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Matter of Debate: Bottom in Commercial-Property Values
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While the pace of commercial real-estate sales remains anemic, a few gutsy real-estate experts are saying prices have stabilized and are even, in some cases, rising from their lows of the recession.
Backers of this theory point to the loosening in the public capital markets, which has allowed dozens of real-estate investment trusts and to raise debt and equity financing to fix up their balance sheets. The bulls also say investors who had been sitting on the sidelines are becoming more active, especially foreign buyers like HSBC Alternative Investments Ltd., which is buying 1625 I St. in Washington D.C. in a deal that values the office building at a respectable $203.4 million.
But one major index shows values continuing to decline as of late last year. Market bears note that with unemployment high and rents and occupancies continuing to fall nationwide, values also have further to drop. Both sides agree that any real-estate recovery would be imperiled if interest rates rise significantly.
The differing opinions and cross-currents are a reflection of the moribund commercial real-estate market in which there are huge questions about the critical issue of property values because so few properties sold last year. Last year, there were only $54.4 billion in transactions, compared with $181.6 billion in 2008 and $557.8 billion in 2007, according to Real Capital Analytics.
Calling a recovery can be tricky. More than two years into the housing crisis, experts are still debating whether that market has hit bottom, despite signs of price improvement in some parts of the country.
Commercial real-estate values bottomed last May, according to a new commercial-property-price index designed by Newport Beach, Calif.-based Green Street Advisors. The index, which is based on their estimates of current REIT asset values and not actual transaction data, shows values are still down roughly a third from peak pricing in August 2007, but are up 9% from a May trough.
"If you asked anyone what would a property have traded for today versus what it would have traded for six months ago, the answer is clearly more today," said Mike Kirby, Green Street's founder.
But according to CBRE Econometrics Advisors, a research firm that relies on the NCREIF value index, prices have declined roughly 30% from their peak in the fourth quarter of 2007, but even though the speed of decline is slowing, they still have further to fall. NCREIF will release its data for the fourth quarter next week.
"We forecast that we're about two thirds of the way through," says Serguei Chervachidze, a capital markets economist for CBRE-EA.
The company believes that the value of office buildings will decline about 41% from its peak before recovering, industrial by more than half, retail will fall by about 30%, while multifamily-property prices will decline 40%, Mr. Chervachidze says. "It's like hitting the brakes on the car: You've put on the brakes but you're still going forward," he says.
Some investors believe that a survey-based price gauge gives a more real-time picture of the market, whereas transaction-based indexes lag behind the current market by as much as six months—the time it takes for a handshake deal to close and enter property records. On the other hand, others say that actual sales data is the only way investors can have confidence in pricing.
"The matter of rising property values is really theoretical at this point," said Anthony Paolone, a REIT analyst with J.P. Morgan Chase & Co. "The transaction volume is so minuscule, you don't have a good sense of how assets would trade."
Several gauges suggest that the pace of price declines has slowed. In October, the latest month for which such figures are available, the Moody's/Real Commercial Property Price Index declined 1.5% from September. By contrast, the index notched an 8.6% monthly decline in April. The index is based on repeat sales of the same properties across the U.S. at different times.
Stabilization in property values would be a huge relief to the commercial real-estate market because it raises hopes that investors may start putting money into the sector again.
To be sure, even if property prices have stopped tumbling, a vast number of commercial buildings will remain underwater, which means their loans are worth more than the property's value. That troubled debt totals hundreds of billions of dollars and sits like a time bomb on bank balance sheets and in commercial-mortgage-backed securities held by institutional investors.
Even bullish experts say that not all property types are showing resilience. The stabilization applies to only the top quartile of properties—fully leased buildings with steady rental income located in established markets. Such properties are often held by real-estate investment trusts, one reason that REIT stocks have surged 93% since their March 2009 lows. Meanwhile, projects under construction, buildings with lots of empty space or developments in emerging areas, are less likely to benefit from renewed investor confidence.
In December, J.P. Morgan Chase agreed to sell a partially leased lower Manhattan office building traded for $107 million, or $120 a square foot, according to company calculations, a dismal price reflecting the building's vacancy, need for renovations and non-prime location.
"[In general] I wouldn't say there's been any improvement in pricing for a property that isn't top-tier," says Robert M. White Jr., president and founder of Real Capital.
The Wall Street Journal, Commercial, Real Estate, January 20, 2010