Commercial Real Estate
David G. Bronner
Edited from a speech given in Birmingham on Jan. 30, 2009
Thank you for the opportunity to address this group of respected real estate professionals. Keep in mind that I am an investor in many financial products. If you feel that I am “way off base,” please feel free to laugh out loudly. Although RSA allocations to real estate are currently 9.8%, it is not from extraordinary building or buying, but due to losses in the world-wide stock markets.
Today, I would like to lay the groundwork by pointing out what I feel as an investor is important to keep in mind about the world’s hot spots and our current U.S. economy. Finally, I will specifically address the five different segments of real estate on the national and state level.
Five world “Hot Spots” which will affect commercial real estate
#1 Pakistan
Neither Iraq, nor Afghanistan, nor Iran poses a bigger threat to the U.S. than Pakistan. They have an inexperienced new government, lots of extremists, and probably the most unstable security of nuclear warheads in the world.
#2 Mexico
Most of us feel strongly about illegal immigration. Drug cartels have caused over 5,000 deaths this past year. A collapse of oil prices could make the country very unstable because 40% of the total budget is derived from oil.
#3 North Korea
North Korea will be an early challenge for President Obama, along with Iraq, Afghanistan and Iran. Keep in mind, Afghanistan is the opium capital of the world with over 50% of its GDP coming from drugs.
#4 Russia
Russia wants its position back as a world power. It wants the price of oil much higher. It fully intends to claim the Arctic, which will put it in direct conflict with Canada and the U.S.
#5 Nigeria
Its oil industry is very corrupt and very violent. Add to it the Middle East with the threats against Israel.
1. Housing: 1+ million in foreclosure with another 1+ million by year-end unless a major policy change.
2.
Our Financial system: Liquidity and Credit – to qualify for loans is almost impossible. Perfect past credit still results in loans being pulled. Banks are hoarding due to bad mortgage pools. Sweden fixed its banks in the 1990s by nationalization. It utilized a bad bank (of which most loans became good loans years later) and the good bank to move forward.
3. Exports are down ½% by year-end.
4. Auto Industry Employment: Direct suppliers bigger. Do buyers that are interested put in real money or only technology with government money?
5. Gas and oil production down drastically at 44%.
6. Deficits hurt the future. Unemployment could hit 9+%, yet inflation will replace deflation.
“Positives”
1. Low interest rates, for now.
2.
Cheap oil for now, but will rise to $2+ per gallon by June.
3. Fed Spending: TARP $825+ billion AND Obama program is great, but state cut-backs are offset. Remember that via IMF what we tell others to do – cut spending, raise interest rates, make credit harder – we are doing the opposite!
4. Public Confidence is about 70+% optimistic.
Pulling this all together and you have “Consumer Spending” as the key. Consumer spending is negative for the first time since 1991!
WHY?
-Investment Wealth
i
- Housing Wealthi
- Wage/Salary Wealthi
All capped with 11 straight months of 2+ million job losses! There has been a total loss of wealth of $20 trillion from a peak of $50 trillion.
We have lived off the savings of all the other people in the world. China is our banker. So far, foreign monies coming in are still holding up, but I believe that changes by foreigners, without a major economic plan in the next 60-90 days, will result in more serious problems.
My last generalization – as I stated to Paul-Volker’s long-time friend in my office – you are throwing money at the wall in hopes it sticks. The bail-out has been “shooting from the hip” or a “sloppy at best” process. I feel it will be late February or March before we fully understand the size and depth of our economic problem. We can solve our problems, but we just don’t know all of them as of yet!
My last point, before addressing Commercial Real Estate, is the U.S. economy is about $14 trillion per year. The most toxic loans outstanding are called CDOs (Collateralized Debt Obligations). I thought 45 days ago the loans were about $40-45 trillion. I was wrong. They are in excess of $55 trillion!
Commercial Real Estate
Generalizations
• 2007 was the year of the decade with $500 billion in transactions. 2008 was like 2003 at $100 billion.
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Ownership of $1.6 trillion: Private investors 39%, Foreign 21%, Pension Funds 20%, Public REIT 17%, Other 3% Insurance / Private Investments.
•
Supply has been reasonably controlled due to the high costs of steel, cement, etc.
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Big help is little securitized debt which is the opposite of housing.
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Lots of off-shore commercial helped our country.
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2009 rents down on average 5%.
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2009 “pipeline” has about 94-100 million square feet coming on board.
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2009 about $160 billion must be Refi. A problem, but $530 billion must be Refi over the next 3 years, so something needs to happen.
Five Classes
1. Office
• National vacancy in 2007 was 12.5%
• 14-15% in 2008
• Could reach 18-19% in 2009 or equal early 1990s
Unemployment 1.9 million (about ½ white collar) means 750,000+ office jobs!
Alabama: Quiet in Birmingham with most new office space on hold, but vast difference in Mobile and Montgomery. No over supply when compared to NYC with Wall Street layoffs. RSA just made a bid this week in bankruptcy court for the old 34-story AmSouth building in Mobile for $6.75 million for 280,000 square feet and 480 car parking garage.
Expect lower rent, greater vacancy, more rent concessions =
i
pressure on value.
2. Industrial
Negative absorption in 2008. The 1st declining year since 2002. Direct relationship to housing & recession especially exports.
Alabama: No big deal one way or another. Again, I think Alabama is different because of its location in the Southeast which is great for warehouses. In addition, my “Mother Bee” concept of the value of clustering like companies: KIA (suppliers or users) will greatly affect us in Central Alabama, the VW plant in Tennessee for North Alabama, and ThyssenKrupp for Mobile will all benefit this sector in Alabama. I like opportunities of suppliers that must be located near the “Mother Bee”, or “users” that need to be near TK in Mobile.
3. Retail
Great run that started a death spiral in 2006 due to consumer spending collapse. Heavy credit card debt, lower housing values, plus Internet competition, and the loss of jobs make it look bleak for 2009.
Very, very few ones due to lack of capital and lack of anchor tenants. Bounce back not until 2011 or 2012. The serious issue is the downgrading of the credit quality of tenants and continued 5,000-6,000 closing of stores via chapter 11 and chapter 7. The big problem is $23 billion of debt maturing over the next 2 years. In Alabama, there is very, very limited growth needed due to pipeline and recent years of big growth. Maybe the Daniels outlet project by Bass Pro is viable but maybe not.
4. Apartments
The renter base will expand due to foreclosures in single family homes and the continuous growth of households. There are about 35 million renters nationally.
Alabama has big plus with foreign industry employees because most do not qualify for mortgages. Vacancy nationwide at about 5%. It will not be a serious problem in Alabama, especially in our major cities and where a new industry is locating. A change in federal government policy can affect this section of commercial real estate more than any other. Beware of any major government change regarding single family housing.
5. Hotels
We are probably in store for a shock. A tremendous decline in business and tourism as a result of the economy. There has not been an over-supply in Alabama, but it will be a concern if supply continues to increase especially in the limited service hotels. Rates and bookings will be down, with companies spending less as well as a slowdown in foreign travelers. Nationally the pipeline delivery will bust and overall resume down 5-8%, but it should not be as bad as after 9/11/01. Alabama should be weak, but foreign industry located here along with golf and hotels being considered the “Best Value” will help us through this period.
My Conclusions
• Cash is truly “King.”
• Lots of opportunities over next 18-24 months.
• Buying existing property vs. building new requires careful consideration.
• Must see what Obama and Washington do. No major decisions need to be made until March.
• We must wait and see. Federal and state government plus much of world will need to create a solution. Foreign perception of our bail-out plan is important.
• My hope for Commercial Real Estate lies in “pump priming” by the federal government, state government, public institutions like universities, hospitals and the ultimate solution of reasonably sustained inflation of 2 to 3%.
• The challenges ahead are NOT unprecedented. We will and we can get past this – but tighten your safety belt.
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