Commercial real estate could be the next wave in financial crisis
Commercial real estate is the next threat to the financial crisis with particular danger to the mortgage-backed securities whose underlying mortgages begin maturing in 2010, according to a new report.
Capitalisation rates on commercial properties are below historical levels and are set to increase, said the report from the Fixed Income Discount Advisory Company, or FIDAC, the investment advisory of real estate investment trust Annaly Capital Management.
Cap rates function similarly to a yield-to-maturity on bonds and are used to measure commercial property values. An increase in the cap rate implies a decrease in the value of the property.
The report said that cap rates traditionally trade in the range of 8.5% to 10%. But according to the report, they began declining after the 2002 recession. In 2004, a time of cheap, excess liquidity “flooded the system and, frankly, trashed cap rates,” and they declined to a range of 5% to 6.5%, where they remain.
FIDAC believes cap rates cannot remain at their present levels, and a reversion to higher levels implies a decline in commercial real estate prices of between 30% to 40%. The report points to a separate analysis from JP Morgan that also indicates price declines of 35% to 40%.
Losses on commercial mortgages are typically recognised in periods of refinancing, which occur when the mortgages are scheduled to mature.
Less than $25bn of securitised commercial mortgages will mature next year, but the majority of them were originated before 2005, when the additional leverage entered the system, as commercial mortgages typically take on a five-year or 10-year term structure.
But the report predicts that things will get worse after that, as loans originated since 2005 will begin maturing in 2010. In that year, 45% of the maturing loans will represent about $17bn in mortgages that were originated in 2005, with a similar percentage applying to 2011 and 2012.
—Write to Cardiff de Alejo Garcia at cardiff.garcia@dowjones.com
del.icio.us
Digg
Newsvine
reddit
StumbleUpon