Doug Cornelius .com

With the fall-out of the sub-prime loans, there is continuing good news in the commercial markets.

London has surpassed Hong Kong to hold the position of having the world’s highest office rents. According to the NAI Global Market Report, the Mayfair submarket in London’s West End reached $265.31 per square foot. That was an increase of $40 per square foot over the prior 12 months. Hong Kong was close behind at $263.20 per square foot.

New York’s midtown market was up to $225 per square foot. That makes Boston’s $90 per square foot look very affordable. Boston came in third in the United States.

The New York market appears to still be strong. According to Cushman and Wakefield’s year end report, 22.2 million square feet of office space was available at the end of 2007, which is down form the 26 million available at the end of 2006. Manhattan’s overall vacancy rate improved for the year, finishing at 5.7%, down from 6.7% at the end of 2006.

The Wall Street Journal has an article in the C Section by Jennifer S. Forsyth and Kemba J. Dunham on real estate mezzanine loans: Real-Estate Investors Like View From Mezzanine Section.

If mezzanine investors think that it is a “no-lose bet” they are getting themselves in trouble. There is a higher return on mezzanine debt because it is riskier.

The senior mortgage lender will often set limitations on the ability of the mezzanine lender to foreclose on the borrower and take over control of the borrower. Typically this will include the mezzanine lender stepping into the guarantees of the now-wiped out guarantors.

Since the collateral is the equity ownership, the mezzanine lender steps into all of the liabilities of the borrower. This may mean that trade debt has piled up and other obligations may be outstanding.

Lastly, the mezzanine borrower is not going to default on the loan unless they think the value is gone. Inevitably, this means the mezzanine lender is not going to be made whole if they have to foreclose and take over the borrower.

On Tuesday, the MSCI US REIT Index (RMZ) dropped 5.61% to 914.85, and the SNL US REIT Equity Index plummeted 5.59% to 235.96 with five winners, 106 losers and four companies closing flat. The losses mark the worst one-day tumble for the SNL US REIT Equity Index since July 25, 1989.

By comparison, the Dow Jones Industrial Average traded down 2.14% to 13,432.77, and the S&P 500 fell 2.53% to 1,477.65. The yield on the 10-year Treasury dropped to 3.97% from Monday’s
4.15% close.

The Federal Open Market Committee voted Dec. 11 to lower its target for the federal funds rate by 25 basis points to 4.25%, noting in its monetary policy statement that “incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending.” In a news release, the FOMC stated that strains in financial markets have increased in recent weeks. The FOMC believes their latest action, combined with previous moves, “should help promote moderate growth over time.” The committee also decided, in a related action, to cut the discount rate by 25 basis points to 4.75%.

The NAREIT Annual Convention was held in Las Vegas on November 14-16. Webcasts of the presentations are available on the NAREIT website: http://nareit.454creative.net/

Gil Menna of Goodwin Procter LLP moderated the panel on the State of the Industry (MP3).

NAREIT is the National Association of Real Estate Investment Trusts.

The MIT Center for Real Estate has just released the results from the third quarter of 2007: Transactions-Based Index (TBI)

The results from the quarter are highlighted by a total return of negative 1.7%
for all properties, including a decline of 2.5% in asset prices. The demand side
of the market showed a 3.37% decrease in reservation prices, while our estimate
of growth in supply side reservation prices (property owners) was negative 1.6%.
Among individual property type sectors, price growth was strongest in apartments
(+5.9%), and weakest in industrial (-2.7%).

According to the Urban Land Institutes’s Emerging Trends Report it will be A Not So Great 2008, as reported in the National Real Estate Investor.

This report is a poll of 600 real estate experts. 78% thought there would be more stringent underwriting standards ahead (only 78%?) and there will be rising capitalization rates. They still expect the commercial real estate market to outperform the return from stocks and bonds.

The report also targets the top markets to watch:

• New York. Ranked as the hottest commercial real estate market in the country. Low vacancy rates and skyrocketing pricing.
• Seattle. Growth controls and geographic barriers have led to concentrated high-density, mixed-use development, which has drawn residents to new downtown neighborhoods. Seattle has become a 24-hour city on Asian commerce routes. It has a highly diversified economy.
• Washington D.C. The government never stops and provides a cushion for real estate owners against abrupt downturns.
• Los Angeles. High prices have driven some business and residents to seek shelter in lower cost states. The Orange County office market has softened. The office market in West LA has never been better. LA/Long Beach remains the nation’s top port, but transportation routes are clogged, creating a hindrance to trade.
• San Francisco. Technology businesses are thriving and taking up lots of space. View space is once again commanding over $100 per square foot, even as supply creeps upward.
• Boston. As the greater Boston market rebounds from the “tech wreck” of the early 2000s, it is seeing resurgence in its offices. New industries, such as professional services firms and bio-tech companies, are beginning to recycle space left vacant by corporate headquarter departures in the recent past. But questions remain about the depth of Boston’s tenant population, causing investors to keep a close and wary eye on the market.
• San Diego. San Diego is a leading indicator for a market correction. Office turnover and out-migration of prime business centers to Del Mar and Oceanside have left San Diego’s downtown looking for new growth opportunities.
• Denver. The only non-coastal city in the top tier, Denver has retooled its downtown to create an “urban burb,” a hip and exciting urban core in the midst of a sprawling suburban area, connected to downtown via a light-rail transit.

Real Estate Finance and Investment is reporting that five securitizations worth at least $4.8 billion have been pulled from the market in the last week.

So far this does not seem to have much impact on pricing of commercial real estate. Surely, less debt is available and the pricing is less favorable, but there is still gobs of capital dedicated to real estate that are looking for investments. Highly leveraged deals and buyers relying on lots of debt are running into trouble. WSJ.com is reporting that the parties have extended the closing for the Tischman Speyer / Lehman acquisition of Archstone-Smith.

The debt markets are continuing to crush the residential real estate market. American Home Mortgage Investment has gone belly-up, National City has stopped offering some products through brokers and now jumbo loans are running into trouble: Mortgage Fears Drive Up Rates on Jumbo Loans (WSJ.com $$).

The problem with the jumbo loans is that they cannot be purchased and guarantied by Fannie Mae or Freddie Mac. That limts the resale value of the debt and the securitizations of the loans.

Robert J. Schiller published a new paper that looks for markers at the ends of real estate booms or busts:
Historic Turning Points in Real Estate by Robert Shiller.

His best guess “is that ends of housing booms have multiple causes, and cannot generally be interpreted as just an unraveling of boom psychology. Still a rising sense of enthusiasm and excitement for the investments, followed by a sense of betrayal and embarrassment at having fallen for the boom and underestimating the supply response to the boom, played a significant, if unquantifiable, role in the booms and their subsequent break.”

Dick Howe at the Middlesex North Registry of Deeds in Lowell reports that foreclosure sales are up but that the foreclosure pipeline has not dramatically increased: Foreclosures Up – but not for long.

In May, 2006, there were 78 Orders of Notice and 8 foreclosure deeds.
In May, 2007, there were 65 Orders of Notice and 40 foreclosure deeds.

It looks like the flow of borrowers in trouble is starting to slow and lenders are clearing the troubled loans from their books.

Based on a comparison of the number or recorded deeds in this registry, the volume of sales has not changed significantly. In April of 2006, 555 deeds were recorded. In April of 2007, 541 deeds were recorded.