Bailout

The commercial real estate boomlet

By Felix Salmon

We saw yesterday that indiviuals across America seem to have learned nothing from the housing bust — and now Dana Rubinstein has a great piece in the NYO showing that exactly the same is true in the world of commercial real estate as well. That’s certainly what Newmark Knight Frank president Jimmy Kuhn thinks:

?There already seems to be a lot of capital out there that thinks that just because it cost $1,000 a foot a few years ago that $500 a foot is cheap,? said Mr. Kuhn, referring to office building prices, which, during the heady boom years, routinely exceeded $1,000 a square foot, even, and most egregiously, for a comparatively modest office building in Soho. ?There are a lot of people starting again to underwrite office buildings with aggressive projections for growth in rents.?

In a sense, this is just a natural arbitrage: if risky junk bonds have been soaring in value, then risky real-estate loans have to be getting more attractive too: this is arguably a capital-markets phenomenon as much as it is a case of real-estate investors having the memory of a goldfish.

But it’s a lot easier to protect your downside in junk bonds: you can always buy some CDS, while the market in credit protection on commercial real estate loans is thin to nonexistent.

The biggest worry of all, of course, is not that these loans go bad but that they end up being highly profitable. That will then confirm in the lenders’ minds that they were right, and that they should double up their bets. And so the cycle begins anew. But we’re not there yet. There’s still an enormous amount of oversupply in the NYC office market, and I have no idea where these projected rent increases are meant to come from, especially when the Port Authority and Larry Silverstein are willing to pounce on any uptick in demand by building enormous new towers at the World Trade Center site. My expectation is that we’re much more likely to see a lot more of these loans going bad than we are to see them vindicated.

Full post as published by Macroprudential on April 07, 2010 (boomark / email).