In the current global economic environment, real estate investors, owners, developers and builders worldwide are primarily focused on two issues:
- Managing their companies through the recession
- Positioning their companies for future growth as global economies and property markets start to recover
At the beginning of 2009 the outlook for global property markets was bleak. Though there have been some bright spots since then, the current climate is decidedly mixed.
In Europe, commercial property markets in a few countries may be showing signs of “green shoots.” In Asia, China’s residential markets are thriving as a result of the central government’s stimulus programs. Japan’s real estate market, which may be close to bottoming out, 1 is starting to attract more international investment.
Although Australia has felt the effects of the downturn, its real estate market is attracting capital from international investors, particularly China.
The differing stage of distress in each geographical region is illustrated in Figure 1, which shows the US as the region with the highest current levels of distressed assets. 2
Figure 1: Global volume of distressed real estate
In the US, there are signs emerging of a potential housing market recovery, with sales and prices recently increasing for the first time in many months. 3
Furthermore, some of the largest homebuilding companies have been able to raise millions of dollars in the public debt market during 2009, with some building up significant cash reserves. “These builders are well positioned for a turnaround,” says Mike Gillmore, head of Ernst & Young’s Real Estate practice in the US Pacific Southwest region.
By contrast, the US commercial property market downturn is generally forecast to worsen in coming months. The US economy is expected to recover slowly, and demand for office, retail, industrial and other space could remain weak and vacancy rates continue to increase, with further rent reductions possible.
Commercial property values have fallen by more than a third from their October 2007 peak, and that decline appears to be accelerating, increasing the difficulty that property owners face in refinancing their mortgages. 4 More debt-burdened owners are defaulting on their loans, adding to the problem loans in the portfolios of both larger and smaller US banks. 5 US banks could ultimately shoulder as much as US$240b in commercial loan losses, possibly resulting in another 700 bank failures. 6
The possible losses, which are illustrated in Figure 2, show delinquency rates on commercial and residential loans increasing since 2005. But in every distressed market, investors see opportunity. Worldwide sales of distressed properties are increasing as more investors form funds to acquire properties at what are seen as bargain prices. 7
Figure 2: United States commercial and residential delinquency rates
Two classes of companies
Before the global recession began, credit was cheap and plentiful, and many real estate companies borrowed heavily to fund development projects or acquire real estate assets worldwide. Most realized attractive returns on their highly leveraged investments — almost every company looked like a winner. Now, however, the recession has had the effect of separating real estate companies into two classes.
In one class are companies that, at the first signs of the recession, had the foresight to refinance their short-term debt with longer-term borrowings at modestly higher rates. “These companies began building liquidity through timely refinancing, even if they had to pay a penalty for prepayment of their existing loans,” states Ad Buisman, an Ernst & Young partner in the Netherlands.
The other class comprises companies that were slower to react. By the time these companies tried to refinance or were forced to do so as a result of debt maturing, banks had tightened loan requirements. “For these companies, refinancing was very expensive, if it could be done at all,” Buisman notes. Some companies, unable to refinance, were forced to sell assets at distressed prices to pay loans coming due.
A need to take action
The credit crisis and global recession have highlighted the need for companies to develop a plan of action to capitalize on opportunities, address the risks in their investment portfolios and operations and position their organizations to grow and compete in global property markets.
Global property values have been declining, and companies with strong balance sheets and access to capital are considering whether to buy distressed commercial properties in select global property markets.
Conversely, highly leveraged companies are preoccupied with crisis management. They are fighting to address liquidity issues, cost-cutting and other steps to try to survive through difficult times.
Regardless, these companies also need to look ahead and plan for the future of their organizations in the global real estate market that will emerge from the recession — a market in which developers, investors and lenders will be more attuned to risk. This was evident in our recent Opportunities in adversity survey of real estate executives worldwide: nearly three-fourths of these executives said there has been a “permanent change” in risk management in their organizations.8
1 “Japan data set to show end to its recession,” Chris Flood, Financial Times, 16 August 2009.
2 Real Capital Analytics defines distress as: the lender has taken the property via foreclosure or the mortgage has a default, bankruptcy or foreclosure pending.
3 “Recovery Signs in Housing Market Stir Some Hope,” David Streitfeld, the New York Times, 28 July2009. http://www.nytimes.com/2009/07/29/business/economy/29housing.html?emc=eta1
4 “Fed Focused on Real-Estate Recession as FOMC Meets,” Scott Lanman, Bloomberg, 10 August 2009. http://www.bloomberg.com/apps/news?pid=email_en&sid=aTOaAnSiL7YM
5 “A Concrete Problem,” The Economist, 30 July 2009. http://www.economist.com/opinion/displayStory.cfm?story_id=14126527&source=hptextfeature
6 Commercial Property Bust Threatens U.S. Banks" Forbes (07/14/09) http://www.forbes.com/2009/07/13/housing-commericial-property-business-oxford-analytica.html
7 “Distressed Commercial Property Sales Rise,” Daniel Thomas, Financial Times, 17 August 2009.
8 Opportunities in adversity: real estate survey snapshot, Ernst & Young, July 2009.
