Maturing Debt Refi Risk Now Is the Top Concern for CRE

New York-Mortgage financing and the ability of fund sponsors to refinance maturing debt on commercial properties in the next 12 to 18 months is the single most important concern in today's market, according to results of a survey of more than 40 major funds released recently by Ernst & Young LLP.

The firm's 2009 "Market Outlook - Trends in the real estate private equity industry" is dominated by concerns over financing with three of the top five strategic priorities for 2009 identified by respondents as debt-related.

In addition to refinance risk, the ability to procure acquisition financing and an overall deleveraging of fund portfolios occupied the fourth and fifth highest priorities, respectively.

"It seems that, despite the widespread infusions of capital into various lending institutions through economic stimulus programs it appears, there is still very little if any lending taking place in the real estate industry right now," said Gary Koster, head of the Real Estate Fund Services Practice at Ernst & Young.

"Our survey suggests that fund sponsors are not obtaining non recourse financing on new deals."

Another key concern for fund sponsor respondents centers on valuations.

According to the survey, capitalization rates for stable income-producing commercial properties in the U.S. are expected to continue to expand this year furthering the value declines experienced in 2008.

Of all the fund sponsors surveyed, 41% of them indicated that cap rates would increase by up to 100 basis points with another 33% of respondents indicating that cap rates would increase by more than 100 basis points.

"Two years ago values were based on peak earnings at peak multiples in 2007.

"Today our survey suggests that values this year may reflect declining earnings at depressed multiples," said Mr. Koster.

He added that the decline in values to date in the commercial property sector have largely been the result of the increasing cost of capital and have been amplified by the amounts of excessive debt leverage employed.

The survey found 92% believe that there will be no economic recovery in the U.S. until after 2009.

According to Ernst & Young LLP, the advantage of a market with severe liquidity constraints and depressed asset values is that the outlook for investing in distressed assets is becoming increasingly attractive.

Mr. Koster pointed out that the great concern for 2009 is declining real estate fundamentals and their impact on net operating income.

Fund sponsors indicated that raising capital for a new fund is the second highest strategic priority sponsors have in 2009.

"During the past five years capital was plentiful and fund sizes grew dramatically with each new raise, but now we are going to see fewer and smaller funds coming to market," he said.

Commercial real estate has been slower than residential real estate in going off the rails but this year CRE has shown a marked slump reminiscent of the one in the early 1990s that depressed markets for a number of years.

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