The commercial real estate market today is mired with complex financial instruments, but it will take real estate pros who understand the industry to get us out of the current crisis, according to Frank Sullivan, principal of the real estate consulting firm Gallin Glick Sullivan O’Keefe. Sullivan spoke at the National Realty Club luncheon at the Williams Club on May 4.
“How a property is viewed by a real estate professional is different than the way an investment banker views it,” Sullivan said.
Real estate professionals—owners, underwriters, leasing agents, building operators—understand the strengths and weaknesses of their buildings and tenants and how to make improvements, he said. Once again the assets on which securities are based will matter, not just the securities.
Right now the commercial real estate market is plagued with illiquidity and inertia. “No one knows how to price equity debt or levels of debt,” Sullivan said. “When the dam breaks, transactions will set values.”
Sullivan said most economists predict the recession will end this year, employment will begin rising again in 2010, and loans maturing over the next few years will be absorbed. As a result, commercial property prices will reset the way they did in the 1990s. Sullivan said he believes the fastest commercial real estate sector to recover will be the hotel industry, while retail will be the slowest.
Sullivan traced the seeds of the current crisis to the mid-1990s when the commercial real estate industry began recovering from the crash of late 1980s, and Wall Street introduced Commercial Mortgage Backed Securities as a way to finance commercial real estate. CMBS’ dominated mortgage debt. Insurance companies, for example, were at a disadvantage because the spreads on securitized debt narrowed to compete with bonds.
Early in the decade, following the dot com bust and September 11, the Fed kept interest rates low and debt was plentiful. When the real estate market took off, owners began flipping properties and taking interest only loans. Borrowers began using 90 percent of cash flow to calculate how much they could borrow and assumed increasing rents would pay the debt.
In the last few years when Wall Street began applying Collateral Debt Obligations to commercial mortgages, the market became supercharged, he said.