Peter Pays Paul

Calculated Risk has a great summary of what is transpiring in commercial real estate.

Calculated Risk: The CRE Bust: Quick Overview.

CoStar.com is reporting:

In a real estate alert to its clients, the law firm of DLA Piper in Atlanta, GA, wrote, “For taxpayers who have exchange funds at LandAmerica 1031 Exchange, the automatic stay imposed by the Bankruptcy Court in connection with the Chapter 11 filing will require Court approval of the release of any funds.”

“Accordingly, it is highly unlikely that those funds will be immediately available, and they may not be available in time for the scheduled exchange closings, if any.”

Another Blow to Faltering 1031 Real Estate Industry – CoStar Group.

CoStar reports that there are 450 exchange customers with transactions pending.

It is likely that some of these exchanges may fall out of contract because those in the “upleg” of their transaction will not be able to purchase the property.

If the bankruptcy court does not move quickly to free the funds, some of the exchanges may incur tax consequences if they do not close within the IRS mandated time frame. This could be a terrible mess for commercial real estate investors.

Straight Talk About Mortgages and Real Estate Investor Sues to Block Mortgage Modifications.

Gov. Arnold Schwarzenegger declared a fiscal emergency Monday and called lawmakers into a special session to address California’s $11.2 billion deficit.

The state’s revenue gap is expected to hit $28 billion over the next 19 months without bold action.

Schwarzenegger declares fiscal emergency in Calif.: Financial News – Yahoo! Finance.

Forbes.com is reporting that JPMorgan will be keeping WaMu’s employees in the mortgage centers in CA. It looks like the bulk of the job cuts will occur in WaMu’s Seattle headquarters.

JPMorgan Plans To Ax The WaMu Suits – Forbes.com.

The landlord of the office space leased to Washington Mutual in Pleasanton may be without lease payments when JPMorgan/WaMu leaves the space.

This is but the beginning of the tumult that commercial real estate may feel as jobs are lost and companies vacate their space.

Washington Mutual’s departure from Pleasanton could do more than eliminate 1,200 jobs and erode the local economy and office market: The exit could leave the failed thrift’s landlord in the lurch without rental payments.

Why? Washington Mutual was placed into receivership by the Federal Deposit Insurance Corp. Under the terms of the deal whereby JPMorgan Chase obtained Washington Mutual’s assets through the FDIC receivership, JPMorgan can decide to cease making rental payments when WaMu vacates the five-building complex at the corner of Johnson and Franklin drives in Pleasanton.

WaMu’s failure may empty offices – ContraCostaTimes.com.

WASHINGTON Reuters – The number of problem U.S. banks and thrifts jumped in the third quarter to 171, from 117 at the end of the prior quarter, marking the highest level since the end of 1995 and adding to expectations that more banks will fail, regulators said on Tuesday.

It looks like we are not out of the rough yet.

U.S. problem banks rise to 171 at end of third quarter: FDIC: Financial News – Yahoo Finance.

The AP is reporting today that California’s jobless numbers jumped to 8.2% this month, a 14 year high.

Subprime’s Impact

Much of the unemployment is related to the collapse of the subprime industry and the ensuing fall of the housing market in California. Countrywide, IndyMac Bank, and other now defunct lenders have gone out of business throughout the state, leaving their workforce unemployed. Locally Diablo Funding closed in October of 2007 leaving 650 mortgage consultants without a home.

The Contra Costa Times is reporting that WaMu/JPMorgan Chase is laying off 1,600 Bay Area workers. The East Bay cut almost 3,000 jobs in Ocotober, bringing the annual total to 22,000 so far in 2008.

A number of the nationwide home builders have been forced to layoff their work force. The construction trades have been dramatically impacted as companies are hesitant to spend money on structures they may not need if consumer demand continues to decrease.

Unemployment Fund Depleted

On top of rising unemployment the AP is reporting that California’s unemployment fund is almost insolvent.

The state’s unemployment insurance fund is expected to have a deficit of $2.4 billion at the end of 2009, forcing it to borrow from the federal government for only the second time since the program was established in the 1930s.

Commercial Real Estate Stress

The unemployment numbers can negatively impact commercial real estate in a number of ways.

1. Vacancy rates may creep up. When companies downsize they need less space. Expect to see rising vacancies in the office and retail sector. The sector least likely to be affect is multifamily, because people still need a place to live and will sacrifice conveniences before they give up their apartment.
2. Rental rates may decline. The basic tenets of supply and demand impact commercial real estate as well. A larger supply of vacant space provides tenants more bargaining power to get rent concessions or to ask for lower rental rates. If the cost of owning a home drops to a level that compares with renting, multifamily rental rates may decrease.
3. Consumer spending is decreasing and will continue to go down. Those without jobs tend to spend less money. (Thank you Captain Obvious.) This hurts both retail stores and service companies. My barber told me that men in lean times will space their haircuts farther apart than during years of plenty. Women will paint their own nails, men may mow their own yard, and Grandma may babysit rather than the au pair.
4. Capitalization rates will rise to their historical averages. Investors will want to be compensated for the added vacancy risk and potential lower income from rent. This compensation will come in the form of higher cap rates. As well, interest rates are likely to rise over the long run due to the affects of inflation and investors will require higher cap rates to cover this costs.
5. Values will decline as capitalization rates rise. Value and cap rates are inversely related. When one rises the other falls.

All of these things are signals that commercial real estate will go through a cyclical downturn. There will be a period of decline as households, banks, and nations deleverage.

Opportunity Knocks

All this news does not mean that commercial real estate is in a death spiral. Quite the contrary. The darkest of night comes before the dawn.

I believe that now smart investors will begin to reenter the market. Not the speculators, that were looking for a quick buck and were hoping for appreciation.

Property values will actually make sense down here on planet earth with real numbers and real calculations. The mythical world of the last 5 years will have to be forgotten.

The bubble has burst and a new day is dawning.

Diana Olick outlines some of the issues that are causing jitters in the commercial real estate world.

“As the market is now deteriorating, as vacancy rates are rising and as asking rents are moderating and in some places declining, gaps in cash flows, how much money is the property producing versus what the debt service payments are, that gap is widening in many cases and it’s making it really challenging to meet the debt service coverage payments.”

Fear Gripping Commercial Real Estate—But Question Is Why?.

SAN FRANCISCO (MarketWatch) — Citigroup Inc. is considering auctioning off parts of the firm or selling the company outright, according to a media report late Thursday. The online edition of The Wall Street Journal, citing unnamed sources, reported that Citigroup executives are in preliminary stages of discussing a possible sale. The report said that the company’s management is still insisting that it has ample capital and a sound strategic direction, though its shares fell a further 26% Thursday.

Citigroup considering selling itself: WSJ – MarketWatch.

Here is the link to the article at WSJ.com if you have access. Citi Weighs Its Options, Including Firm’s Sale

(HT: Tom Vanderwell)