Tom Barrack: Commercial Real Estate In ‘Massive Meltdown’
Legendary real estate investor Tom Barrack warned in his “Chairman’s Corner” blog on the Colony Capital website that the commercial real estate sector was in a “massive meltdown” and will “suffer greatly in the near term.” Barrack, who many call the “world’s greatest real estate investor,” wrote on November 23:
We thought now was a good time to re-examine something we should know more than a little bit about – the Commercial Real Estate (CRE) market in general and the health of the CRE loan market in specific.
Here is the Cliff Notes summary – Real estate is experiencing a seismic liquidity shock as a result of a complete closure of the credit and capital markets for both debt and equity. CRE and the debt which fueled its growth are in a massive meltdown.
The chairman of Colony Capital, one of the largest private-equity firms devoted solely to real estate, added:
CRE is rapidly depreciating in value across all sectors and geographic regions. For the past 14 years CRE has benefited from an expanding economy and cheap and plentiful debt that was lent on aggressive terms with no recourse to the borrower. The emergence of securitization dramatically increased available leverage and reduced its cost. New equity participants flooded the commercial arena, escalating real estate values. Equity REITs became popular and produced great decade-long returns and thus increased the equity pool available for acquisitions. Supply and demand remained in check, but only because construction financing didn’t fit neatly into the securitization model. For well over a decade, values continued to climb and pension funds and endowments correspondingly increased their allocations to CRE as a diversification tool and an inflation hedge. The market had seemed to have finally recovered from the hangover of the last CRE crisis and capital was pouring into the sector. As always, more capital drew novices and speculative investors that bid up all the markets. Real estate was forgiven for being the “drunk driver” along the road of the USA economy.
Because of the closure of credit and capital markets for both debt and equity, Barrack predicted:
CRE will suffer greatly in the near term, will struggle for refinancing options in the mid term, but will excel in the long term as a result of limited supply and eventual renewed demand. Well positioned properties in A and B markets which have been reasonably leveraged will be fine.
Realized losses in CMBS portfolios may hit or exceed subordination levels previously thought impossible and the complications of working through unproven structures with a special servicer will not be simple.
Many regional and small banks will be crushed by the weight of failing loans, especially of the CRE flavor.
The greatest opportunity is in surgically carving through complicated debt structures and being prepared to fund “non-milking cows” in the short term. This will be a $2 trillion redistribution of real estate wealth to those who have patient, non-mark-to-market capital and a restructuring tool kit.
Most real estate investors will be on the sidelines. Institutions will be over-allocated, core and value-added funds will be handling their own issues, REITs are not structured to take advantage of this part of the cycle, foreign investors are stymied by FIRPTA and volatility in exchange rates. This crisis will be more complicated than the early 90s, given the multiple constituencies involved with present structures: borrowers, master servicers, special servicers, trustees and myriad classes of investors with different motivations based on the specific priorities of their tranches within the securitized debt stack.
Source:
“Today’s Debt is Equity PLUS a Few Suggestions to Help President-Elect Obama Ease the Pain”
Thomas J. Barrack, Jr.
Colony Capital (Chairman’s Corner blog), November 23, 2008
New Book!
November 28th, 2008 at 9:01 pm
“CRE……….will excel in the long term as a result of limited supply and eventual renewed demand.”
By long term, Tom must mean 20 to 30 years.
December 1st, 2008 at 12:23 pm
Black swan you have a very negative outlook on this issue. You must be going through some hard times in your life to be so negative. Maybe you should re-evaluate your life.
December 1st, 2008 at 10:37 pm
Thanks for the comment black swan. Not too sure what Mr. Barrack meant by long-term. However, I’m hoping he’ll talk again soon about commercial real estate on his blog— and elaborate on this timeframe.
December 1st, 2008 at 10:38 pm
Thanks for the comment Golden Swan. Care to share your outlook on CRE with Investorazzi readers?
December 2nd, 2008 at 8:43 am
I believe that the market and our government have learned a hard lesson in the financial markets. A welfare housing program that was formed by congress to allow people to buy homes that they were previously unable to purchase has caused this financial meltdown; everyone should know this by now. You cannot distort the market with government programs. The fundamentals of business will never change, so now that this is out of the way what do we do from here? We bring confidence back to a financial market, and understand that now the only way to fix this problem is by helping the banks that were forced to loan money to people that should not have typically received the loan in the first place. If our government and our free market can work together on this issue, then the market will turn around before you know it. I think that we are on the right track currently, and I think that Obama will be more beneficial than we think. Obama’s philosophy is to help the working class and middle class people, and these are the people that are in the foreclosure category. I did not vote for Obama, but I will say that in this type of crisis, he should be able to solve this problem better than McCain. My final point is that we have been in a recession for approximately 12 months, and the longest recession our country has ever been in is 16 months. This statement should point out that we have are on the way out of this recession and brighter days are right around the corner.
December 2nd, 2008 at 10:57 am
Interesting points, Golden Swan.
“You cannot distort the market with government programs.”
If only Washington could understand this.
“If our government and our free market can work together on this issue, then the market will turn around before you know it. I think that we are on the right track currently…”
I think we will see results from all of this activity. However, it will take time for all these efforts to filter through the financial system. Couple of more months, perhaps?
“My final point is that we have been in a recession for approximately 12 months, and the longest recession our country has ever been in is 16 months. This statement should point out that we have are on the way out of this recession and brighter days are right around the corner.”
Golden Swan, I’m sure a lot of readers are hoping you are right!
December 11th, 2008 at 5:55 am
Bunch of bunk…… commercial real-estate values will be worth something, maybe they were a little over valued like everything else.
However, the drop in stock prices seems to be a little neurotic.
However, I’m sure there are those who are making a killing.
When the market turns around like they say real-estate, real-estate, real-estate.
Let’s hope so !
December 11th, 2008 at 11:50 pm
Thanks for the comment Charlotte Agent.
December 16th, 2008 at 8:35 am
Editor’s Note:
On December 6, Mr. Barrack explained in a “Chairman’s Corner” blog post his outlook for CRE in more detail. I talked about this development in a December 16 post entitled, “Tom Barrack Explains Near Term Commercial Real Estate Outook.”