Wilbur Ross, billionaire investor and member of the Committee on Capital Markets Regulation, believes the US is at the beginning of a "huge crash in commercial real estate." Will this necessitate the creation of another Resolution Trust Corporation by the government (RTC)? You have to wonder. From Bloomberg:
“All of the components of real estate value are going in the wrong direction simultaneously,” said Ross, one of nine money managers participating in a government program to remove toxic assets from bank balance sheets. “Occupancy rates are going down. Rent rates are going down and the capitalization rate - the return that investors are demanding to buy a property - are going up.”
To anyone in the industry, this news comes as no surprise. Also weighing in on this issue today was George Soros:
'George Soros, speaking today at a lecture organized by the Central European University in Budapest, said a “bloodletting” may be coming for leveraged buyouts and commercial real estate.'
All this sounds reminiscent of the S&L crisis of the the early 1990s. Will it lead to an RTC II? The Moody's Commercial Property Price Index is now down 41% since its October 2007 peak.
One reason for declining commercial real estate values is that capitalization rates are rising. Why are capitalization rates (called "cap rates" in the industry) important? They are one tool used to determine value. The value of an income producing property is often calculated using the following formula: net operating income divided by cap rate = value. So if cap rates go up, values must go down.
When the Federal Funds Rate dropped to 1.0% in 2003 and 2004, cap rates were also at unheard of lows: they were 5% and 6%, when for decades they had been in the 8-10% range, generally. This means that there was a bubble in commercial property, just as there was a bubble in residential property. And much like the S&L crisis of the early 90s, reckless, loosely-regulated lending practices were a root cause. But this time around, too-low interest rates were also a factor. Now as cap rates rise, many commercial property owners are finding themselves underwater, with negative equity, and like many homeowners, unable to refinance their mortgage loans.
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