The Good Old Days

There are a lot of similarities between the current real estate cycle and the industry’s last big downturn in the early 1990s but also some key differences. Solomon Brothers, which had one of the best commercial real estate research operations on Wall Street 20 years ago, put out a report called “It’s 50 Cents on the Dollar, Stupid,” with “stupid” referring to Bill Clinton’s famous campaign mantra in the 1992 election, “It’s the economy, stupid.” This was the average price decline for office properties during and after the 1990-91 recession. I’ve seen other estimates of declines ranging from 40 to 60 percent back then, but you get the picture: it wasn’t pretty. Nowadays the industry is graced with better research. The Moody’s/REAL Commercial Property Price Index, which is calculated from repeat property sales tracked by Real Capital Analytics, reports a decline of 43.7 percent from the peak in October 2007 to the trough in October 2009. That is at the lower end of price-drop calculations for the previous downturn, but it is in the ballpark. In the leasing market, Grubb & Ellis reported that the office vacancy rate peaked at 18.0 percent in the fourth quarter of 1990 and again in the third quarter of 1991, compared with the current (mid-year 2010) vacancy rate of… 18.0 percent.

There are some interesting differences as well, chief among them the Resolution Trust Corporation. The RTC, which was in existence from 1989 to 1997, took distressed assets, primarily commercial real estate properties and loans, from failed savings and loans and other financial institutions, and sold them off to private buyers relatively quickly and efficiently, in hindsight. This time around regulators are taking back some properties from failed banks and selling them off, but their strategy is to encourage banks to negotiate with borrowers and in some cases restructure loans to avoid foreclosure. By keeping interest rates very low and providing TARP funds to some banks, regulators have helped banks bolster their capital reserves, giving them room to incentivize borrowers to keep properties. In theory, the regulators have created an artificial constraint on the supply of distressed properties relative to the capital sources lined up to buy them. By doing so, they have succeeded in arresting the two-year freefall in commercial property prices – that’s the good news. The bad news is that banks and CMBS special servicers eventually will need to get rid of these troubled assets. Despite the 8.6 percent increase in the Moody’s/REAL CPPI from last October through May of this year, most non-core assets remain undercapitalized or underwater. They are not yet on the radar screen of investors unless they have been drastically discounted. As these assets gradually come to market over the next year or two, they are likely to delay a broad recovery in pricing, i.e. a recovery that extends beyond the core assets now in demand. Thus instead of a V-shaped recovery in overall prices, it may look more like a shallow U.

One Response to “The Good Old Days”

  1. Moody’s/REAL CPPI « Apex Commercial's Blog Says:

    […] be playing out much differently than the industry’s last recessionary cycle in the early 1990s. Building Knowledge, Grubb & Ellis’ blog on commercial real estate, compares the two […]

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