1. PIMCO
U.S. Commercial Real Estate June 2010
Project
In 2005, PIMCO’s Investment Committee dispatched the firm’s
mortgage team to the top 20 U.S. housing markets in a boots on
the ground effort to assess the leverage-fueled housing boom.
The Housing Project was born and it led to our forecast for an
unprecedented decline in residential home prices. What we
learned was critical to PIMCO’s navigation of the credit crisis
on behalf of our clients.
The commercial real estate market shares most of the sins of
its residential cousin – extremely weak loan underwriting,
excessive leverage and the absence of risk management from
both banks and rating agencies. So PIMCO undertook
the Commercial Real Estate Project to understand
local real estate dynamics on the
front lines in ways not revealed
in the published data, to better
understand how the current cycle
is different from previous cycles
and to inform asset selection in
local markets.
2. PIMCO U.S. Commercial Real Estate Project
Recognizing that commercial real estate (CRE) We believe that the CRE market faces significant
property-level fundamentals continue to decline and uncertainty around valuations that will affect the
capital markets are changing rapidly, PIMCO portfolio prospects for recovery. Investors therefore should
managers and analysts fanned out across 10 cities to proceed with caution when examining the complex
conduct on the ground research. Our teams met with opportunities that are surfacing. Considering the
over 100 industry representatives, including local complexities introduced by capital markets since
investment sales advisors, leasing brokers, CRE lenders, the last CRE crisis, any approaches to analyzing
special servicers, real estate developers and property and investing in this market will need to depart
owners across the largest commercial sectors – office, significantly from those of previous cycles.
industrial, retail, hotel and multifamily. Through
these meetings, we developed a real-time view of local
All That Glitters Is Not Gold
conditions and insights into key assets.
Capital has returned to CRE and high levels of bidding
activity in certain sectors have made many observers
Summary of Key Findings:
and participants optimistic. Transactions have
1. Capital is clearly returning to commercial real
generally been limited and capital flows have been
estate, helping to stem the value decline in the
concentrated in trophy properties and in properties
sector. But optimism should be tempered, because
where below-market Agency financing is available.
national price indices are misleading when
This has provided a false sense of clarity on the real
transactions are limited and fail to reflect the
level of property values. A significant volume of weaker
significant uncertainty around property valuations.
and distressed assets has yet to be liquidated and this
2. Changes in the structure of capital markets – foreshadows further pressure on values. Against this
notably the proliferation of complex securitizations backdrop, we caution against the presumptions that a
since the last CRE crisis in the early 1990s – will rapid broad-based recovery is underway.
lengthen the deleveraging process and suppress
a recovery. The impaired ability to transfer CRE Capital is Back
risk out of the banking system relative to previous Accommodative monetary policy and increasing levels
cycles makes a stable, let alone a V-shaped, recovery of liquidity have ushered in the return of both equity
unlikely. Instead, many CRE assets likely will not and debt capital to the commercial real estate sector.
return to 2007 prices until the end of this decade. Not surprisingly, capital has returned to the most liquid
sectors of CRE first – public equities through Real Estate
3. Macroeconomic headwinds such as limited GDP
Investment Trusts (REITs) and commercial mortgage
growth in the U.S., elevated unemployment,
backed securities (CMBS). REITs were successful in
potential re-regulation and a secular increase in the
raising over $24 billion of equity and issuing $10 billion
savings rate will force the market to re-evaluate the
of debt in 2009. As shown in the chart following, from
assumptions it has used to price CRE. These trends
the first quarter of 2009 to the first quarter of 2010, the
severely affect the outlook for rents, vacancies and
inflow of capital into REITs and CMBS drove REIT prices
capitalization rates, highlighting the downside
up over 96% and tightened super senior CMBS tranche
risks that remain in CRE.
spreads (the most senior class of CMBS) by nearly 70%.
June 2010 2
3. Capital is Chasing CRE Assets operating income divided by property value, or in other
1,000
CMBS Super Senior 215 words, the current yield at which a property trades) and
900
DJ Equity REIT Index
Spread to Swaps (bps)
800 190 per-square-foot values close to the peak prices seen in
700
Index Value
165
2006 and 2007.
600
500 140 Buyer demand has also returned for multifamily
400
115 properties financeable through Fannie Mae and Freddie
300
200 90 Mac’s longstanding lending programs. While loan
terms have become significantly more conservative in
0
Ju 9
Se 9
O 9
D 9
Ja 9
Ap 9
M 0
Ap 0
Ju 9
Fe 0
M 0
N 9
M 9
Au 9
-1
-0
0
0
-0
-0
-0
1
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0
1
r-1
-0
r-0
l -0
g-
p-
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ay
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Source: Bloomberg, PIMCO
CRE over the past two years, Fannie Mae and Freddie
Mac continue to offer financing terms reminiscent of
those offered in 2007. This attractive financing has led to
On the debt side, insurance companies are actively
transactions pricing at 2005-2007 levels in the 5% to 6%
looking to finance quality properties, former Wall Street
cap rate range.
investment conduit groups are re-forming and several
private debt vehicles are raising capital. Values Bottom, But Recovery Will Be Slow
In response to the recent surge in bidding levels for
Transaction activity has resumed in earnest for
lower-risk “trophy” CRE assets, both equity and debt
relatively liquid assets such as stable, trophy properties
capital have begun to migrate along the risk curve
in major markets. Investors and lenders have
in search of yield. Indeed, well capitalized REITs
aggressively returned to major markets, including
are once again looking to acquire assets and several
Manhattan and Washington, D.C., where demand
private equity funds are actively searching for new
from foreign capital has led to recent office trades that
acquisitions, even in challenged markets.
have been completed at capitalization rates (annual net
Today, buyer yield requirements imply that CRE asset
values have generally declined 35% to 45% from their
peak levels in 2007 - a marked improvement over early
2009, when buyer yield requirements spiked to levels
that implied a value decline of over 50% from 2007. We
caution against the presumption, however, that this
implied improvement in CRE asset values portends
a rapid recovery in actual CRE asset prices. Instead,
as over $500 billion of over-leveraged CRE properties
slowly reach the market through lender dispositions or
restructurings, we expect general CRE asset prices to
remain 30% to 40% below 2007 peak pricing levels for
three to five years.
3
4. PIMCO U.S. Commercial Real Estate Project
The point here is that transaction activity in trophy Have We Reached Bottom?
Moody's CPPI Level, Dec 2000 = 100
210
properties and Agency-debt eligible multifamily
190
properties should not be considered a leading indicator
170
of a broad-based recovery in CRE asset values. Recent
150
transactions imply a rapid recovery to 2007 pricing
130
levels; however, these asset classes face risk of future
110
value declines. In the case of the aforementioned
90
Washington, D.C., office properties, for example,
0 1 1 2 2 3 3 3 4 4 5 05 5 6 6 7 7 8 8 8 9 9 0
-0 -0 t-0 r-0 -0 -0 -0 -0 r-0 -0 -0 l- -0 -0 t-0 r-0 -0 -0 -0 -0 r-0 -0 -1
PIMCO met with several local investors who were ec ay Oc Ma ug Jan Jun ov Ap ep Feb Ju ec ay Oc Ma ug Jan Jun ov Ap ep Feb
D M A N S D M A N S
perplexed by the extent of non-U.S. capital funneling Source: Moody’s CPPI, Real Estate Analytics LLC as of 5/31/10
into their market. This reliance on non-U.S. capital
for rapid appreciation highlights the potential for residential home prices, we caution that indexes such as
exogenous factors to drive CRE values at the local level. the CPPI are relatively meaningless in today’s limited
For multifamily properties, a small change in loan transaction environment – commercial real estate
terms would have an immediate effect on multifamily transaction volume fell nearly 90% from 2007 to 2009.
asset prices given the significant reliance on Fannie Mae
Our ride along meetings highlight another limitation
and Freddie Mac for financing.
of the CPPI. Based on repeat transactions, the index
Misleading Indices excludes the truly distressed or overpriced properties
National price indices such as the Moody’s Commercial acquired in the past few years that have yet to trade, and
Property Price Index (CPPI) can provide misleading is instead skewed by the high proportion of trophy asset
indications of a recovery in CRE asset price levels. Since and Agency-financed multifamily transactions. In fact,
November 2009, the index has rebounded 3%. for every broker story regarding a bidding frenzy for a
trophy asset or multifamily property, our team heard
While it is natural to draw comparisons between the
of multiple instances of owners embroiled in workouts
CPPI and the S&P/Case-Shiller index used to gauge
June 2010 4
5. on properties they believe to be worth less than 50% Deleveraging: A Messy Unwind
of peak valuations. When these distressed properties The often byzantine debt and equity structures that
finally do trade, they will have a disproportionate evolved over the last decade will take significantly
effect on the CPPI. For example, the CPPI index price longer to unwind than the distressed CRE inventory
change in March 2010 was based on only $1.7 billion of the 1990s, because securitization has changed
of transactions. By contrast, a single deal, the highly the primary holders of CRE risk. This prolonged
publicized Stuyvesant Town property in Manhattan, deleveraging process is expected to result in a sustained
sold for $5.4 billion in 2006. If this property were to period of limited price transparency and risk aversion.
liquidate today (the property is currently in default),
In the last major crisis, CRE was relatively isolated from
many estimate that it would sell for 60% less than its
the broader economy. The rally and subsequent fall
2006 purchase price.
was spurred by tax-driven oversupply. Furthermore,
CRE capital structures were straightforward,
The Long, Long Road consisting of senior lenders (savings and loans, thrifts
to Recovery and banks) and private borrowers. Considering the
The development of increasingly complex capital relative isolation of CRE risk holders, the FDIC was
structures since the 1990s without accompanying able to contain the fallout. The FDIC spearheaded the
policies to efficiently resolve conflicts implies that the rapid transfer of CRE risks through the creation of
deleveraging process will take far longer to play out in the Resolution Trust Corporation (RTC), which used
this cycle. In addition, as regional banks are forced to tools such as bulk sales, equity partnerships with a
recognize losses on their construction loan portfolios, private sector partner and, ultimately, securitization to
eventual dispositions will do little to speed a recovery restructure and sell risk.
or clarify property values. The drawn out resolution
process for both complex securitization structures and Flash forward: the evolution of CMBS, large loan
regional loan portfolios makes the prospects for a quick, syndications, mezzanine debt vehicles, collateralized
V-shaped recovery unlikely. Instead, many assets may debt obligations (CDOs) and private equity funds has
not return to their peak 2007 values until the 2020s. greatly added to the complexity of the capital landscape.
As such, the risk holders on a property today frequently
include hundreds of direct and indirect owners across
the capital structure, often with conflicting interests.
In CMBS, for example, subordinate bond classes have
approval rights regarding loan workouts that lead
5
6. PIMCO U.S. Commercial Real Estate Project
to a preference to extend loans rather than initiate case, even if properties with floating rate debt can
foreclosure proceedings. Conflict arises when a successfully avoid defaults in the short term, rising
foreclosure would maximize recovery to the trust but longer term rates will create a floor for cap rates and
would wipe out the subordinate bondholder’s principal. limit recoveries.
All of this will serve to limit the speed and effectiveness Small Loan Dispositions Offer Little Clarity
of previous deleveraging strategies, dragging the While evolving U.S. guidelines and a low fed funds rate
unwinding process out for years and limiting visibility allow banks to employ a “pretend and extend” strategy
on the level of a bottom in property values. Indeed, for the resolution of troubled commercial loans, large
many of the CRE law firms that we met with said volumes of construction loans are expected to force
their loan restructuring assignments have become a day of reckoning for many regional banks. Banks
significantly more complicated than previous cycles due cannot keep listing construction loans as performing
to the higher number of participants within a property’s when the reserves they must carry against them are
capital structure. depleted and borrowers refuse to contribute new
capital. Similarly, CMBS special servicers will likely
Higher Cap Rates Here For the Long Term
sell portfolios of small non-performing CMBS loans, as
We expect that the spread between cap rates and 10-year
these loans are not profitable for the servicer to resolve.
Treasuries will remain above its average of 265 basis
points seen since 1995, as the litigious deleveraging Loan portfolio dispositions will likely lead to an
process leads to a sustained period of risk aversion in increase in transaction volume relative to 2009;
the sector. however, portfolio sales of small, non-performing loans
give little clarity to values overall. For example, in an
As shown in the accompanying chart, the 10-year
FDIC sale that took place in early 2010, only 41.5% of
forward curve implies that 10-year Treasuries will
a $1 billion portfolio consisted of loans backed by
approach 5% over the next several years. If cap rate
traditional commercial real estate properties. The rest of
spreads remain above their average, the market can
the loans were backed by assets such as land, car washes,
expect long term cap rates near or above 8%. In this
churches and funeral homes – not exactly a useful
Higher Expected Treasury Yields comparable for assessing the value of office buildings.
Put a Floor on Cap Rates
9.0 A Brief Comparison to Japan
8.0 The broader success of transferring CRE risk out of the
7.0 banking system will also drive the timing of recovery.
Percent (%)
6.0
Consider Japan, where zombie banks – financial
5.0
institutions that continue to operate despite severely
4.0
Cap Rate impaired balance sheets – held on to underwater loans
3.0
10-Year UST Yield
2.0 for years because they were not forced to mark to market.
1 1 1 1 1 1 1 1 1E 3E 5E 7E 9E
Q Q Q Q Q Q Q Q This led to a sustained period of limited price discovery
95 97 99 01 03 05 07 09 201 20
1
20
1
20
1
20
1
19 19 19 20 20 20 20 20
and a prolonged downturn where values did not bottom
Source: Bloomberg, Property and Portfolio Research
for more than 10 years after the decline began.
June 2010 6
7. We hope that the lessons learned from the Japan crisis Where’s the V?
Japan Timeline
will help the U.S. avert some of the fiscal and tax
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00
01
02
03
04
policies that led to Japan’s “lost decade.” Parallels can 200
Japan MTB-IKOMA CRE Index:
Actual 1983 - 2004 (top axis)
certainly be drawn, though, between Japan’s policies 250
regarding bank recognition of CRE loan losses and the 200 Bullish Projection -
Index Level
1990's U.S. style recovery
U.S. government’s recently relaxed bank guidelines. 150
As we learned through meetings with CRE brokers 100
U.S. CPPI Index: Actual
and consultants, many regional banks continue to find 2000-2007 (bottom axis)
50
Bearish Projection - Japan style recovery
ways to avoid marking loans to their current value. 0
For example, several brokers told our analysts of cases
00
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U.S. Timeline
where a bank loan officer would specifically direct a Source: Moody’s, MTB-IKOMA Real Estate Investment Index,
ESRI, Bank of Japan, PIMCO as of Q4 2009
broker to provide only a verbal opinion of value on a
property financed by the bank, presumably to avoid any
documentation that would force recognition of a loss. Avoiding the Pitfalls
The credit crunch of 2007 and 2008 encompassed a
The accompanying chart extrapolates and compares
large set of problems – corporate, residential, consumer
a recovery that mirrors Japan’s CRE lost decade cycle
lending and, of course, commercial real estate. As
versus a recovery scenario based on the U.S. recovery
a result, CRE will most likely not benefit from the
in the 1990s, where the FDIC forced a rapid transfer of
surge of economic growth that typically follows a
CRE risk through the Resolution Trust Corporation.
cyclical downturn. Instead, the market – and indeed
Interestingly, as veterans of the 1990s will attest, even
the broader economy – will be exposed to a whole
that recovery was far from V-shaped in CRE.
new set of obstacles to recovery on the path to a New
Normal: limited GDP growth in the U.S., a stubbornly
high unemployment rate, potential re-regulation and a
secular shift in the savings rate that results in reduced
consumption. Accounting for and understanding the
effect these macroeconomic
trends will have
7
8. PIMCO U.S. Commercial Real Estate Project
on rents, vacancies and cap rates will be key to avoiding are hesitant to disclose concessions because doing so
the pitfalls to recovery in CRE, where many assets will could incentivize savvy tenants to negotiate better
continue to decline in performance and value over the terms. This makes accurately tracking effective rents
next three to five years. nearly impossible.
Rents Are Down More Than Reported… …With More Declines to Come
Market reports on industry fundamentals such as Although nominal GDP growth turned positive during
vacancy rates and rental rate changes are misleading the third and fourth quarters of 2009, property cash
in a limited leasing environment. PIMCO’s interviews flows are poised to decline for the next one to two years
with leasing brokers and property owners across the as expiring leases reset at lower levels. This lag effect is
country paint a significantly more sobering picture of evident in the office and industrial sectors, where the
the rental environment than market reports show. strongest historical correlation between nominal GDP
and cash flows occurs on a two year lag.
Property and Portfolio Research (PPR) reported
meaningful declines in nationwide asking rents, Of ce/Industrial Net
Operating Income Lags GDP
shown in the accompanying table. These clearly 1.5 2.5
illustrate a decline in performance across all real estate
Quarterly GDP Growth (%)
Quarterly NOI Growth (%)
1.0
2.0
sectors; however, these measures fail to capture the 0.5
0 1.5
extent of the concessions landlords are offering to
-0.5
attract and retain tenants. 1.0
-1.0
0.5
-1.5
National Average National Average -2.0 0
Yearly Rent - 2007 Yearly Rent - 2009 % Change
4
4
4
4
4
4
4
4
4
4
4
4
4
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
-Q
Apartment (per unit) $16,238 $15,142 -6.8%
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95
97
99
01
03
05
07
09
Quarterly NOI Growth (2yr lag) Quarterly NOI Growth
Office (per square foot) $26.99 $24.28 -10.0% Quarterly GDP Growth (RHS)
Retail (per square foot) $20.02 $17.76 -11.3% Source: Bloomberg, Property and Portfolio Research
Industrial (per square foot) $5.26 $4.63 -12.0%
Source: Property and Portfolio Research In addition to the demonstrated lag effect between
GDP and CRE cash flows, severe real estate value
Effective office rents, (rents net of concessions such as corrections can create other, less obvious sources of
free rent and temporary rent breaks) have dropped rent pressure. For example, sophisticated tenants have
much further than asking rents. According to Reis Inc., become increasingly concerned about zombie buildings
a commercial real estate information provider, asking where the current owner has negative equity and little
rents in the Manhattan office market were down more incentive to maintain a property. In fact, several leasing
than 20% at the end of 2009 from the peak in the fall brokers told us that, for the first time in their careers,
of 2008. However, our interviews with leasing brokers they are seeing tenants demanding detailed financials
suggested that effective rents in those same areas have on the landlord. Over-leveraged properties financed
declined by as much as 40%. Not surprisingly, landlords with CMBS loans are particularly vulnerable to being
deemed as zombies, because brokers representing
June 2010 8
9. large tenants are able to access the specific financial According to PPR, vacancy rates in the first quarter of
information for these assets. Thus, potential tenants 2010 were almost 20% on a national level, the highest
will be able to actively avoid these buildings, further level in 20 years and well above the average 15% rate
pressuring property values. seen over that same period. Even with limited new
supply, we expect vacancy rates to stay consistently
Should foreclosures accelerate and more landlords give
above trend, ultimately limiting office rent growth
back the keys on underwater properties, the lower cost
over the secular horizon. As the accompanying table
basis for buyers of these distressed properties would
highlights, rental growth doesn’t meaningfully increase
reduce the rent required to generate desirable returns.
until vacancies fall well below the historical average.
These basis resets would have a marked effect on local
area rents, requiring special attention to potential
Annual Rent Growth Rises
property value shocks and a detailed knowledge of as Vacancies Fall
equity positions in nearby properties. 15
Vacancy Rate Vacancy Rate
as of 1Q 2010 15-year Average
10
Office Rent Growth (%)
Interviews with retail property owners also highlight
5
the continued challenges landlords face. Retail owners
0
may have been able to prop up occupancy levels by
-5
converting struggling tenants to a percentage rent
-10
structure; however, performing anchor tenants will
-15
eventually demand rent reductions as well. Several 22 20 18 16 14 12 10 8
Vacancy Rate (%)
retail owners that we met with indicated that even Source: Property and Portfolio Research top 54 MSA rent
and vacancy averages
performing anchors are attempting to negotiate lower
rent structures, as these tenants recognize that they are
often the key to a property’s viability. A Rising Tide Will Not Lift All Boats
Long term changes in consumption and savings
Elevated Vacancies Lean on Values
patterns have specific implications for properties tied
Given the sharp drop in real estate values, commercial
to consumer spending, such as the luxury hotel and
real estate development (i.e., new supply) is expected
upscale retail sectors. PIMCO’s expectation for a long-
to remain limited for several years. Long term changes
term increase in the savings rate suggests the potential
in employment will result in depressed demand as
recovery for these asset classes will be constrained as
well, stifling absorption of vacant supply. In markets
consumers reduce discretionary spending habits.
such as Phoenix, finance- and real estate-led growth
in office employment will remain muted for years, as Despite recently reported increases in hotel revenues
many of these jobs were ancillary to the construction relative to the first quarter of 2009, many luxury hotels
industry. Thus, secular changes in office-using may not see their room rates reach 2007 levels for
employment will keep vacancy rates above historical several years and many full-service hotels will
averages for several years, even in a limited struggle to maintain profitability in low margin
supply environment. business lines such as spa and restaurant services.
9
10. PIMCO U.S. Commercial Real Estate Project
To the extent hotel revenues decline further, the Re-regulation: Another Risk
negative effects on property net cash flows will become An increasingly uncertain regulatory environment may
increasingly amplified as fixed costs consume a greater also constrain the recovery of CRE values. Recently
proportion of operating expenses. Many of the full- proposed regulatory and accounting rule changes
service hotel operators that we met with confirm that (such as FAS 166 & 167, which impact the off-balance
they have already “squeezed out” most of the possible sheet treatment for securitized assets) may reverse, or
fixed cost savings in 2008 and 2009, as certain costs at least limit the re-emergence of traditional conduit
such as insurance and real estate taxes cannot be lenders. Federal proposals to date have not clearly
reduced further. addressed risk retention requirements for CMBS
issuers and the uncertainty around future regulatory
Certain retail properties could also struggle in the New
pressures may negatively affect the economics of new
Normal. Many retail properties built in anticipation
securitization. Without further clarity on these issues,
of large housing developments will simply suspend
limited securitization will deprive CRE markets of an
operations, because sustained reductions in the home
important source of capital.
ownership rate mean that many planned housing
developments will not restart for years.
Spotting the Opportunities
Luxury retail properties may also struggle in this
As the deleveraging cycle unfolds, attractive
environment. Retail rents are often structured to
opportunities are likely to be available to investment
include a base rent and a percentage rent (overage) that
platforms with the flexibility to access CRE
is tied to store sales. This direct link between rental
opportunities across the capital landscape and who can
rates and store sales highlights the sensitivity of luxury
provide liquidity over the long term. The slow recovery
retail properties to both short term drops in sales
cycle, however, favors patient investors who understand
and long term reductions in discretionary spending.
the relative value dynamics of both capital structures
The chart below illustrates the challenges that luxury
and asset profiles.
retailers faced in 2009.
We conclude by looking at some of these opportunities:
Retailer Sales per Square Foot
YOY YOY
FDIC Dispositions – Regional and community
2008 2009
Change Change banks are particularly sensitive to both national and
Saks Inc. $410 -6.6% $351 -14.4% local economies and have been acutely affected by
Tiffany & Co.* $3,051 -10.7% $2,759 -9.6% the distress in residential and commercial real estate
Nordstrom, Inc. $388 -10.8% $368 -5.2%
markets. There were 140 bank failures in 2009 and
Macy's $160 -5.3% $152 -5.0%
an additional 78 through May 2010, representing
* Estimate
Source: SEC approximately $240 billion in assets.
Troubled banks have suffered losses on their CRE loan
portfolios and eventually will be forced to transfer
these risks off their balance sheets either through
June 2010 10
11. FDIC assisted transactions or voluntarily ahead of understand the relative risks between various bond
receivership. Historically, intensive risk transfer classes and CMBS deals.
environments have provided opportunities for
Relative Value Opportunities – Capital flows alone
investors to acquire distressed loan portfolios. Recently,
should not be a gauge of where attractive investment
the FDIC has also indicated that it will consider
opportunities lie. As mentioned earlier, many owners
securitizations of bank CRE loan portfolios.
in primary markets are perplexed by the extent of
While bank loan dispositions may offer compelling non-U.S. capital flowing into their markets. With this
opportunities to acquire loan pools at discounts, we in mind, new investors should not expect a continued
caution that these opportunities are complex. The rapid appreciation in pricing for trophy assets in these
limited transaction time frames and non-institutional markets. Conversely, owners of grocery-anchored
nature of the underlying collateral requires investors retail assets in smaller markets express frustration in
to have both the experience and infrastructure to securing financing today, despite strong tenant profiles
underwrite and manage large pools of loans efficiently. and positive demographics. As capital returns to CRE,
we expect this yield spread (as reflected by cap rates)
Restructuring of Large CRE Loans – Most of the
between trophy assets and less liquid, quality assets in
private-equity-fueled mega deals of 2006 and 2007 are
smaller markets to eventually tighten.
just beginning to unwind. As large CRE loans mature,
lender syndicates that own the debt will look to exit or As with any market that is undergoing unprecedented
restructure. Property recapitalizations, including loan change, attractive opportunities will exist for the
restructurings (where a new investor contributes capital prudent and disciplined investor. Though difficult
in exchange for a reduced senior loan principal balance to measure in a limited transaction environment,
and a preferred equity position), can provide investors commercial real estate valuations have clearly returned
with a lower cost basis and a share of the upside to more rational relationships with property-level
returns. However, these types of restructurings are fundamentals. However, the deleveraging cycle and
complex transactions that will require investors to have structural headwinds will result in a slow recovery
substantial capital to participate in larger deals, as well with pockets of volatility to be expected. Extreme
as relationships with both lenders and borrowers. discipline in assessing both the asset level and
macroeconomic risks will be critical to making the
CMBS Opportunities – Many traditional buyers of
right investment decisions.
subordinate CMBS tranches, including mortgage
REITs and special servicer affiliates, have disappeared,
creating an opportunity for new investors to acquire
discounted subordinate positions and potentially
influence the outcomes of CMBS-securitized loans.
Also, constantly shifting spreads among bond classes
create arbitrage opportunities for investors who
11
