Dr. Mark Dotzour - Chief Economist of Texas A&M University

1. Economic Outlook for 2010:
Commercial Real Estate
Dr. Mark G. Dotzour
Chief Economist
Real Estate Center @ Texas A&M
College Station, Texas
Brought to you by NAR Commercial

2. Today’s Topics
• The US and global economies and jobs
• Lender appetite for real estate loans
• Timeline for the CRE recovery
• Outlook for CRE prices

3. The U.S. and global economies
and the outlook for jobs

4. It’s Not So Complex,
It’s Just Big (1)
• Banks and other high-powered Wall Street firms
made a lot of bad loans for houses, and
commercial real estate`
• They also made a lot of bad loans for businesses,
credit cards, and M&A.
• They lost more money than their equity
• The losses are so big that the government can’t
allow banks to take them all at once

5. It’s Not So Complex,
It’s Just Big (2)
• They can’t auction the bad assets because it would
reveal the true extent of the losses.
• So they have “injected capital” so that the banks
can amortize their losses over years.

6. Total Net Loan Charge-offs

7. Commercial and Industrial Loans
at All Commercial Banks

8. Real Estate Loans at
All Commercial Banks

9. U.S. Government Securities
at All Commercial Banks

10. “Extend and Pretend”
The New Definition of Value – FASB 157
…fair value is the exchange price in an orderly transaction to
sell the asset in the market that the reporting entity would transact
for the asset that is the most advantageous market..
“Therefore, the definition focuses on the price that would be
received to sell the asset, not the price that would be paid to acquire
the asset.”
“The notion of unobservable inputs is intended to allow for
situations in which there is little, if any market activity…”
However, the reporting entity must not ignore information about
market participant assumptions that is reasonably available without
undue cost and effort.

11. It’s Not So Complex,
It’s Just Big (3)
• The Fed will keep rates low for a long time until
the banks “earn their way” out of the massive
losses they have incurred
• Savers are afraid of the market due to the high
levels of risk and Madoff-style fraud
• Savers buy US Treasury bonds and have created a
bubble in that market driving rates low

12. It’s Not So Complex,
It’s Just Big (4)
• Businesses are hesitant to borrow for expansion
right now due to manifold political risks
• So banks borrow money from the Fed for free and
buy Treasuries with no risk
• Rates will stay low, even when the Fed decides to
“tighten”.
• They will just pay interest on reserves and the
banks will loan to the Fed instead of businesses
and consumer. That way, CD rates stay low for a
long time.

13. Jan-09
Total US Non-Farm Employment
Jan-07
Jan-05
Jan-03
Jan-01
Jan-99
Jan-97
Jan-95
Jan-93
Jan-91
Jan-89
Jan-87
Jan-85
Jan-83
Jan-81
140000
120000
100000
80000

14. Small Business Outlook
“Planning To Hire People In The Next Six Months”
25
20
Net % of Respondents
15
10
5
0
-5
-10
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
National Federation of Independent Business

15. Corporate Hiring Plans:
Next 6 Months
Q4-09 Q3-09 Q2-09 Q1-09
More Jobs 19% 13% 6% 7%
Less Jobs 31% 40% 49% 71%
Updated 12/11/09
Source: Business Roundtable

16. Gross Private Domestic Investment
$2,300
$1,900
Billions
$1,500
$1,100
$700
$300
Jan-80
Jan-82
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Source: Department of Commerce

17. Unemployed Americans

18. Unemployed for 27 Weeks or More

19. It’s Not So Complex,
It’s Just Big (5)
• The FDIC funds ran low, so they refilled the gas
tank with another $500 billion authorization.
• The FDIC is ramping up staffing to handle the
volume of failed banks coming up.
• Be ready for the stream of distressed assets that
will be coming onto the market in the next year.

20. It’s Not So Complex,
It’s Just Big (6)
• American consumers spent more than they earned
(“Fairyland dream”)
• They maxed out credit cards and HELOCS
• Businesses ramped up staffing and locations to meet
Fairyland demand
• All levels of government ramped up spending on
Fairyland revenues

21. Net Home Equity Extraction
Equity Monetized by Refinancing Mortgages
$800
$700
$600
$500
$400
Billions
$300
$200
$100
$0
-$100
-$200
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

22. Debt Service Payments
as a Percent of Disposable Personal Income
15
14
Percent
13
12
11
10
Jan-80
Jan-82
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Source: Federal Reserve Board

23. 1/1/2009
1/1/2007
1/1/2005
Personal Savings Rate
1/1/2003
1/1/2001
Source: Department of Commerce
1/1/1999
1/1/1997
column2
1/1/1995
1/1/1993
1/1/1991
1/1/1989
1/1/1987
1/1/1985
1/1/1983
1/1/1981
10
14
12
8
6
4
2
0
-2
Percent

24. Corporate Profits
(With Inventory Valuation Adjustment & Capital Consumption Adjustment)
$1,300
$1,200
$1,100
$1,000
$900
Billions
$800
$700
$600
$500
$400
$300
$200
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Source: Department of Commerce

25. It’s Not So Complex,
It’s Just Big (7)
• So the Fed and Treasury are trying to replace the post-
Fairyland consumers
• Consumers got a tax credit in 2008, but they saved it
• They are trying to prop up homeowners that bought a
house they couldn’t possibly afford
• They are trying to prop up businesses that need to
right-size
• They are trying to prop up state and local governments
that need to right-size

26. The Best Case Scenario
Favorable corporate earnings 4Q09
Stocks rise about four months prior to that
Consumer confidence rises with stocks
More spending results in higher profits
Layoffs end by the end of the 2009
“Jobless recovery” in 2010
Higher interest rates and inflation in 2010-11

27. The Worst Case Scenario
The securitized lending market doesn’t reopen
Bad banks and businesses propped up
No price discovery for “toxic” mortgages
Political risk for business stays high
Business / investors “sit on their hands”
Unemployment goes well over 10%
Commodity deflation and price deflation

28. State Government Budgets
• 21 states have furloughed workers
• Some states are letting prisoners go on early
release
• Hawaii has gone to a 4-day school week
• NY tax revenue has dropped 35%; they
need $3 billion more budget cuts - Patterson
• The loss to the states was about double the
stimulus package benefits – Gov Patterson

29. Where Will the Next Bubbles Be?
US, Japan, China, Europe all pumping massive quantities of
cheap money into the system
• China’s stock market.
• U.S. Stocks
• Commodities
• US commercial real estate

30. Timeline for
the
commercial real estate
recovery

31. A Timeline for CRE Recovery
2009
•Prices fall as cap rates revert to 2002 levels
•Occupancy falls a job layoffs continue
•Rents fall as owners covet tenants
•New construction continues to add new supply
•Foreclosures increase as refinancing is precluded

32. A Timeline for CRE Recovery
2010
•Prices continue to fall as price discovery continues
•Occupancy falls as firms downsize staff
•Layoffs end, but downsizing continues for cost savings
•Rents fall to compete for smaller tenant base
•New projects started in 2007-08 are completed
•No new construction projects undertaken

33. A Timeline for CRE Recovery
2011
•More rapid job growth increases absorption rate
•No new supply delivered to the market
•Rents start to rise as space starts to fill
•More foreclosures from properties bought 1H07
•Property values start to increase, anticipating positive
absorption and very limited new supply.

34. A Timeline for CRE Recovery
2012
•More rapid job growth soaks up more space
•Occupancy rate increases significantly
•No new buildings delivered to the market
•Prices continue to increase due to rising fundamentals
and falling cap rates

35. The Progression of Investors
Returning to Commercial RE
First buyers will be high net worth investors,
buying for their own account. They can afford
to miss the bottom and still make good money.
Cap rates will be at their highest as buyers seek
opportunistic returns.
Once prices stabilize at the bottom, then
institutional buyers will re-enter the market.
Cap rates will start to fall as “core buyers”
enter the market.

36. Apartment Comp
Advanced Real Estate Services Inc. has paid $23.6 million for the
Courts at Artists Village, a 196-unit apartment complex in Santa
Ana, Calif.
The sales price results in a capitalization rate of 6.7 percent.
The property, at 301 West 2nd St., includes 12,222 square feet of
ground-floor retail space that is 25 percent leased to restaurants and
high-end retailers, and 1,412 sf of storage and office space. The
apartment portion is 86 percent occupied.
Copyright ©2009 Commercial Real Estate Direct, a
service of FM Financial Publishing LLC. All rights
reserved

37. Commercial Real Estate Value Trends
Blackstone marked down its real estate portfolio by
30%in 4Q08 and another 19% in 1Q09. WSJ 5/7/2009
A Goldman Sachs biggest private real estate equity
fund called Whitehall Street Global Real Estate LP
2007 invested $3.7B between May 2007 and Aug.
2008 in a portfolio of casinos, hotels and office
buildings. They have since written down those
assets by $2.1B and have issued a $1B capital call
to LP's to cover some debt. . WSJ 5/15/2009

38. CRE Value Trends
• Opportunistic funds are down 52%
according to the NCREIF/Townsend fund
indices.
• Core funds are down 36.3% from their peak
by the end of 3Q09.
Source: Real Estate Law and Industry,
published by the Bureau of National Affairs.

39. TIAA-CREF Real Estate Fund
is down 37.4% from peak on April 17, 2008
Source: TIAA-CREF.org

40. MIT Transactions-Based Index
shows prices off 36.5% from peak
Prices actually
increased 4.4%
in 3Q09.
Source: MIT Center for Real Estate

41. CRE Value Trends
• MIT Transaction-Based Index shows
property values have fallen 39.2% from
their peak by the end of June, 2009.
• Moody’s/REAL CPPI shows property
values down 40.6% as of the end of August.
• NACREIF Property Index indicates that it
has recognized less that two-thirds of the
coming right-down in property values.
Source: Real Estate Law and Industry,
published by the Bureau of National Affairs.

43. CRE Value Trends
• MIT Transaction-Based Index shows
property values have fallen 39.2% from
their peak by the end of June, 2009.
• Moody’s/REAL CPPI shows property
values down 40.6% as of the end of August.
• NACREIF Property Index indicates that it
has recognized less that two-thirds of the
coming right-down in property values.
Source: Real Estate Law and Industry,
published by the Bureau of National Affairs.

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Dr. Mark G. Dotzour Rebecca A. Vesconte
Chief Economist Manager, Member Development
Real Estate Center, Texas A&M Email: rvesconte@realtors.org
Email: dotzour@tamu.edu www.REALTOR.org/commercial
www.recenter.tamu.edu 800-874-6500