Editor's note: This column originally was published in an R.B. Murray Co. e-newsletter.There's a lot to be learned from studying the past, and dealing with an economic downturn is no exception.
The Kansas City chapter of the Society of Industrial and Office Realtors asked the Federal Reserve Bank to give its take on the credit markets as they pertain to the commercial real estate sector, specifically in industrial, commercial, office and multifamily lending. Chuck Morris, vice president and economist for the Fed's Kansas City Region, gave a presentation that detailed every economic downturn to date since 1929 and shared his perspectives.
Here are summaries of key points I took away from September SIOR meeting.
Commercial real estate funding comes from a few key sources. Specifically, Morris said, these are commercial banks (45 percent); commercial mortgage-backed securities (26 percent); insurance companies (9 percent); and the remainder from other sources.
Mortgage-backed securities are currently the most problematic method of funding, due to the fact that there is no market for them at this time.
The main concern with respect to this market is where the replacement funds are going to come from when the pool of these mortgages comes due in 2011 and 2012.
In fourth-quarter 2007, CMBS mortgages accounted for $60 billion in lending, but by first-quarter 2008, that number was nearly zero, and now it's negative. The absence of that financing has added to the market's liquidity problems.
I asked Morris what the Fed has planned to do, and he replied that this problem is currently being discussed, but there is no plan of action. I believe that this is a serious issue for the future of the financial markets, especially in the markets that were overheated, such as Florida, Las Vegas, Phoenix and California, but I do not think Springfield has anywhere near 26 percent of its lending coming from these troublesome sources.
By their nature, CMBS loans are usually associated with large-scale projects, of which Springfield only has a few. Some of this debt, however, is present locally via apartments and a few commercial developments. Since few of our eggs are in the CMBS basket, I am hopeful commercial banks will fill in the gaps as needed.
Loan demand is very weak compared to past recessions, so loan growth is flat. This stems from the fact that the commercial borrowers that drive loan growth are suffering from low earnings or losses.
Weak loan demand, however, isn't leading banks to drop interest rates for their borrowers. This seems odd because the spread that the banks are paying for deposits versus what they're charging in interest rates is very high compared to historical data. Morris was pressed on this issue, and he responded that every bank makes its own decision about the interest rates it charges. He surmised that the overexposure of past lending practices is reflected in the banks' efforts to comply with Federal Deposit Insurance Corp. regulations and liquidity issues.
Property sales volumes have declined nationwide. For sales of $5 million or more, sales in 2001 totaled $76.5 billion, a terrible year due to Sept. 11. In each year that followed, sales volume improved, to a high of $421.2 billion in 2007. In 2008, sales fell to $132 billion, which was caused by the mortgage collapse in the third quarter. Through August this year, sales were $23 million.
Housing is the best indicator of an economic turnaround. Morris said that has been the case for the last 10 recessions. The average time from the bottom to the beginning of the turnaround is 12 months for housing, 24 months for durable goods and services and 36 months for commercial real estate on a nationwide basis, although real estate values are determined by local markets.
In the 1980s, southwest Missouri stumbled due to the Resolution Trust Corp. days, but we never did face the severe declines of some other regions. Our region possesses the same assets as it did in the past, so I do not believe that it will take as long to return to a more normal market here as it will in other areas of the U.S.
Mortgages will return once normal amortization takes place. As loans are paid down, interest income falls and the only way for institutions to recapture that lost income is to loan money. When institutions focus on earnings, the loans will return.
And finally, real estate is still a good long-term investment.
There is only so much land available, and this scarcity ensures that with proper planning and management, real estate will continue to provide for good returns over the long term. Some of today's problems are caused by a few attempting to make a liquid asset out of an illiquid tract of real estate. Real estate never has been or ever will be liquid in the true definition of the word. Much has been said about mark-to-market accounting with respect to the stock market, but similar tactics are being used by some financial institutions. This is arbitrarily forcing larger percentages of equity into transactions that do not merit such penalty. Just because some assets have issues, it is unwise to penalize the entire market, which, unfortunately, is exactly what has happened.
Soon, once the dust has settled and a little time as passed, the market will return - a bit smarter and wiser.
David C. Murray is vice president of Springfield-based R.B. Murray Co. and a member of the Socity of Industrial and Office Realtors. He may be reached at dave@rbmurray.com.
