Economic Outlook for 2010 - Dr. Mark Dotzour

Economic Outlook for 2010:

Commercial Real Estate

Dr. Mark G. Dotzour

Chief Economist

Real Estate Center @ Texas A&M

College Station, Texas

Brought to you by NAR Commercial

Today’s Topics

• The US and global economies and jobs

• Lender appetite for real estate loans

• Timeline for the CRE recovery

• Outlook for CRE prices

The U.S. and global economies

and the outlook for jobs

It’s Not So Complex,It’s Just Big (1)

• Banks and other high-powered Wall Street firms

made a lot of bad loans for houses, and

commercial real estate`

• They also made a lot of bad loans for businesses,

credit cards, and M&A.

• They lost more money than their equity

• The losses are so big that the government can’t

allow banks to take them all at once

• They can’t auction the bad assets because it would

reveal the true extent of the losses.

• So they have “injected capital” so that the banks

can amortize their losses over years.


Total Net Loan Charge-offs

Commercial and Industrial Loans

at All Commercial Banks

Real Estate Loans at

All Commercial Banks

U.S. Government Securities

at All Commercial Banks

“Extend and Pretend”The New Definition of Value – FASB 157

…fair value is the exchange price in an orderly transaction to

sell the asset in the market that the reporting entity would transact

for the asset that is the most advantageous market..

“Therefore, the definition focuses on the price that would be

received to sell the asset, not the price that would be paid to acquire

the asset.”

“The notion of unobservable inputs is intended to allow for

situations in which there is little, if any market activity…”

However, the reporting entity must not ignore information about

market participant assumptions that is reasonably available without

undue cost and effort.


• The Fed will keep rates low for a long time until

the banks “earn their way” out of the massive

losses they have incurred

• Savers are afraid of the market due to the high

levels of risk and Madoff-style fraud

• Savers buy US Treasury bonds and have created a

bubble in that market driving rates low


• Businesses are hesitant to borrow for expansion

right now due to manifold political risks

• So banks borrow money from the Fed for free and

buy Treasuries with no risk

• Rates will stay low, even when the Fed decides to

“tighten”.

• They will just pay interest on reserves and the

banks will loan to the Fed instead of businesses

and consumer. That way, CD rates stay low for a

long time.

Total US Non-Farm Employment

80000

100000

120000

140000

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National Federation of Independent Business

-10

-5

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5

10

15

20

25

Jan

-98

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-02

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Jan

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Net

% o

f R

esp

on

den

tsSmall Business Outlook

“Planning To Hire People In The Next Six Months”

Corporate Hiring Plans:

Next 6 Months

Source: Business Roundtable

Updated 12/11/09

Q4-09 Q3-09 Q2-09 Q1-09

More Jobs 19% 13% 6% 7%

Less Jobs 31% 40% 49% 71%

http://www.businessroundtable.org/

Gross Private Domestic Investment

Source: Department of Commerce

$300

$700

$1,100

$1,500

$1,900

$2,300

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Jan

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Unemployed Americans

Unemployed for 27 Weeks or More


• The FDIC funds ran low, so they refilled the gas

tank with another $500 billion authorization.

• The FDIC is ramping up staffing to handle the

volume of failed banks coming up.

• Be ready for the stream of distressed assets that

will be coming onto the market in the next year.


• American consumers spent more than they earned

(“Fairyland dream”)

• They maxed out credit cards and HELOCS

• Businesses ramped up staffing and locations to meet

Fairyland demand

• All levels of government ramped up spending on

Fairyland revenues

Net Home Equity Extraction

-$200

-$100

$0

$100

$200

$300

$400

$500

$600

$700

$800

1992

1993

1994

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Bil

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Equity Monetized by Refinancing Mortgages

Source: Federal Reserve Board

Debt Service Paymentsas a Percent of Disposable Personal Income

10

11

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13

14

15

Jan

-80

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-82

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-84

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Per

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Personal Savings Rate


-2

0

2

4

6

8

10

12

14

1/1

/1981

1/1

/1983

1/1

/1985

1/1

/1987

1/1

/1989

1/1

/1991

1/1

/1993

1/1

/1995

1/1

/1997

1/1

/1999

1/1

/2001

1/1

/2003

1/1

/2005

1/1

/2007

1/1

/2009

Per

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column2

Corporate Profits(With Inventory Valuation Adjustment & Capital Consumption Adjustment)


$200

$300

$400

$500

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

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• So the Fed and Treasury are trying to replace the post-

Fairyland consumers

• Consumers got a tax credit in 2008, but they saved it

• They are trying to prop up homeowners that bought a

house they couldn’t possibly afford

• They are trying to prop up businesses that need to

right-size

• They are trying to prop up state and local governments

that need to right-size

The Best Case Scenario

Favorable corporate earnings 4Q09

Stocks rise about four months prior to that

Consumer confidence rises with stocks

More spending results in higher profits

Layoffs end by the end of the 2009

“Jobless recovery” in 2010

Higher interest rates and inflation in 2010-11

The Worst Case Scenario

The securitized lending market doesn’t reopen

Bad banks and businesses propped up

No price discovery for “toxic” mortgages

Political risk for business stays high

Business / investors “sit on their hands”

Unemployment goes well over 10%

Commodity deflation and price deflation

State Government Budgets

• 21 states have furloughed workers

• Some states are letting prisoners go on early

release

• Hawaii has gone to a 4-day school week

• NY tax revenue has dropped 35%; they

need $3 billion more budget cuts - Patterson

• The loss to the states was about double the

stimulus package benefits – Gov Patterson

Where Will the Next Bubbles Be?US, Japan, China, Europe all pumping massive quantities of

cheap money into the system

• China’s stock market.

• U.S. Stocks

• Commodities

• US commercial real estate

Timeline for

the

commercial real estate

recovery

A Timeline for CRE Recovery2009

•Prices fall as cap rates revert to 2002 levels

•Occupancy falls a job layoffs continue

•Rents fall as owners covet tenants

•New construction continues to add new supply

•Foreclosures increase as refinancing is precluded


•Prices continue to fall as price discovery continues

•Occupancy falls as firms downsize staff

•Layoffs end, but downsizing continues for cost savings

•Rents fall to compete for smaller tenant base

•New projects started in 2007-08 are completed

•No new construction projects undertaken


•More rapid job growth increases absorption rate

•No new supply delivered to the market

•Rents start to rise as space starts to fill

•More foreclosures from properties bought 1H07

•Property values start to increase, anticipating positive

absorption and very limited new supply.


•More rapid job growth soaks up more space

•Occupancy rate increases significantly

•No new buildings delivered to the market

•Prices continue to increase due to rising fundamentals

and falling cap rates

The Progression of Investors

Returning to Commercial RE

First buyers will be high net worth investors,

buying for their own account. They can afford

to miss the bottom and still make good money.

Cap rates will be at their highest as buyers seek

opportunistic returns.

Once prices stabilize at the bottom, then

institutional buyers will re-enter the market.

Cap rates will start to fall as “core buyers”

enter the market.

Apartment Comp

Advanced Real Estate Services Inc. has paid $23.6 million for the

Courts at Artists Village, a 196-unit apartment complex in Santa

Ana, Calif.

The sales price results in a capitalization rate of 6.7 percent.

The property, at 301 West 2nd St., includes 12,222 square feet of

ground-floor retail space that is 25 percent leased to restaurants and

high-end retailers, and 1,412 sf of storage and office space. The

apartment portion is 86 percent occupied.

Copyright ©2009 Commercial Real Estate Direct, a

service of FM Financial Publishing LLC. All rights

reserved

Commercial Real Estate Value Trends

Blackstone marked down its real estate portfolio by

30%in 4Q08 and another 19% in 1Q09. WSJ 5/7/2009

A Goldman Sachs biggest private real estate equity

fund called Whitehall Street Global Real Estate LP

2007 invested $3.7B between May 2007 and Aug.

2008 in a portfolio of casinos, hotels and office

buildings. They have since written down those

assets by $2.1B and have issued a $1B capital call

to LP's to cover some debt. . WSJ 5/15/2009

CRE Value Trends

• Opportunistic funds are down 52%

according to the NCREIF/Townsend fund

indices.

• Core funds are down 36.3% from their peak

by the end of 3Q09.

Source: Real Estate Law and Industry,

published by the Bureau of National Affairs.

TIAA-CREF Real Estate Fund is down 37.4% from peak on April 17, 2008

Source: TIAA-CREF.org

MIT Transactions-Based Index

shows prices off 36.5% from peak

Source: MIT Center for Real Estate

Prices actually

increased 4.4%

in 3Q09.

CRE Value Trends

• MIT Transaction-Based Index shows

property values have fallen 39.2% from

their peak by the end of June, 2009.

• Moody’s/REAL CPPI shows property

values down 40.6% as of the end of August.

• NACREIF Property Index indicates that it

has recognized less that two-thirds of the

coming right-down in property values.



CRE Value Trends

• MIT Transaction-Based Index shows

property values have fallen 39.2% from

their peak by the end of June, 2009.

• Moody’s/REAL CPPI shows property

values down 40.6% as of the end of August.

• NACREIF Property Index indicates that it

has recognized less that two-thirds of the

coming right-down in property values.



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Dr. Mark G. DotzourChief EconomistReal Estate Center, Texas A&MEmail: [email protected]

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