Read the headlines or watch the news and it?s a little hard to get excited about the prospects of any kind of U.S. real estate. Reports of still-depressed residential and commercial property markets across the U.S. abound, and data certainly don?t support a U-turn anytime soon.
If you?re in private equity, however, it?s a very different story. Blackstone Group, the biggest private-equity firm out there, noted recently that it expects more deals in distressed U.S. commercial real estate and the fact that European banks are starting to sell troubled property assets represents a ?sizable? opportunity.
They?re not alone. A recent report by Brookwood Financial Partners (click here to download) notes: that it?s not a matter of if, but when, the U.S. commercial real estate market in particular will recover, and how quickly the recovery will unfold.
The report, written by Brookwood Financial founder and CEO Thomas Trkla, notes that the U.S. real estate market is entering a period ?in which there will be historic opportunities to acquire high-quality commercial properties and loans from distressed sellers in selected regions of the U.S. at significant discounts.?
He further notes, ?Although we are still experiencing the longest recession since the Great Depression, it is not a matter of if the market will recover, but when and at what pace. Over the next six to 24 months, we believe substantial opportunities will arise to acquire fundamentally sound properties at substantial discounts to previous peak pricing and current replacement cost.?
Why?
For starters, the financial stress commercial real estate developers are currently under is pretty heavy. Depressed values and more stringent loan terms have put the squeeze on a lot of players, according to the report, which as the chart below shows has made getting financing tough. According to the report, some $1.3 trillion of commercial mortgages are scheduled to expire over the next four years.
The onslaught of maturities coming due from loans originated at the height of the market will make refinancing difficult due to equity gaps, unrealistic initial underwriting assumptions and stricter lending standards, including lower loan-to-value ratios, the report says.
?As a result, we believe that there will be a marked increase in the number of properties for sale at discounts of greater than 50%,? says Trkla.
What?s more, there?s more opportunity coming down the commercial real estate pike, in particular acquiring both performing and non-performing loans at significant discounts ? from banks and others ill-equipped to be operators of real estate, especially those who have been postponing mortgage defaults by extending loans or modifying loan terms in a bid to stave off a fire sale. The chart below shows the correlation between U.S. commercial property prices and net flows of new mortgages.
Of course, the premise of the good-opportunity story includes at least the beginnings of a tentative U.S. economic recovery, which at this stage most economists and the Federal Reserve would agree isn?t quite happening. Indeed, the opportunities will depend on sellers being forced into the market where few capital resources are available ? leaving ?tremendous? opportunities for prudent, patient investors.
It will also depend on how one defines ?opportunity?. The most true adage for any kind of investment is that it?s only worth what someone else is willing to pay for it. Even at 50% off, the jury is still out on whether buyers ? private equity shops or anybody else ? will be willing to line up to pay half-off for something that was overvalued, over-financed and over-leveraged to begin with.
There are always at least two sides to any bet, and history will tell whether Blackstone, Brookwood and others are correct. One thing that?s clear is that the outlook and the opportunities will depend on what happens with the economy.
We wonder what the Federal Reserve, the U.S. Treasury, the White House or any other properties in the D.C. area might currently be worth ? or perhaps the building that houses the U.S. mint.
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