Looking for a rose amid thorns of the economy

-- Looking for a rose amid thorns of the economy Last year will go down as the one the financial markets became unhinged. Jolting stories unfolded at a breakneck pace leaving few investors secure.

Commercial real estate was far from immune to the car nage. All of the stories seemed to run together like a hazy passage from Hunter S. Thompson's "Fear and Loathing in Las Vegas," only the characters are large institutions. In January 2008, they were symbols of financial power. Today either they do not exist or are a shell of their prior selves. And the haze has not lifted as we move into 2009.

Banks are fearful of what the year holds and loathing the loans on their books that were underwritten in 2006 and 2007.

As in the residential market, the number of sales that occurred during the year for all commercial-property types was down significantly from 2007, and values fell. Commercial-mortgage volume was down in 2008 from 2007 as well, with one indicator, Wall Street's CMBS issuance, off more than 90 percent.

Even though the yield on the 10-year U.S. Treasury note started 2008 at 3.91 percent and ended at 2.25 percent, commercial-mortgage rates are an entirely different story.

Fiveand 10-year commercial mortgages are pricing in the 7 percent to 7.75 percent range today, according to the John B. Levy & Co. Commercial Mortgage Survey, with some banks lending at lower rates.

In January 2008, rates were 5.25 percent and 6.30 percent for fiveand 10-year commercial mortgages.

That means commercial-mortgage rates went up 1.5 percent at the same time Treasury yields declined 1.65 percent.

Interest rates are hard to gauge today but are expected to remain somewhat high for the next few months and possibly longer for two primary reasons.

First, capital availability continues to be constrained. That means those with capital can command higher rates.

Although the Treasury spent the past few months evaluating banks' balance sheets and doling out billions of dollars to get capital flowing again, it is going to take a few months, and perhaps quarters, to get that money to real estate projects.

Second, there are some fantastic alternative opportunities for investment dollars today that make commercial mortgages a relatively poor investment below their current rate levels.

Put differently, if you are the chief investment officer of an insurance company that can invest in A-rated corporate bonds that trade regularly and can be bought without much effort at your computer for a yield of 7.5 percent, the rate you would charge on a commercial mortgage has to be relatively higher. A commercial mortgage takes 30 to 90 days to get on the books, cannot be sold easily, and requires a whole back office to evaluate and originate.

Where is the rose in all these thorns?

The good news is that the commercial real estate market is not horribly overbuilt. This means that when the economy does start to produce jobs and consumers and businesses start spending again, commercial real estate will stand to benefit.

The current lender attitude in the market is that we are going to be retrenching for many years, and that may well be the case. The point is that we will re-emerge, and it won't be long after that commercial real estate is back in favor because it was never overbuilt.

As for the local economy, 2009 will prove difficult because of major contractions of several significant employers.

Richmond has been here before, and the amazing thing is that the local economy is unbelievably resilient. Richmond breeds smart people who have an innovative spirit and competitive mind-set.

Although 2009 will be a step backward, major upheavals in the past have led Richmonders to start new businesses that create jobs. There is a good reason that Richmond ranked high (fifth) on MarketWatch's 2008 list of "Best Metro Areas for Business."