correction was likely. Of course, they did not expect residential subprime lending to ignite one of the biggest meltdowns in the history of the global credit markets.In a little over a year, debt markets that were once a punchbowl from which everyone could drink have halted their flow, resulting in limited credit, failures of major financial institutions and significant government intervention. Right now, fundamentals in the multi-family and commercial sectors are not expected to reach distressed levels. CMBS delinquencies are still around 0.5 percent, quite different from the delinquencies of more than 7 percent back in 1990, when the active industry slogan was “stay alive until ‘95.” Although new activity has been significantly curtailed today, solid fundamentals are allowing most property owners to wait until credit markets stabilize before making sale or refinance decisions. Of course, any further erosion of the economy will increase delinquencies and problems in our sector–and there is a reasonable risk that such erosion could occur. But that does not mean commercial real estate players have to sit helplessly on the sidelines.There is very little debt available for commercial and multi-family properties. Fannie Mae and Freddie Mac, recently put into conservatorship, have been the most active suppliers of senior debt. Insurance companies are quoting deals, but very selectively and with very conservative underwriting. Banks are in a capital preservation mode and, at best, are lending only to good clients and depositors. And, of course, the CMBS market has disappeared, at least for the foreseeable future.One of the concerns is that sufficient capital will not return to refinance maturing loans. There is, reportedly, significant capital available for equity investment, but it is waiting on the sidelines for deals to pencil out, which will require significant price declines and more abundant and flexible debt capital. Given these conditions, most industry experts do not expect a slogan for the real estate capital markets of “we’ll be fine in 2009.” Hopefully, the current government actions will slowly help restore needed confidence, and provided the economy does not fall off a cliff, credit conditions should improve by 2010. In the meantime, assuming fundamentals remain stable, traditional sales and financing transactions should continue to be slow, since sellers will not significantly reduce prices and leverage will not be available to buyers in adequate amounts at reasonable pricing. But there will be opportunities available for buying and selling notes backed by performing collateral. There have been numerous recent announcements of funds to buy debt securities, including high-yield CMBS. Also, owners will need to recapitalize or sell properties with short-term debt, especially in the case of deals that were underwritten during the past 12 to 24 months with unrealistic expectations for cash flow and value increases. There are in fact many firms expanding or acquiring asset management capabilities in expectation of a significant increase in problem properties.We at Northmarq have ourselves historically expanded our market share in down cycles by focusing on select opportunities. Part of such market share gains often comes from a fallout among smaller, undercapitalized firms. But tough times also offer opportunities to hire historically productive people (in addition, while it is prudent to tighten the “expense belt,” good people should be retained) and to acquire strategic core businesses at more reasonable economic terms than in the past.Acquisition considerations should include opportunities to increase recurring revenue sources as well as transactional revenue. In building our business, for instance, we at NorthMarq have focused on both new origination and portfolio servicing opportunities, and our $37 billion servicing portfolio will provide a cushion for us in this period of reduced origination activity. It is times like these when a business relies on its people, historical relationships and prudent decision making to ride out the storm.Craig Butchenhart is president of NorthMarq Capital Inc.