Offering Predictions for 2011, Carnac-Style

By Bob Dougherty, Buchanan Street Partners

Got answers about the future of the capital markets? Bob Dougherty has questions.

Readers of a certain age will recall from “The Tonight Show” Johnny Carson’s comic prognosticator, Carnac the Magnificent. In reverse order, a la Jeopardy, Carson’s sidekick Ed McMahon would read the answers, after which Carnac would attempt to divine the corresponding question. Thus, in decidedly less comedic fashion, here are one observer’s predictions for 2011’s real estate capital markets . . . Carnac-style:

Answer: Rising

Question: What are interest rates? The S&P 500 has exhibited a sustained rally for equities since mid-September, signifying that investors are increasingly coming out of their shells and, attracted by strong corporate earnings reports and projections, are willing to take on more risk. With more risk-taking and capital investment in projects along with securities, the hiring picture will eventually improve. Consumers are already exhibiting a more bullish outlook in their spending patterns, and this increased demand for goods and services will add to latent inflationary concerns stemming from the dramatic expansion of the U.S. money supply. Long-term federal deficit concerns will further augment the climb in interest rates broadly.

Answer: Euthanasia

Question: What will regulators finally inflict upon dead-man-walking U.S. regional and community banks? Expect the number of bank failures to continue to rise, surpassing the 157 recorded by the FDIC in 2010 which, in turn, exceeded the 140 charted in 2009 and was the highest annual figure since 1992.

However, the aggregate asset value of failed banks should level off if not decrease this year, resulting in a diminishing aftershock to the overall banking system. As of Sept. 30, 2010, approximately 860 banks were on one industry expert’s “watch list,” compared with 752 at year-end 2009 and only 252 at year-end 2008. Aggregate asset values of these watch list banks, however, had decreased to $379 billion by the end of the third quarter versus $403 billion at year-end 2009 and $252 billion at year-end 2008, indicating that most of the troubled banks are small- to medium-sized institutions.

With the economy on more sound footing and regulatory agencies now better staffed to handle the crisis volume, they can afford to, and likely will, exercise a more firm hand in closing so-called “zombie” banks. The real story, though, will be what a non-story this proves to be in the institutional-grade investment realm.

Answer: $40 billion

Question: What is your best guess for CMBS loan originations in 2011? Clearly, the actual figure is a guess better left by Carnac to more active conduit players. For instance, a recent Standard & Poors study pegged 2011 estimated originations at $35 billion. Citigroup projects $25 to $41 billion in 2011. However, the anecdotal evidence suggests at least a four- or five-fold increase above 2010’s estimated $10 billion in originations. Witness these recent headlines:

• Credit Suisse To Revive CMBS Origination Platform (Total Securitization)- December 15, 2010
• Berkadia Targets CMBS Originations (Bloomberg)- November 24, 2010
• BofA Joins Aegon in CMBS Venture as Market Rebounds (Business Week) – December 21, 2010
• CMBS Revival Marks Step Toward Recovery (Wall Street Journal) – September 22, 2010
• Wells Fargo Builds CMBS Business Once Dominated by Wachovia (Bloomberg) – August 24, 2010

Additional high-profile conduit platforms are being run by current clubhouse leader JP Morgan, Cantor Fitzgerald, UBS, Goldman Sachs, Deutsche Bank, and others. With all this activity and an estimated $1.4 trillion of mortgage debt maturing over the next 4 years, it’s easy to believe that “CMBS 2.0” will play a greater than expected role in meeting the market’s financing needs. What will likely temper conduit production volume is how many properties will get “unstuck” from their current financing gridlock.

Answer: “I’ve fallen and I can’t get up!”

Question: What popular TV commercial catchphrase will remain a familiar refrain in real estate in 2011? While property prices and REIT share values have rebounded from their post-recession lows and capital seems to be flowing more freely from healthier big banks, the conduit lenders, and an emerging “shadow banking” system, commercial real estate’s woes are not yet in the rear-view mirror. Certainly, increased enthusiasm will translate to greater risk-taking which will serve to boost asset values. However, a stubbornly stagnant employment situation continues to challenge property fundamentals. Additionally, mortgage delinquencies continue to loom large with Trepp LLC estimating that fully 52 percent of the aforementioned $1.4 trillion of 2011-2014 maturing mortgages are under water. Lender-borrower stalemates will continue to form logjams to a more free-flowing and efficient transaction market but will also present interesting opportunities to the opportune investor.

Of course, even Carnac understands that the most predictable element of our real estate capital markets will be unpredictability. Who would have foreseen last January how 2010 would play out? Now, may you avoid the scourge of “the fleas from a thousand camels” and enjoy a prosperous 2011, whatever fortunes it brings.