Commercial Real Estate Property Brokers Experience Profit Drop as Market Slows Down

Commercial Property companies are starting to experience decrease in their profits as the commercial real estate market start to lose its heat.

According to Bloomberg.com, CBRE Group Inc. and Jones Lang LaSalle Inc. experienced their biggest loss since 2011 due to difficulties in equities. The loss brought a 14% drop for CBRE Group and 16% for Jones Lang LaSalle. HFF Inc. dropped with 20% in August while Marcus & Millichap Inc. dropped with 17%.

The possible further decrease in real estate transactions is raising concern among big brokerage firms that their profit will also decline together with the transactions. The possible drop in profit might cause for the firms to lease their properties instead of selling them.

Brad Burke, analyst at Goldman Sachs Group Inc., said that the profit growth at the companies "is in the rear- view mirror at this point. This is a natural maturing of the real estate cycle."

According to Real Capital Analytic Inc., commercial real estate transactions in the U.S. increase with 23% during last year's second quarter. Major several sales made early last year had "front- loaded" the first half volume of $255.1 billion. Two industrial portfolio were included in the transaction, namely Manhattan's Waldorf Astoria Hotels and Willis Tower in Chicago.

Sam Chandan, founder and chief economist of Chandan Economics, said that "We have had a very rich transaction market for some time, so the rate of growth in activity has necessarily begun to taper off. It's not the kind of growth we saw when we were coming off the bottom."

According to ChicagoBusiness.com, a quarterly report from Federal Reserve Data revealed that "the expansion in real estate lending is slowing." A 2.7% increase in outstanding commercial- mortgage debt in 2013 was observed and it raised again by 4.2% last year.

Various factors affect the slowdown in commercial property market business. Some of those factors were a strong dollar's effect non- U.S. profit, drop in oil prices that causes decrease in real estate demand "energy hubs" such as Calgary and Houston.

An S&P Ban Seen Having Big CMBS Impact

Word that the SEC may suspend S&P from rating commercial MBS transactions sent a shudder through the sector this week.

CMBS lenders said a ban would have a major negative impact on the single-borrower market, where S&P is the dominant rating agency. CMBS shops would likely have to turn to Moody’s or Fitch, which generally take a harder credit-quality stance on single-borrower deals. That would result in smaller loan sizes or higher interest rates, which could depress CMBS issuance by driving borrowers to other types of lenders or by rendering some acquisitions and refinancings uneconomical.

The secondary-market impact could also be significant if an SEC action voided S&P’s outstanding ratings during a suspension. That could force investors whose guidelines require a rating from a major agency to dump bonds, depressing prices.

Bloomberg reported on Monday that the SEC "is seeking to suspend" S&P from rating CMBS transactions. The news agency added that S&P was holding settlement talks in an effort to avoid the sanction.

Nomura researchers speculated that a ban could last one year. The SEC and S&P declined to comment.

The exact nature of the SEC’s investigation is unclear. In July, S&P disclosed that it was being investigated for possible violations of federal securities laws connected to its ratings and disclosures for six CMBS transactions in 2011. Bloomberg said the SEC was investigating whether S&P "bent rating criteria to win business."

Given the uncertainty about the likelihood, scope, timing and length of any SEC sanction, CMBS lenders said they were taking a wait-and-see attitude for now, continuing to quote loan terms on the expectation that S&P will rate transactions. But they acknowledged that they risk taking losses on loans being warehoused when an SEC action is announced.

Likewise, traders said the Bloomberg report had no immediate impact on prices in secondary-market trading.

S&P has almost disappeared from the conduit market because of a series of missteps since the crash and issuer complaints that its methodology doesn’t produce consistent rating patterns. But that same methodology produces relatively favorable credit-enhancement levels on single-borrower transactions, enabling lenders to write larger loans at lower rates. That has made S&P the dominant agency in that sector, with an 81% market share this year, versus 19% apiece for Moody’s and Fitch. Single-borrower transactions account for one-quarter of overall U.S. issuance.

But if S&P isn’t used, a lower percentage of a loan would qualify for an investment-grade rating. That would force a property owner to either borrow less or use mezzanine financing to make up the difference, increasing the blended coupon.

Lenders said the impact would vary widely from loan to loan, but as examples, they said that leverage ratios might decrease to 65% from 70%, and coupons might rise by 25-75 bp. Borrowers would then have to decide whether to pay the higher cost, borrow less, turn to another lender or not proceed at all.

Senior CMBS executives were glum about the prospect of a suspension. One said it would have "a major impact." Another said it would make "a material difference." A third said it would "cast a dark cloud over the CMBS market."

One veteran in the large-loan market said that profits have already been squeezed by increased lending competition this year. "We’ve been skating on thin ice as it is," he said. "If S&P goes away, it’s going to make this business extremely tough."

"Stand-alone deals will still get done," said another lender, "but it means the whole pipeline will have to get re-priced. If it

happens suddenly, there will be some people who’ll get stuck. They’ll have priced a deal a certain way, then find they have to change directions mid-stream. That’s where the pain will occur."

For the secondary market, the worst-case scenario is that S&P would be forced to withdraw its rating on outstanding bonds. Some buy-side shops have investment guidelines requiring that bonds carry a rating from S&P, Moody’s or Fitch. So if S&P’s ratings are dropped and neither of the other agencies rates the bonds, those investors could be forced to sell.

"If [S&P has] to take all their prior ratings off, that would be a problem," said one CMBS trader. But another trader noted that since the market crash, some institutional investors have dropped the requirement of having a rating from the traditional "big three." And the impact would largely be limited to post-crash single-borrower transactions.

So far, secondary-market prices haven’t been affected. This week, unrelated to the Bloomberg report, an unidentified holder sold about $55 million of single-borrower CMBS rated in most cases by S&P but not the two other major agencies. All of the bonds traded at levels that met or exceeded price talk circulated by dealers.

The SEC’s investigation is believed to stem at least partly from a controversial incident in July 2011, when S&P abruptly withdrew its ratings on a $1.5 billion CMBS transaction that had already priced and was about to settle. The unprecedented action derailed the multi-borrower transaction and caused issuers

Goldman Sachs and Citigroup to lose millions, touching off a firestorm of criticism in the industry and prompting angry issuers to boycott the agency on conduit transactions.

S&P attributed the unprecedented action to the discovery of a possible inconsistency in how its analysts had been calculating the debt-service-coverage ratios for new and legacy transactions.

Market Volatility Drives Down CMBS Prices

Volatility in the stock and Treasury-bond markets put downward pressure on commercial MBS prices this week.

The 10-year Treasury yield finished at 2.16% yesterday, after falling to as low as 1.86% on Wednesday, as a plunge in the stock market touched off a flight to safety. The yield was down by 12 bp from last Friday and 46 bp from the recent high in mid-September.

The decline caused CMBS spreads to widen this week, for two reasons. First, credit spreads in general rose on concerns about the U.S. economic outlook, the European debt markets and spread of the Ebola virus. Also, investors were insisting on a higher spread to compensate for the decline in the Treasury yield.

Many CMBS buyers require a minimum absolute yield to take down new issues. In the last two conduit deals, the benchmark bonds yielded 3.29%. The long-term super-senior class of a $1.3 billion offering led by J.P. Morgan and Barclays (JPMBB 2014-C24) carried a spread of 83 bp over swaps. The comparable tranche of an $842 million issue led by Citigroup and Goldman Sachs (CGCMT 2014-GC25) priced at 87 bp over swaps.

Because of the drop in Treasury yields, the next conduit offering — a $1.2 billion transaction by Deutsche Bank, UBS, Cantor Commercial Real Estate and Natixis (COMM 2014-CCRE20) — will have to carry a wider spread to match that 3.29% yield. With the 10-year swap yield down to 2.328% yesterday, the benchmark spread would have to be 96 bp to reach 3.29%.

"That says it all right there," one CMBS banker said. "The spread will have to be 10-15 bp wider to get it done."

A pullback by some bond buyers is also putting pressure on spreads, according to one CMBS trader. "It’s a tough ride right now," he said. "Any time you have that kind of Treasury volatility, people put their pencils down and say, ‘Let’s think about what we’re doing.’ "

Virtually no bonds from recent conduit issues changed hands in the secondary market this week. But dealers have widened their bid-ask spreads, indicating that they were willing to buy long-term super-seniors from those deals at spreads of 94-96 bp and sell them for 90-91 bp.

Elsewhere in the new-issue market this week, Colony Mortgage Capital continued to market a $320.8 million securitization of seasoned performing mortgages collateralized mostly by multi-family properties. Bookrunners Credit Suisse and J.P. Morgan circulated price talk of 100-bp area over swaps on the only offered class — $220.6 million of bonds with a weighted average life of three years and a triple-A rating from Moody’s.

Meanwhile, RAIT Financial started shopping a $219.4 million offering backed by 22 floating-rate mortgages on various types of commercial properties. The $126.4 million senior class of 2.4-year bonds is rated triple-A by Moody’s and DBRS. The subordinate classes are rated only by DBRS, including a 2.8-year tranche of junior triple-As. UBS structured the transaction and is running the books with Citi.

UBS and Citi were also pitching a $335 million offering backed by the senior portion of a fixed-rate debt package on the 506,000-square-foot office tower at 1500 Broadway in New York’s Times Square. They originated the 10-year package last Friday, including $170 million of mezzanine debt, on a 50-50 basis for Tamares Real Estate of London. The transaction is rated by Moody’s, DBRS and Morningstar.

Rialto, Eightfold Circle 3 B-Pieces

Rialto Capital has agreed to buy the junior portions of two upcoming conduit offerings, while Eightfold Real Estate Capital has circled the B-piece of a third deal.

Rialto’s purchases involve a $1.25 billion offering led by J.P. Morgan and Ladder Capital, and a similarly sized deal led by Wells Fargo and RBS.
Eightfold, meanwhile, has circled the bottom piece of a $1.25 billion offering by Goldman Sachs, Citigroup, MC-Five Mile, Starwood Mortgage Capital and RAIT.

Two of the three B-piece agreements — Eightfold’s purchase and Rialto’s contract with J.P. Morgan/Ladder — were awarded on a "negotiated" basis. That means the issuers didn’t hold multi-party auctions. Instead, they approached Eightfold and Rialto directly and came to terms.

Issuers often avoid auctions to simplify the sales process. The maneuver can also lead to a better execution, because the buyer might be tempted to pay a little more or accept questionable collateral loans if it means bypassing a bidding contest. On the other hand, the issuer also risks leaving money on the table if it fails to capture a sudden increase in B-piece valuations that an auction would have uncovered.

In any event, negotiated sales enable issuers to shore up their relationships with B-piece investors that may have been crowded out of the market in recent auctions.

Rialto has landed 10 B-pieces so far this year. Eightfold has circled three.

Abe Eyes Land-Price Reflation in Zones to Spur Building Boom

Japan wants to trigger a jump in inner-city property prices by loosening building restrictions in test zones under Abenomics, a government adviser said.

“Central-city property prices will likely rise when various plans are announced,” Tatsuo Hatta, 70, a member of a government council on special economic zones, said in an interview in Tokyo last week. The economic impact from the urban-planning changes will be “extremely big,” he said.

Prime Minister Shinzo Abe is trying to sustain an economic rebound that risks losing steam in April when a sales-tax increase will damp consumer spending. While Hatta’s comments offer some insight into the government’s plans for special economic zones, investors are still waiting for fuller details of Abe’s growth strategy in what Goldman Sachs Group Inc. calls a “critical year” for Abenomics.

Home prices in Tokyo are around 120,000 yen to 150,000 yen per square foot, Chicago-based Jones Lang LaSalle said last year. That compares with about 280,000 yen to 400,000 yen in Hong Kong and 200,000 yen to 250,000 yen in Singapore, it said.

According to Hatta, the changes will make it easier to construct residential buildings in business districts in designated zones, creating opportunities to improve urban planning and make cities more enticing for employees of foreign companies.

Stock Bust

The bursting of a bubble in the stock market, which peaked in 1989, and a real-estate market bust in the 1990s saddled banks with bad loans, plunging Japan into a deflationary slump that it’s still trying to shake.

While prices in some cities picked up after former Prime Minister Junichiro Koizumi cleaned up the banking system in the early 2000s, a sustained rebound has been elusive. Nationwide residential real-estate prices at the end of September were down 51 percent from a peak in 1991.

Introducing special economic zones is a cornerstone of Abe’s effort to create opportunities for Japanese companies, along with steps to boost industrial competitiveness and open up the country more to international trade.

The government may decide in March where it will locate the special zones, Abe said on Jan 7.

2020 Olympics

The council will decide on criteria for selecting these areas at its next meeting expected to be held at the end of January or early February, Hatta said. There will be a maximum of five zones, with one or two “virtual” areas and the rest in big cities, he said.

Tokyo’s real-estate market has started to perk up, helped by unprecedented monetary easing by the Bank of Japan and the city’s successful bid to host the 2020 Olympics. The monthly average vacancy rate in Tokyo business areas fell to 7.34 percent at the of December from 8.67 percent a year earlier and 9.01 percent at the end of 2011, according to data from Miki Shoji Co.

The real-estate subindex of Japan’s benchmark Topix of shares climbed about 62 percent over the past year, outpacing a 43 percent gain in the Topix index.

Japan’s commercial real-estate transaction volume jumped 41 percent in October-December from the previous quarter, led by Japan Real-Estate Investment Trust activity, according to DTZ Research. Sales of commercial property more than doubled last year to 3.54 trillion yen ($34 billion), the highest since 2007, it said in a research note this week. Commercial property includes office buildings, shopping malls and distribution centers.

Attracting Foreigners

Loosening rules on residential construction in business districts would create more demand for education, medical and other services in those areas, Hatta said.

“Labor and other issues are more important and will have an impact over the long term, but this will have a strong impact in the short run,” Hatta said of the building deregulation. “The focus, as far as attracting foreign nationals is concerned, is to make living in city centers comfortable,” Hatta said.

Goldman's Hatzius: How Much Risk to Homebuilding?

Summary: Housing starts will be a key component to economic growth over the mid-term.

--(CalculatedRiskBlog)--

Goldman Sach chief economist Jan Hatzius wrote today (research note): How Much Risk to Homebuilding? A few excerpts:

The housing news has deteriorated recently across a broad set of indicators, and the FOMC accordingly downgraded its assessment of the housing market in Wednesday's post-meeting statement. How much should we worry about our forecast that residential investment will continue to grow 10-15% and directly contribute 1/2 percentage point to real GDP growth next year?

The risks to our housing forecast are on the downside in the near term, but there are three reasons why we still take a positive view beyond the next 1-2 quarters. First, there is a clearly identifiable reason for the recent weakness, namely the sharp increase in mortgage rates. Some of this increase has reversed recently, and barring another shock the impact should be mostly complete by early 2014.

Second, the fundamental supply-demand picture for housing still looks positive. If the population grows at the rates projected by the Census Bureau and the size of the average household trends sideways to slightly lower--in line with historical trends--we estimate that household formation should climb to 1-1.3 million and steady-state housing demand to 1.3-1.6 million. This implies significant upside for housing starts from the current 900,000 level once the remaining excess supply has been eliminated

Third, while home sales and starts have disappointed recently, house prices have continued to rise at double-digit rates, with few signs of deceleration. This suggests that the supply/demand balance in the housing market still looks favorable. That said, we continue to expect that home price appreciation will slow over the next year.

Clearly housing has slowed recently. This has shown up in housing starts and new home sales, and the slowdown is also evident in home builder reports. However I think this slowdown is temporary, and I expect the housing recovery to continue in 2014.

This graph shows single and total housing starts through August (the September and October reports will be both released on November 26th).

There has been a dip in housing starts recently, but I think starts are still closer to the bottom than the next cycle top. I agree with Hatzius that starts will continue to increase over the next several years - and this will be a key driver for economic growth.