Market stagnates as future remains cloudy

Hopes for the economy to pull out of its nose-dive were bolstered last month with the passing of a $787 billion stimulus package. According to the latest survey from The Conference Board, consumer confidence is at an all-time low, and when combined with mounting job losses, it's no wonder that personal consumption has fallen off a cliff.

Since personal consumption makes up about 70 percent of economic activity, the government is attempting to fill the spending gap through its stimulus initiatives. Put another way, the economy is flat-lining, and Uncle Sam is applying the paddles.

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While most economists agree that the government has no choice but to spend to get things rolling again, few can agree on when we will emerge from the recession - and even fewer can predict what everything will look like in three or five years. As one chief investment officer at an insurance company indicated, "this is a transformational downturn . . . but I can't get my arms around what things will look like on the other end."

That sentiment is what has led to a virtual seizure of commercial real estate investments. Apartment sales are perhaps the best example of investor psyche. Despite Fannie Mae and Freddie Mac providing multifamily loans at rates under 6 percent for 75 percent to 80 percent of the purchase price, sales are anemic.

According to Real Capital Analytics, January apartment sales were down about 90 percent from sales in January 2008. Even though cheap money at relatively high leverage is still available, buyers are not certain what the future holds, so they are not willing to transact.

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The problem is more pronounced for investments in other property types where there is little credit available. Very few office, retail or industrial properties are trading because there is little certainty regarding office employment, retailer strength or warehouse capacity.

Commercial mortgages are still available but at somewhat restrictive terms. According to the John B. Levy & Co. National Mortgage Survey, fiveand 10-year commercial mortgage loans are now pricing in the 6½ percent to 7½ percent range, with larger loans pricing higher than smaller loans. Multifamily loans are priced lower, falling in the 5¾ percent to 6 percent range for Fannie Mae and Freddie Mac-eligible properties.

Even though doom and gloom prevails in the economy, investment opportunities abound as lenders are unloading troubled loans at steep discounts. An arcane rule related to risk-based capital for pension funds and insurance companies has led lenders to move potentially defaulting loans off their books prior to an actual default.

As an example, a performing $140 million loan secured by a 340,000-square-foot retail center in Florida and owned by a joint venture, including the country's largest pension fund, CalPERS, was recently purchased for $42 million, a 70 percent discount to its face value. The original developer of the center is Menin Development, which also developed several centers in the Richmond area, including Hanover Commons, Downtown at Short Pump and Brandy Hill Plaza. Reportedly, Menin sold the center to CalPERS in 2007 for about $275 million.

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While the Federal Deposit Insurance Corp. is selling assets from banks that are taken over, Richmond has not experienced a bank failure. Nonetheless, local lenders are moving troubled loans off their books through DPOs, or discounted payoffs.

So far, the discounted loans have been tied to the residential housing market, but troubled commercial projects are raising pressure on local and national lenders alike.

As we enter the 15th month of the recession and tenancy weakens at many commercial properties, we can expect to see an increase of commercial mortgages that are either sold at a discount or legally enforced through foreclosure action.

Andrew Little is an investment banker with John B. Levy & Co. He can be reached at