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Are We Going to Smile or Frown in 2010?

By Karsang Sherpa Vice President
Caldera Asset Management, Denver
ksherpa@calderaassetmanagement.com

As 2009 finally comes to an end, there is some optimism about 2010. It seems that both Bulls and Bears have valid arguments regarding factors that drive values.

Bull versus Bear !

Value Drivers	Data	Bullish Case	Bearish Case
Vacancy rates	National rate up to 7.7% (5.9% in 3Q 2008) Source: REIS	Increase in vacancy is slowing. Only .2% from 2Q 2009	Third quarter is typically the best leasing quarter of the year. PPR estimates 2010 vacancy to be over 9%.
Rental Rates	Rent rolls continue to decline. 3Q 2009 rental rates (-3.3%) vs. 3Q 2008 Source: REIS	Quarterly sequential decrease is slowing. Only (-.5%) from 2Q 2009.	Third quarter is typically the best leasing quarter of the year. Concessions are growing in most markets. Once a floor is reached, it is much more difficult to raise rents than drop them. The market rental rates include more newly built deals with higher rents thus the absolute % change is skewed
Development pipeline	Starts have fallen dramatically in 2009. Very little expected in 2010. Source: DB, MPF	The slowdown in new product will help the market recover faster.	Fewer new constructions means fewer construction workers who are typically more transient and apt renters.
Jobs	Recorded unemployment is 10% (Dec 2009). The under employed is approximately 16%. Source: Fed, Bloomberg	The stimulus will create jobs which will in turn create renters.	The recovery will be slow and very few new jobs will be created. More people will continue to live at home. (Source: Pew Research report Nov 2009)
Interest rates	Agency rates are 210 -230 bps +/- over 10 Year Treasury. Interest Only's are only 1 to 2 years. Source: Dus & Freddie Mac lenders	Solid positive arbitrage for the first two years. Recovery will take hold by the time the I/O period ends. Agencies will continue to support apt.	Rent rolls need to flatten and start rising quickly to offset the amortization impact in year 3 or deals at current cap rates will have effective negative amortization.
Cap rates	Core, urban deal cap rates have declined 25-50 bps. Source: RC Analytics and discussions with brokers	Sellers getting 25 to 30 offers per deal. Lots of capital on the sidelines.	New owners need the job market to improve to make their underwriting work. When the economy improves, interest rates will also rise quickly, effectively driving up cap rates.

FDIC – How bad will the C&D Loans go?

FDIC made front page news when it ran out of cash in September of this year, an event that had not happened since the S&L crisis in late 1980's. However, a bigger story should have been the sheer volume and percentage of construction and development (“C&D”) loans that are non-current. As of September 30, $73.78 billion loans (15% of all C&D loans) are non-current, a 63% jump from $45.17 billion (7.32% of all C&D loans) only 12 months before. The FDIC's “Prudent Underwriting Plan” may slow the rate of assets going into non-current status, but the problem is still sitting on the banks’ books.

Conclusion

The conclusion is actually very inconclusive as to the outlook for 2010. As Larry Summers claims that the U.S. economy has climbed out of recession, the outlook on job market continues to look uncertain, and the outlook for commercial real estate continues to be murky.

About the Author
Karsang Sherpa is a vice president at Caldera Asset Management, a turnaround management and restructuring consulting firm specializing in multifamily assets. Caldera’s team has experience working with lenders, equity investors, lawyers and other consultants to solve complex problems associated with distressed multifamily assets including turnaround, refinancing, stabilization, restructuring, dispositions and property management. For more about Caldera, please visit www.calderaassetmanagement.com.