Real Estate Faces Tough Recovery Slog
The Wall Street Journal
By Nick Timiraos and Anton Troianovski
January 4, 2010
Real estate, which sparked the global economic downturn in 2008, struggled to recover in 2009. But the path to a full return to health is littered with land mines that could send the sector spiraling downward again, possibly upending the nascent economic revival.
The past year's progress in the housing market has relied on government programs that are scheduled to be phased out. The commercial real-estate market is faced with huge amounts of unoccupied space and a deluge of defaults and foreclosures that are putting new stresses on banks and other financial institutions that already are on life support.
The outlook for 2010 is uncertain, at best.
On the bright side, housing markets stabilized in 2009 as the Federal Reserve's policies drove mortgage rates to 50-year lows for much of the spring and fall. Home prices posted six consecutive months of modest gains through October. The supply of foreclosed homes for sale has declined, in part the result of an ambitious program the Obama administration launched in February designed to keep at-risk borrowers in their homes.
But the underpinnings of the positive trends are fragile. The Fed brought down mortgage rates by committing to purchase up to $1.25 trillion in mortgage-backed securities. That program, already extended once, is set to expire in March.
Rates could rise by a full percentage point after those purchases end, sapping any housing recovery, says Ronald Temple, portfolio manager at Lazard Asset Management. He predicts that prices could fall by 15% to 20% if the program ends as planned in March.
Home sales also have been supported by an $8,000 tax credit for first-time buyers. It, too, was set to expire in 2009 but was extended by Congress through the first half of 2010.
On the foreclosure front, the government's battle is far from won. Loan servicers signed up 728,000 borrowers through November for trial loan modifications under the Obama program. Just 31,000 have received a permanent fix so far, or fewer than 5% of those eligible.
Adding to the problem, the number of struggling homeowners is steadily mounting. One in seven households with mortgages was either in foreclosure or delinquent on payments at the end of September, the most recent data available from the Mortgage Bankers Association. Some owners are defaulting because they have lost their jobs.
Some are giving up their homes because the value has fallen below what they owe. Prices have fallen 29% from their July 2006 peak to October 2009, based on the S&P/Case-Shiller Home Price Index, which tracks home values in 20 cities. Nearly one in four mortgage holders owe more than their homes are worth, according to First American CoreLogic, leaving many potential "move up" buyers trapped in homes they can't sell.
"You don't see the normal food chain working," says Ivy Zelman, chief executive of Zelman & Associates, a housing-research firm.
More foreclosures are expected next year as loan delinquencies climb. "It's really hard to envision a positive scenario of home prices going up when you've got this huge overhang," Lazard's Mr. Temple says.
Meanwhile, the pain is just beginning for commercial-property markets. Deal makers who took out huge loans to buy property during the boom often justified the sky-high prices they paid by assuming that rents and occupancy rates would keep rising. Instead, both have plummeted.
Take Midtown Manhattan, the most expensive office market in the U.S. The amount of available space has increased by 16 million square feet since the beginning of 2008, according to brokerage CB Richard Ellis Group Inc. That is roughly equivalent to 16 empty 40-story office towers. Midtown building owners have dropped their asking rents by more than 30% since November 2008.
As rents and property values fell and the extent to which banks are exposed to commercial-real-estate losses became increasingly clear, the government scrambled to contain the damage. The Federal Deposit Insurance Corp., which has been seizing banks hurt by bad property loans, is offering private investors lucrative financing to buy and work out those loans.
In the biggest such deal, Barry Sternlicht's Starwood Capital Group last fall led a group of investors who paid $2.8 billion for a portfolio of 112 construction loans made by Chicago's Corus Bank with a face value of $5 billion. Small and midsize banks are particularly vulnerable to being dragged down by their real-estate portfolios.
"There are going to be huge losses and a huge number of banks failing," says Deutsche Bank commercial-real-estate analyst Richard Parkus. "This is just the tip of the iceberg."
More than $1.4 trillion in commercial mortgages will come due by 2013, and as much as 65% of those will have trouble getting refinanced, Mr. Parkus says.
One major wild card in 2010: When will big investors get back into the market?
For now, institutions that control more than $100 billion in unspent capital earmarked for real-estate deals have been gun-shy, waiting for prices to drop and more distress to come.
Research firm Real Capital Analytics recorded only $42 billion in U.S. commercial-real-estate transactions through November 2009, compared with $136 billion in the same period in 2008 and $489 billion in 2007. But optimists believe that all that money on the sidelines will make for a quick rebound when investor sentiment improves.
"When confidence returns to the markets," says Dan Fasulo, Real Capital's head of research, "I think things are going to spiral upwards again very quickly."
Corrections & Amplifications
More than $1.4 trillion in commercial mortgages will come due by 2013, according to a Deutsche Bank analysis. A previous version of this article incorrectly said the number was $1.4 billion.
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