Commercial Real Estate Prices May Drop 15% in Next Year

Yves Smith at Naked Capitalism submits:

Experts warn that the boom in commercial real estate prices, fueled by cheap credit, is going sharply into reverse.

Fitch had noted as early as April, and again in July that commercial real estate lenders were engaging in the same lax practices that led to grief with subprimes: 0% down, overly optimistic projections, deal terms that made sense only if you assumed price appreciation and a refinancing.

Bloomberg reports that investors are holding back from closing transactions because they believe prices will fall. If enough people believe that, which appears to be the case, it becomes a self-fulfilling prophecy. A second factor is that rising financing costs have driven high leverage buyers, such as private equity firms, to the sidelines.

Ironically, the story mentions the sale of Sam Zell's Office Properties Trust to Blackstone, a $23 billion deal concluded in February. Sam Zell is widely regarded as one of the savviest value investors around. The fact that Zell, an old hand in real estate, was cashing out was widely seen as the sign of a market top.

That view proved to be correct. The deal was done at a record low capitalization for a REIT (lower cap rates = higher prices).

From Bloomberg:

Investors in July bought the fewest commercial properties since August 2006 and apartment building acquisitions were down 50 percent from June, data compiled by industry consultants at New York-based Real Capital Analytics Inc. show. Archstone-Smith Trust in August postponed its $13.5 billion sale to a group led by Tishman Speyer Properties LP until October. Mission West Properties Inc., the owner of commercial buildings in Silicon Valley, said on Aug. 13 that the company's $1.8 billion sale may fail after a bank withdrew funding.

``There are so many deals falling apart,'' said David Lichtenstein, chief executive officer of Lakewood, New Jersey- based Lightstone Group, an owner of more than 20,000 apartments and 30 million square feet of office and retail space. ``People who can get out are getting out.''.....

Average prices for commercial properties might drop 5 percent to 15 percent in the next two years depending on the type of property and its quality and location, said Matthew Ostrower, an industry analyst at New York-based Morgan Stanley, the second-largest U.S. securities firm by market value.

Michael Knott, a senior analyst at Green Street Advisors Inc., a real estate research firm in Newport Beach, California, estimates commercial prices may fall about 10 percent in the next 12 to 18 months and up to 15 percent in the office market during that period....

Commercial mortgage rates have climbed as defaults rose in the subprime part of the residential real estate market....

The increase has halted a rally that lifted prices for office buildings, apartments and hotels to records this year. The average price paid for high-quality office properties in city centers reached $291 a square foot, up from $188 in 2005 and almost double the average $152 in 2001, Real Capital reported...

``You've got a lot of fear in the system from the capital markets,'' Stein said. ``As far as the pricing of credit, it was greed six months ago and it's fear today.''.