Commercial Real Estate Darwin Style

The wolves are hungry but calculating. They will strike and pick off distressed assets causing an avalanche of equity pricing in the commercial real estate market to come crashing down on our heads. Commercial real estate pricing is based on 1.) Returns (rental income weighted with risk) 2.) Comprable Sales and 3.) Replacement Cost.

Returns, based on capitalization rates (income divided by price) were artificially compressed in the 2004-2007 periods where prices went through the roof simply because there were more bidders, willing to take lower rates of return - not necessarily because the income was any greater. This has collapsed.

Replacement costs were heavily inflated in the 2005-2007 period when cement, gypsum, copper and glass prices went through the roof. This has collapsed.

Comprable sales are coming in now and they aren't pretty. The latest example is the Watergate Hotel which went to auction at $25 million - there were no bidders. When owners can no longer make payments on their debt (based on unjustifiable prices from a past era)commercial real estate will collapse.

It is important to remember that the word "collapse" is not equivalent to extinction. There will still be a market, there will still be demand - it will be watered down. Only the strong shall survive.

Equity In U.S. Commercial Property May Evaporate

By Ilaina Jonas

NEW YORK (Reuters) - The equity in $1.3 trillion worth of U.S. commercial real estate acquired or refinanced in 2006 through early 2008 is at risk of being completely wiped out by price collapses, according to a report by Real Estate Capital Analytics.

About $2.2 trillion of properties acquired or refinanced after the 2004 start of the commercial real estate bubble have lost value, according to the report, released on Wednesday by the real estate data company. As most those deals were financed with 70 percent to 80 percent or more of debt, the lower value will directly eat away at the equity.

"By the end of 2010 you'll have begun to see terrible, terrible capital structure disintegration," said Philip Blumberg, chairman and chief executive of Blumberg Capital Partners. "The first thing to go is the equity."

About $165 billion of commercial mortgages this year will mature and need to be refinanced or sold. Some $11.8 billion matured in June, according to mortgage data analysis provider First American CoreLogic.

The number of distressed properties in the top 10 markets topped 5,000 in March, the most recent recording period, for the first time since CoreLogic began keeping record in January 2003.

"The maturities haven't really gotten into full play yet," Blumberg said. "We are seeing the early edge of the hurricane of debt in real estate."

Prices for warehouses, office buildings, shopping centers and apartment buildings are down about 37 percent from the peak in 2007, according to Moody's REAL Index. The cost and availability of new loans has dried up, and lenders that will grant loans will do so only at 50 percent to 60 percent of value. Prices have plunged at an increasing rate, dropping 18 percent in the first five months of 2009, Real Capital Analytics said.

Meanwhile, the value has declined even more as rent and occupancy rates have tumbled.

Properties bought or refinanced in 2006 through 2008 have seen a 25 percent decline in value, Real Capital Analytics said.

The value of distressed properties has more than doubled so far in 2009. Some $93 billion of office, industrial, retail, and apartment properties in the United States have fallen into default, foreclosure or bankruptcy this cycle, Real Capital Analytics said.

Struggling hotels and other commercial property types add at least another $31 billion to the total.

Less than 10 percent of the distressed situations that have emerged have been resolved. Lenders have been slow to foreclose and have chosen to instead extend the loans.

Loans originated at the peak of the market in 2007 are seeing the highest levels of default

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