Never has there been a time where so much “capital is sitting on the sidelines.” The headlines speak the madness: “Starwood Distressed Opportunity Fund targets $3 billion,” “Blackstone Group completes a $4 billion equity raise,” and “The Carlye Group confirms $2.3 billion for its sixth fund.” Real estate investors of all sorts and sizes, from the monster firms to “Mom and Pops” on Main Street are slated to raise $182 billion for both debt and equity investments in global real estate ventures in less than a one year period. With the catastrophic pieces in place and the proverbial dam bursting at any moment, we continue to wait for the other shoe to drop, but when?
With so much money raised by some of the brightest minds in real estate, you would think that we would be awash in transactions, but that’s not the case. The statistics are dismal. Realty Trac states that right now, over 4 million properties are in some phase of the foreclosure process. On the residential side, the “robo signing” scandal is prolonging a foreclosure process that normally six months. In many cases, defaulted Bank of America/Countrywide properties are taking two years or more to hit the auction block. Accordingly, owners of single family residences (SFRs) through four-family dwelling places are relishing in the never-ending saga to stay in their homes rent free. On the commercial side, the statistics are no better. The average delinquency across property types averages approximately 13%; surprisingly, multi-family properties are leading the way at 16%. Ten percent of commercial, mortgage-backed securities are delinquent with an aggregate value of nearly $60 billion. This recession has shown itself to be non-discriminatory in deciding which sector suffers. Hotels are 12% delinquent, and so are industrial properties as well. Only office properties appear to have made significant improvements from 17% to 7%. Nonetheless, with one in eight properties in delinquency, you would expect there to be more deals, but there aren’t any to report yet.
As one landlord in the Pasadena area hypothesized, the interest rates are the problem. Rates are just too low. With the Federal Reserve Bank actively engaging a policy of a 0.00 – 0.25% targeted Fed Funds rate, “extend and pretend” is an easy proposition to follow. Currently, Prime is 3.25% and 6-month LIBOR is .75%; as such, many borrowers are enjoying variable payments which in many cases are 10%-20% lower than their fixed rate payment. Accordingly, those who should be struggling in a normal environment where rates on commercial properties would average between 5.5 – 9.0%, depending on the property type and its commiserate risk, are biding their time due to an artificially low threshold. Now, it is not uncommon to come in contact with a borrower who had a 6-7% rate who is now exhibiting a rate of 2.5 – 3.75% on a fixed 5-year deal. Once rates start to rise, many borrowers will be unable to maintain their ratios, or sustain their once sufficient cash flow due to their increased interest expense. For now, we all will have to wait.
Who knows how much longer we will have to wait for the spigot to burst. Extend and pretend can only go on for so long, as the financial institutions with so many distressed properties on the books can’t kick the can down the road much longer; eventually the road will start to go up hill. Three trillion dollars of capital has to be deployed somewhere, and .25% on a CD won’t cut it. It may very well require an unsustainable number of banks shutting their doors for the mass fire sale to start. I know that Blackstone is waiting. The investor down the street is waiting. How about you??
Preston Howard is a mortgage broker and Principal of Rose City Realty, Inc. in Pasadena, CA. Specializing in various facets of real estate finance, he can be reached at firstname.lastname@example.org.