NEWS
October 21, 2009
Fed President Says Loan Losses From Commercial Real Estate Will Be ‘Manageable’
DOW JONES NEWSWIRES
“The magnitude of the deterioration seems consistent with past recessions. It looks like a manageable problem,” Lacker said during a press conference after an economic workshop at the Richmond bank.
Community and regional banks will take the biggest hits, he said, “because that’s their bread and butter.”
Federal Reserve data showed banks holding $1.7 trillion in commercial real estate loans at the end of the third quarter. Defaults are expected to increase in 2010 as the first of $300 billion worth of commercial-backed security loans come up for refinancing at a time when real estate values have dropped. Lacker said he doesn’t think government intervention is warranted to stave off the commercial defaults.
In fact, the bank president called for less government involvement in the housing industry. Looking back on the financial crisis, he said, “Government policies that encouraged leveraged investment in housing, those I think contributed to excessive investment in housing.”
Asked about criticism of the role that the government and the Federal Reserve may have played in the crisis, Lacker responded, “The last two years, the way the turmoil has played out, the perception of the guarantee of the liability of large financial institutions played a central role. To the extent that that’s laid at the door of policy makers, I would accept that critique.”
Moving forward, he said government-sponsored enterprises such as mortgage finance giants Fannie Mae and Freddie Mac have outlived their usefulness. “… We need to consider weaning ourselves off of subsidies for housing and subsidies for housing finance,” said Lacker. “I think we should work to a point maybe a decade hence when we don’t need government-sponsored enterprises.”
Lacker was optimistic about what seems to be the beginning of an economic recovery. In 2010, he expects growth in the 2.5 to 3 percent range. “Inflation should remain where it is now, at 1.5 percent.” However, he added that it may take some time for employment levels to return to normal.
Commercial real-estate prices fell 8.6% in April as deals were closed after having been negotiated during the dark days of late 2008 and early 2009, Moody’s Investors Service said.
“The size of April’s decline, following a 5.5% decline in January, also suggests that sellers are beginning to capitulate to the realities of commercial real-estate markets,” says Moody’s Managing Director Nick Levidy. He added more distressed sales appear to be occurring.
The monthly decline, which leaves prices down one-quarter from a year earlier, continues the losing streak for the commercial real-estate sector, which had held out longer than residential real estate. However, commercial real estate began to feel the recession late last year, as retailers and other businesses cut back when financial markets and consumer sentiment were plunging.
Overall sales volume also fell sequentially in the month to 285, the lowest level since Moody’s began tracking the figures in 2000.
By region, apartments are holding up the best in the East, down 12%. The South, the worst-performing region over the past year, saw declines of more than 20% in all sectors.
The three major office markets – New York, San Francisco and Washington – suffered declines as well, with Washington posting the biggest year-over-year fall at 21%. New York and San Francisco had declines of 13% and 20%, respectively.
THOUGHTS
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TOP 5 MISTAKES FROM SMART INVESTORS
1 – Failure to pay attention to the balance sheet.
There are four ways to make money in real estate: cash flow, appreciation, equity growth, and tax benefits.
The operating statement will show the cash flow while the balance sheet shows the remaining three.The balance sheet is managed to best utilize the business’s assets. Many believe that the key measure is the ROI (return on investment) when, in fact, it is the ROE (return on equity). The decisions made on appreciation, equity growth and tax benefits and efficiency will affect the business’s speed of wealth creation.
If an investor doesn’t understand their balance sheet then they need to sit down with an accountant and learn the basics.
2. Making bad deals and bad partnerships.
The decisions investors make can not be right every time. They must learn from the bad decisions and create a smarter process for closing a deal. Real estate investors will end up with properties that will not perform as expected or take a beating from a drop in the market. Investors must learn to spot a losing investment quickly.
Every project will have a few headaches attached so having perseverance is a requirement for all investors. But the deals that go awry on several aspects at once are candidates to be considered learning experiences. Avoid falling in a trap of being “married” to an investment because the financial responsibilities will consume you.
Investors find that some problems are not caused because of the property, but because of the people involved in the investment plan. Problems may arise in partnerships.
Spelling out a detailed agreement early on, inclusive of a partner’s exist, will instantly end any haggling or jockeying for positions.3. Over-reaching
Investors who aim for high-risk, home-run-type deal that requires more capital or expertise than they have is an absolute recipe for disaster.
Before “thinking outside of the box” they need to know the operational methods that are inside the box.
In addition to hard-work, determination and property-specification plans, it is a good idea to construct a “big-picture” plan of your investments. Investors should know where they need to go, how they will get there, and when they should arrive.
As knowledge and capacity increases, so will the size of the deals. Investors will know they are ready to tackle higher, more profitable transactions when they automatically focus on the pitfalls before the rewards.
4. “Borrow from A, Pay B”
If an investor has multiple properties, using the profits from some to cover losses of others, they are fighting a losing battle. It is time to realize they need back away from the cliff, despite the temptation to freefall.
Study the details of your portfolio, immediately identify, and complete, necessary improvements, and unload losing properties. These actions are a step in the right direction to focusing available energy and resources on maximizing the value of remaining investments.
5. Ignoring local market knowledge
A national real estate market does not exist.
Property value is determined by local market conditions such as rental rates, occupancy levels, competitive space supply, demographic trends, etc. Existing investments may provide an opportunity for performance and a market that has a competitive edge over other investors. But it is only an edge if investors use it.
By systematically collecting just a few local demographic statistics (job growth, population growth and income) and property performance fundamentals, investors can get ahead of the curve, seeing trends coming in advance rather than trying to catch it at the end.