Agora Financial’s Rude Awakening

Jump to Comments

Laguna Beach, California

• The crippled financial industry drags on commercial real estate,
• Vacancy rates on the rise across the US,
• Office space in desperate need of a sober friend much plenty more…

Eric Fry, reporting from Laguna Beach, California…

“Two are better than one,” the writer of Ecclesiastes observes, “If one falls
down, his friend can help him up. But pity the man who falls and has no one
to help him up!”

The commercial real estate market is that pitiful man. It needs a friend, but
does not have one.

Oh sure, a lot of folks are fond of the commercial real estate market, but
none of them will be around after the market starts to stumble. And even if a
few fair-weather friends did stick around, they could not possibly, by
themselves, lift the commercial real estate market off its back. Only the
mighty U.S. economy could do that…and the mighty U.S. economy is already
flat on ITS back, looking around for a friend of its own.

Office vacancy rates across the United States increased to 12.5% during the
final quarter of 2007, according to Colliers International. That’s the first
jump in vacancy rates in more than four years. We suspect it will not be the
last. Details below…

— Bulletin Board Elite Remaining Positions —

The Lithium-Ion Secret: One tiny company leads the technology that could be
in 80% of  new cars in less than a decade

A pair of recent contracts pushed the stock up 195% in 4 weeks…

And it only gets more exciting from here — one small sector of the industry
this company leads could grow 10-fold in the next 10 years…

But you must hurry, because we can reveal the name of this tiny company to
only 470 readers while it’s still around 60 cents per share…Read On.

————————————————-

The Echo-Bubble, Part II
By Eric J. Fry

“We are all about to become experts on defaults, delinquencies, foreclosures
and write-downs,” moans Ross Moore, senior vice president and director of
market & economic research at Colliers International, a worldwide provider of
commercial real estate services. “Retail and consumer spending is tenuous at
best, job growth is down and this negative trend is almost certain to
continue.”

Mr. Moore presents a compelling case…which is not good news for his
employer, or for any other participant in the U.S. commercial real estate
market.

The nearby chart compares the price trend of the KBW Bank Stock Index (BKX)
and the Collier’s Midtown Manhattan Office Rent Index. These two indices
probably share no scientifically valid connection with one another. (The
local MENSA chapter would probably scoff at the comparison). Nonetheless, the
BKX and the Collier’s Index appear to move in sync. Or rather, the BKX
appears to lead the Colliers Index. So the squiggly lines on this chart might
offer a valid insight, no matter what MENSA would say about it.

When the finance industry is flourishing, so is Midtown Manhattan. And when
Midtown Manhattan is flourishing, office rents are rising. At present, the
U.S. finance industry is not flourishing, it is foundering. And the only
reason it has not slipped under the waves is that hundreds of billions of
dollars of foreign bailouts have kept it afloat.

The U.S. finance industry has survived, but it is hardly seaworthy. A
crippled finance industry cannot be good for Midtown Manhattan rental
rates…or for the rest of the nation’s commercial real estate market. The
imploding finance sector is a nationwide crisis – one which undermines the
viability of almost every capitalistic endeavor, especially endeavors like
buying and building commercial real estate.

For the moment, commercial construction spending remains robust. But this
apparent strength owes a larger debt of gratitude to the hopeful expectations
of 2005 and 2006, than to the grim realities of 2008. Commercial projects
operate on a much longer timeline than residential projects, due to the
onerous permitting and approval processes. So many of today’s commercial
construction sites are merely the gestation of ideas conceived two to three
years ago.

That’s why we would expect the commercial construction trend to begin
mimicking the sickly trend of its residential counterpart…especially
because the economy is slowing and the nation’s banks already hold too many
commercial loans on their books.

Commercial real estate loans are dicey assets to hold in a slowing economy. A
developer’s hoped-for occupancy projection can vanish faster than morals at a
frat party. So the hoped-for cash flows don’t flow and, eventually, the banks
become the proud owners of empty office buildings. Because of this risk,
banks tend to curtail their commercial lending at the first sign of
recession…or at least at the second or third sign. They’re banks, after
all.

During the current economic slowdown, however, banks might pull the plug on
commercial lending very abruptly. They’ve got too many commercial real estate
loans already. The ratio of commercial real estate loans to capital has
nearly doubled in the past six years, according to U.S. Comptroller of the
Currency, John C. Dugan. At the end of a five-course meal – topped off with a
cheese plate and a snifter of Armagnac – no one longs for a second 5-course
meal.

“Even more significant than this overall industry statistic is the number of
individual banks that have especially large concentrations,” Mr. Dugan adds.

“Over a third of the nation’s community banks have commercial real estate
concentrations exceeding 300 percent of their capital, and almost 30 percent
have construction and development loans exceeding 100 percent of capital.”

And like every other kind of loan in this great (indebted) land of ours,
commercial loans are starting to go bad as quickly as…well…morals at a
frat party. In the area of construction and development (C&D) loans,
nonperforming loans in community national banks amounted to 1.96 percent of
the total at the end of the third quarter, double the rate of the year
before.

“The combination of these conditions,” Mr. Dugan relates, “is putting
considerable stress on one particular category of commercial real estate
lending: residential construction and development – and other categories of
commercial real estate loans will feel similar stress if general economic
activity slows materially.”

Net-net, the commercial real estate market rests on a shaky foundation, which
is why Colliers’ Mr. Moore seems to express more fatalism than confidence.

“Since the onset of the credit crunch in mid August,” Moore explains, “the
investment sales market has slowed significantly. What was expected to be a
minor blip has turned into a major event.  Following the credit woes in
August, the immediate reaction by many was that things would almost certainly
get back to normal post Labor Day, as the Federal Reserve and other central
banks intervened and provided the required liquidity.”

The Fed indeed intervened, as did other central banks, but things did not
“get back to normal.” Instead, the credit markets remained abnormally
dysfunctional.

“As writedowns continued,” Moore went on, “and debt became more difficult to
source – and more expensive once found – markets nationwide began to see
deals collapsing or falling out of contract as buyers fully digested the
turmoil gripping credit markets around the globe…Deals that had looked
highly attractive just a few months ago were now nowhere near meeting
required rate-of-return thresholds.

“The central issue remains debt, both the availability and price,” Moore
concludes. “Until the credit markets settle down it is highly unlikely the
investment sales market will return to anything resembling normal. The
following are issues which need addressing:

· If you can’t price money, how can you price real estate?

· If everybody is sitting on their hands, how can a market function
normally?

· Top tier markets are still attracting multiple bids, but many of the
rest are nearing a “no bid” environment.

· If the consensus view is that prices will be lower a year from now, why
not wait? - even for well capitalized investors.

· How will REIT’s react? - Many are in a position to acquire, but a
sinking stock price makes acquisitions more difficult…”

What’s the possible good news for the commercial real estate market? One
possibility would be that foreign buyers step in to buy, just like they’ve
stepped into the U.S. finance sector – i.e., without paying fastidious
attention to the merits of their investments. Over in the troubled finance
sector, the sovereign wealth funds and other foreign investors have blurred
the traditional lines between buyout and bailout by providing tens of
billions of dollars of equity financing to operations that excel at
destroying shareholder wealth. These dubious investments have created an aura
of recovery and newfound stability in the finance sector. Bailing out the
entire U.S. commercial real estate market would require a much smaller
suspension of investment judgment, but a much larger collective investment.

Nevertheless, we would not rule out the possibility.

“This time around,” Moore concludes, “the key is the credit markets – and we
watch this very closely…Credit is the economy’s lifeblood…It looks as
though the first quarter [of 2008], and increasingly likely the second
quarter, will be very quiet with no privatizations or large portfolios
trading and significantly less single asset sales. Sellers will be reluctant
to sell and buyers still highly cautious. For the balance of 2008 much will
depend on the Federal Reserve, both in terms of setting monetary policy and
providing reassurances that the banking system is sound and credit still
available. Hopefully the economy will come to the rescue.”

Yes…hopefully.

—- Outstanding Investments Special Gold Hedge Report —-

Hulbert’s #1 Ranked Advisory Letter of the Last 5 Years Announces

“A Hidden Way To Buy Gold For Less Than One Penny Per Ounce”

Even if $800 Gold hits $2,000 by the end of 2008… here’s a hidden way you
can get in for less than one cent per ounce…Full Report Right Here.

————————————————————

[Rude Endnote: “I agree 100% with your forecast,” writes one Rude reader from
our new hometown of Dubai.

“This recession seems to be muted (job losses) compared to the last major
Housing/Auto recession in early 90s. It is probably due to the large number
of outsourced manufacturing jobs, and that many houses are built in Florida,
Arizona and California by illegal Mexican workers. The US economy has been
able to outsource part of its unemployment to Mexico and Pac Rim.
 
“However, the amount of wealth that swashed around housing and all related
’support industries’ was enormous - most of these firms were awash in cash
and not price sensitive when signing commercial leases. The ones that have
not gone bankrupt will soon become highly price sensitive when renewing
leases. Once everyone realizes that the housing crisis will continue for at
least 3 years (same as in early 90s) there will be many more bankruptcies. 
Think of the number of small brokers who rented expensive commercial space
and are now unemployed or strapped financially.
 
“In the 90s, the Fed was able to lower rates off a higher base (10%), and the
Aerospace industry was at a bottom (at a peak today). Lower rates will have
less of an impact this time, as many ‘boomer’ consumers will likely use the
lower rates to increase retirement savings (house will not be enough
anymore). The picture gets much worse if we get Stagflation, where food/oil
erode purchasing power. 
 
“It is not bad owning real estate during inflationary times - question is
will the inflation drift into houses once again?  I doubt it, as the easy
money of the past was due to Banks and Mortgage firms lending money like
drunken sailors.”

Got some of your own thoughts for the outlook in the US commercial real
estate market? Send them along to us here and, again, watch this space.

Cheers,

Joel Bowman
Rude Awakening