The commercial real estate market (CRE) peaked in 2007 and has been in a prolonged process of collapse ever since. This is true for asset valuations on all property types (residential apartments, office, industrial, warehousing, healthcare, etc.), as evidenced by rising capitalization rates (cap) across the board.
Capitalization rates are for real estate what P / E ratios are for stocks; they measure the value investors are willing to attribute to every dollar of net operating cash flow generated by the property. In other words, capitalization rates can be calculated by dividing net operating income (NOI) by the value or amount an investor paid for a property.
Rising capitalization rates mean that investors are demanding higher risk premiums on their commercial real estate investments. The prevailing rate for high-quality CRE is approximately 7 percentage points above the 10-year Treasury bond, or an equivalent “risk-free rate” of maturity.
In a continuation of the CRE saga, Bank of America announced that more than half of commercial mortgages have failed to refinance as the notes reach maturity.
Nearly $ 1.24 trillion of commercial mortgages must be refinanced over the next four years. With so much outstanding debt and in need of refinancing, the BofA announcement makes the situation worse.
Between 50 and 60 percent of loans for skyscrapers, hotels, shopping centers and apartment complexes were not rolled over within months of their due date this year, analysts at Bank of America Merrill Lynch said in a report.
As a comparison to what happened during the boom years, we should note that a record $ 251.1 billion in commercial mortgage-linked bonds were issued in 2007 compared to $ 1.7 billion issued so far in 2010.
Commercial real estate firms are increasingly desperate. According to Thomson Reuters, there are at least 12 CRE companies planning to sell shares in IPOs over the next year. Given that stock sales earlier this year have not fully materialized or been executed at deep discounts, CRE companies are unlikely to be able to re-capitalize properties that have increasingly less profitable operating margins.
Without a big government bailout, the CRE’s 41 percent drop since 2007 could be the start of something much worse.
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