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Spec Is
a Wreck
Market uncertainty and international economic turmoil
dry up commercial real estate funding
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Business New Haven
11/2/1998
By: Susan Banfield
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Asia may seem far away, but it doesn't take long these days for international financial fluctuations to have a very real and tangible effect on our local economy.
One of the most noticeable results to date of the troubles in the Asian, Russian and Latin American economies - and the related instability of the market back home - has been a sudden and dramatic decline in the funds available for large speculative commercial real estate projects.
One of the most popular means of financing such projects over the last several years have been Commercial Mortgage Banking Securities (CMBSs). CMBSs function something like a mutual fund, only the securities of which they are comprised are bonds backed by mortgages that have been bought up and bundled by Wall Street investment houses. These firms anticipate repayment based on payments by the mortgagors.
At the beginning of the decade, no one had heard of CMBSs. According to Bill Farley, Connecticut region president of C.B. Richard Ellis, these are now a $160 billion market. CMBSs were more aggressive than more traditional lenders such as banks or insurance companies, and so have gained a major share of the commercial real estate market in recent years.
The availability of this type of financing has all but evaporated over the last 90 days or so. In September, says Farley, there were less than $6 billion worth of commercial backed bonds issued - compared to an anticipated $15 billion. According to Dana Brome, managing director of the mortgage bank Holliday, Fenoglio & Fowler: “The CMBS market has temporarily been almost eliminated. There's essentially no purchasers of the securities.”
The principal cause of what Farley terms a “massive change in fund availability” has been events abroad. “It all starts with the turmoil in Asia, Russia,” he says. “We're hearing the word recession now. It affects the investor mindset.”
Brome also describes the phenomenon as a “function of the international market. This form of security is not in vogue. There's been a flight to quality.” He notes that the corporate bond market has dried up in similar fashion, and for the same reason.
Bob Greer, senior director at Cushman & Wakefield, points out that Wall Street money is still available for projects such as apartment buildings or shopping centers, but that “For speculative office buildings or hotels, that money is virtually non-available.”
Of course, CMBSs are not the only funding mechanism for large, speculative projects. However, none of the other options available are currently faring well, either.
Another source of speculative capital for large commercial real-estate projects has been REIT (Real Estate Investment Trust) stocks. But Brome points out that these, too, have been “severely battered” over the past 90 days, having lost between 25 and 40 percent of their original IPO offerings.
Mezzanine-structured financing was a third option for such projects, but as this was based on CMBSs, Brome notes, “The CMBS market struggles mean the mezzanine-structured finance has also been weakened.”
Farley notes that more traditional types of financing for commercial real estate projects - banks and insurance companies - “are now poised, ready to jump back in.” However, Greer says, it is doubtful how willing such firms will be to finance speculative projects.
Will this sudden evaporation of funding blow over quickly, or is it just the beginning of a longer trend? Opinions vary. Brome thinks the pendulum will soon reverse course. “The real-estate market is fundamentally strong,” he says. “We all think it's a short-term thing.”
Farley and Greer disagree. “I think the CMBS piece is not going to bounce back too fast,” says Farley “As people worry, they'll become naturally more conservative.”
Greer agrees. “I see this as lasting a long time.” He believes the only speculative projects that may get built are those for which there is “an absolute need,” and for which developers are willing to put up their own money.
Whether short- or long-term, what will be the effects of the current funding crisis?
Farley believes it will lead to a slowdown, and values will decrease. He notes that already the prices of commercial properties have dropped off ten to 15 percent.
Greer and Brome are more optimistic. “This is probably good medicine,” says Greer, who says the current lack of funding will help to avoid the commercial real-estate problems of the early '90s, which he views as the product of overbuilding.
“Most feel this little correction is a good thing,” says Brome. “Capital was too available for a while. It took away the judgment aspect.”
Conventional wisdom also says, however, that the health of a local economy is closely tied to the availability of funds for speculative commercial real estate project. It seems here that only time will tell the full story.”
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