Global Economy Weighs on Property Here and Abroad

MBA (4/29/2008 ) Murray, Michael
In an age of financial uncertainty, property markets around the world hinge on the global economy and business decisions for office, industrial and retail space.

Real Capital Analytics, New York, reported London as the second most active city for commercial real estate investment in the world—following New York City and preceding Washington, D.C.—as London cross-border investors made up 75 percent of the activity last year for commercial real estate.

Dan Fasulo, managing director at RCA, said foreign investment in U.S. commercial real estate is “certainly a presence in the U.S. markets like D.C. and Manhattan, but we are nowhere near the levels that some other global cities around the world are at.”

However, tenant demand in the United Kingdom dropped further in the first quarter and at its fastest pace in more than six years, based on a commercial market survey from the Royal Institution of Chartered Surveyors (RICS) Economics, London.

The RICS Economics first quarter report said available space increased in all sectors while tenant demand declined mostly in the U.K.’s retail sector—weakest in the survey’s history.

“Generally looser market conditions have led surveyors to revise down their rental expectations across the market,” the report said. “Surveyors now expect rents to fall in both the office and industrial sectors for the first time since 2003. In the retail market, the pace of decline in rents is expected to double in the coming quarter.”

In its CMBS: European Red-Yellow-Green Year-end 2007 Update of Office Property Markets report, the London office of Moody’s Investors Service said the most significant market deterioration at the end of last year was in the city of London.

“It is noteworthy that all three London office sub-markets showed signs of deterioration mainly due to a decline in forecast take-up levels,” the report said. In a report earlier this month, Moody’s questioned overall credit quality for corporate tenants in the United States.

"I'm not very surprised that Moody's would question the overall credit quality going forward [in the U.S.] for corporate tenants, especially given what's going on with the economy," Fasulo said. "There is no question that if we have a sustained downturn over the next couple of years that some corporations are going to have a more difficult time paying the rent."

Fasulo, however, said the strength of U.S. commercial real estate fundamentals should keep the U.S. commercial market relatively active, particularly in its major cities.

“The wild card is certainly just a prolonged recession that not only is U.S.-based but trickles over to the whole globe,” he added. “That’s the only thing I can see being a real knockout punch for places like Manhattan and D.C. It would be some sort of global slowdown just because of the nature of businesses generating so much of the revenue from overseas at this point. The small companies now, too—lawyers, architects, accountants—everyone has more of a global clientele than ever before.”

In its Global Emerging Markets Survey, Los Angeles-based CB Richard Ellis said quality and range of real estate opportunities were the main operational considerations for retailers moving into emerging markets.

“80 percent of retailers will reconsider the decision to enter a market if their preferred real estate format is not available,” said Anthony Buono, executive managing director of CBRE Retail Services at CB Richard Ellis. “In fact, 56 percent of retailers base their entry into an emerging market on the availability of suitable property, compared to 46 percent in developed markets. Additionally, the presence of a franchise or local partner is another key consideration, as this can help foster rapid market penetration.”

India was the most sought-after emerging retail market in the world, with 27 percent of retailers surveyed opening stores or actively planning to do so in the country, followed by 24 percent in the Ukraine. Russia, Malaysia and Turkey rounded out the top five in the report.

Moody’s report, Chinese Property Developers: Greater Risk from Tighter Liquidity and a More Volatile Market, authored by Peter Choy, vice president and senior credit officer, and Kaven Tsang, assistant vice president and analyst at Moody’s, said it holds a negative outlook for China's property-development sector as tighter credit conditions likely prevail in the next 12 to 18 months and business prospects become much more challenging. based on its report,

CB Richard Ellis, however, said most retailers—19 of 20—who consider China and Thailand later open stores there. The report also said South Africa is the most important market for retailers from the Asia Pacific region.

Moody’s said increases in interest rates negatively affected South African RMBS securitizations during the second half of 2007, and it expects deterioration in performance to continue for this year.

“The overall sector has negative prospects in the near and medium term because developers face challenges in funding their capital expenditure with domestic and overseas funds, while also facing a more problematic sales environment,” the report said.

The ratings agency also anticipates a more challenging year in Spain because of tighter credit conditions and a softening global and domestic economy. Rising unemployment, slowing employment growth, higher mortgage interest rates and the tightening impact of an appreciating euro are likely to weigh on Spanish mortgage holders, the ratings agency said.

Nitesh Shah, a Moody's economist and co-author of the Spanish RMBS Q4 2007 Indices, said the housing boom “clearly passed” in Spain, and activity is declining for construction and mortgage approvals.

“In addition, as elsewhere in the Eurozone, Spanish GDP growth has peaked," Shah said. “Whilst the impact on an economy that has 13 percent of the labor force employed in construction could be significant, the budget surplus that Spain has built up over the years will enable the government to better withstand a housing market shock through fiscal stimuli than the U.K., the U.S. or Ireland, for example," Shah said.

In Moody’s CMBS: European RYG Office report, the ratings agency forecasts completions and less take-up would weaken the demand-supply relationship for commercial real estate in Barcelona.

A March article by James Ziegler, vice president of real estate & structured finance, and Sean O’Connell, vice president and director of real estate & structured finance research at Advantus, St. Paul, Minn., Is the Commercial Real Estate Market the Next to Fall? A Comparison to the Residential Capital and Property Markets, Ziegler and O’Connell make an argument for opportunistic value in U.S. commercial real estate because it is not the same as residential.

The article said that while the synthetic ABX Index for subprime was a predictive measure in defining subprime mortgages, questions remain as to whether the synthetic CMBX Index, a pricing hedge for the commercial mortgage-backed securities (CMBS) market, actually signals a collapse in the commercial property markets.

“We see opportunity in this market,” the article said. “The excesses on the 2006-2007 CMBS market are real. However, we do not believe that the pricing of CMBS/CMBX in the capital markets is predictive of a coming commercial real estate meltdown. Commercial real estate is markedly different than residential. In-place cash flows and generally strong sponsorship protect on the downside, and the incentive to default is not as strong as with the stressed residential owner. Commercial real estate also benefits from longer-term financing. As such, most well-underwritten loans made over the past five to ten years should have the benefit of appreciation and should mitigate significant refinance stress.”

Fitch Ratings, New York, said that after reviewing the maturity profile in its rated floating-rate large loan transactions, floating-rate U.S. CMBS have or should be able to refinance 88 percent of the time.

“Floating-rate loans are typically structured with options to extend and Fitch anticipates borrowers will take advantage of these options. These extensions will allow borrowers additional time for the real estate capital markets to stabilize before a mandatory refinancing of their assets,” said Mary MacNeill, managing director at Fitch. “Although most borrowers are extending their loans, often times it is due to their current or extended rate being more attractive than getting new financing, as most loans are performing within their rated debt levels.”

“By no means do we see this opportunity through rose colored glasses,” Ziegler and O'Connell's article added. “Investors should have the staff and experience to evaluate individual loans and structures in the CMBS market. Even at the AAA level, all bonds are not created equal. Investors must also have the fortitude to deal with the mark-to-market issues facing the fixed income market today. Numerous daily price swings of multiple points are becoming more of a norm. This is not a market for the faint at heart.”

Moody’s European RYG report said the German markets improved at the end of the year. Berlin’s improvement was based primarily on increased net take-up and a corresponding decrease in vacancy levels while the Hamburg market improved primarily from decreasing vacancy levels and lower supply forecasts.

GE Real Estate, Norwalk, Conn., acquired a nearly $1.988 billion portfolio of senior and whole loans in a performing commercial property loan book from Capmark Europe. The portfolio consists of 39 loans on a range of different assets throughout Europe, the majority of which are domiciled in Germany.

Michael Rowan, managing director of GE Real Estate UK, said its purchase from Capmark Europe allowed GE to capitalize on its AAA-rated corporate balance sheet and its local and global resource to invest in the market “during a period of market uncertainty.”

“This, our second large debt deal within the last six months, was attractively priced against good quality underlying real estate which is providing strong cash flow,” Rowan said.

In November, GE acquired a nearly $3.972 billion portfolio of performing commercial property loans from Bradford & Bingley PLC in Yorkshire, England.