Real estate market not sick but not well, either

The commercial real estate market has been labeled by many bond traders and portfolio investors as the next shoe to drop.

But there are signs that perhaps news of commercial real estate's demise are somewhat exaggerated.

To borrow a line from a song by indie rock band Harvey Danger, "I'm not sick, but I'm not well." This aptly describes the state of today's commercial real estate market.

Massive amounts of debt are maturing, and new debt is virtually unavailable.

This is forcing investors to "right size" their loans and find cash to bring loan-to-value ratios to more conservative levels.

Of course, conservative is a tough concept after so many years of borrowing aggressively and riding real estate values upward.

As in prior booms and busts, what goes up must come down. Real estate values have fallen 22.8 percent since the peak in October 2007, according to Moody's/REAL Commercial Property Price Indices.

For a typical investor who bought a $10 million property in October 2007 and borrowed $8 million using a two-year floating rate loan, the property has fallen in value to $7.72 million.

Now the investor needs to refinance that two-year loan on a property whose value is 22.8 percent lower than it was in 2007. In today's lending environment, the investor would be lucky to get a $5.4 million loan (which is a 70 percent loan-to-value ratio) and would have to come up with $2.32 million in cash. The process of paying off the debt is called deleveraging.

So where's the sunshine?

Publicly traded real estate investment trusts, or REITs, have been embracing the concept of deleveraging during the past few months by raising some $12 billion of equity in the stock market to pay off debt or build up their cash positions for the months and years ahead.

The benefits of issuing new shares to pay off debt has helped some REITS with operations in the Richmond area, including Highwoods Properties Inc (NYSE: HIW), Brandywine Realty Trust (NYSE: BDN) and Forest City Enterprises (NYSE: FCE-A).

The ability of such high-profile real estate owners to raise capital in a difficult environment will help the overall stability of the Richmond region's commercial real estate market, as few properties will need to be sold at fire-sale prices.

As the equity markets provide hope and debt markets labor through violent deleveraging, loans remain available.

Rates for 5-year and 10-year commercial mortgages now range from 6.90 percent to 7.75 percent, according to the John B. Levy & Co. National Mortgage Survey. Lower rates are available for multifamily projects, and higher rates are prevalent for larger transactions.

For rates to improve, more capital must become available from banks and the conduit market. The federal government continues to tweak its TALF (Term Asset-Backed Securities Loan Facility) program in ways that could revive the conduit market.

The changes, while somewhat arcane, are designed to bring investors back to the commercial mortgage-backed securities market and lead to a solution to the lack of real estate capital, albeit too late for many borrowers.

There are $36.2 billion of conduit loans -- loans that are the collateral for commercial mortgage-backed securities -- that are stressed and are being managed by "special servicers" or loan workout teams, according to Trepp, a New York-based provider of commercial mortgage-backed securities and commercial mortgage information.

That represents almost 5 percent of the conduit loan market and is a new record.

Although land deals haven't fared so well, surprisingly few income-producing properties in the Richmond area have ended up in the headlines as workout candidates.

As we make our way into the sixth quarter of this recession, a few bright spots are lining the commercial real estate landscape.