A commercial real estate price index, developed by the Massachusetts Institute of Technology Center for Real Estate (MIT/CRE), posted a staggering 18.1 percent drop in the second quarter. The index, which collects commercial real estate purchase and sales data from leading real estate firms, is now down 22 percent for the year and 39 percent from its peak in Q2 2007. The information was released by MIT/CRE Monday to the dismay of commercial property investors nationwide.
These numbers do not bode well for owners of income producing buildings who may need to refinance soon. Shrinking valuations will make it harder for buildings to qualify for institutional financing in this tight credit environment. Banks have significantly decreased their loan-to-value ratios (LTV) as a result of the credit squeeze and the unpredictable markets. The combination of tighter lending criteria and lower appraisals will result in a large number of buildings that will fail to get refinanced.
This is a half a trillion dollar problem and the government can offer only nominal assistance; the public has no more appetite for bail-outs. The situation is dire indeed; investors are left hoping for a rebound that they know won’t come.
All the bad news, however, is a harbinger of good news. The very best financial professionals know that pessimism is a bullish indicator. A market bottom, by definition, is the moment of maximum pessimism.
The sheer magnitude and the incredible speed of the price declines could be an indication that sellers have capitulated and now believe that getting out is more important than getting their price. It is worth noting that the 18.1 percent drop reported by MIT/CRE is the steepest in the 25 year history of the index and that the peak to trough decline of 39 percent is considerably worse than the 27 percent decrease reported during the last great commercial real estate meltdown in the 1980s. Further, the commercial property collapse has now eclipsed the downturn in residential real estate which is off 30 percent from its highs. The best bad news of all, however, is that the supply side index of prices sellers would be willing to accept plummeted 18.5 percent to a new record low. Who could be blamed for considering that number a white flag of surrender?
Predicting a bottom is a fool’s errand but it would be equally foolish not to watch for signs of recovery. Hidden and overshadowed by all the bad news in the report is the fact that sales actually picked up over the last 3 months. Transaction volume showed a nice increase in the 2nd quarter, the first such up-tick in nearly 14 months.
I don’t know when the turn around will happen, but I do know that a predominantly bearish sentiment is a bullish indicator and that just because something is counterintuitive doesn’t mean it’s wrong.
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