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Revisiting Old Macro Calls on Real Estate



July 14, 2010 – Comments (2) | RELATED TICKERS: CX , USG , KBH

When the entire world was excitedly singing a recovery song, I sustained my unpopular conviction that commercial real estate represented yet another shoe to drop onto the toes of a frightening overall environment for real estate and related debts.

Revisiting my dour call, we find that commercial mortgage defaults doubled YOY in the fourth quarter of 2009.

Feb. 24 (Bloomberg) -- The default rate for commercial property mortgages held by U.S. banks more than doubled in the fourth quarter and may reach a peak of 5.4 percent at the end of next year, according to Real Capital Analytics Inc.

The default rate for loans on office, retail, hotel and industrial properties surged to 3.8 percent from 1.6 percent a year earlier, the New York-based real estate research firm said yesterday in a report. The default rate for loans on apartment buildings climbed to 4.4 percent from 1.8 percent.

More recently:

Borrowers are struggling to refinance with values down 41 percent from October 2007 highs, according to Moody’s Investors Service. Late payments on commercial property loans packaged into securities are at a record 7.5 percent, according to Moody’s, and may reach 11 percent by yearend.

And here:

"The number of distressed properties continues to grow, and if borrowers are unable to access capital for leasing costs or are unable to restructure their loans to a leverage level commensurate with sustainable property values, they may stop subsidizing debt service payments."


That provides a snapshot of the commercial-side debt picture ... now let's see how commercial builders are faring. Not any better, I'm afraid:

* Nonresidential construction spending seen down 20.3 pct

* Hotels seen down 43.3 pct, office category down 29.1 pct

* Survey cites oversupply, weak demand, tight credit

NEW YORK, July 14 (Reuters) - Spending on U.S. nonresidential construction is likely to fall more than 20 percent this year before recovering slightly in 2011, according to a semiannual survey by an architects' trade group.

For 2010, survey respondents had forecast a 13.4 percent drop in January and only a 12 percent decline a year ago.

Construction spending on hotels will drop more than 43 percent this year, construction of office buildings will decline almost 30 percent, and retail and industrial categories will be down more than 20 percent, the AIA said.

[Here are some companies with exposure to nonresidential construction, although I view Caterpillar's overall prospects as sufficiently strong to overcome such a hit]

A partial list includes Honeywell International Inc (HON.N), Tyco International Ltd (TYC.N), Ingersoll-Rand Plc (IR.N), Johnson Controls Inc (JCI.N), Caterpillar Inc (CAT.N), Deere & Co (DE.N), Terex Corp (TEX.N), Emerson Electric Co (EMR.N), Parker Hannifin Corp (PH.N), Manitowoc Co (MTW.N), Oshkosh Corp (OSK.N), ITT Corp (ITT.N) and Eaton Corp (ETN.N). 


And here are some of my archival articles and blog posts on the residential and/or nonresidential real estate sector. You be the judge ... 

Housing Discussion with Charts (March 2008)

So you were hoping to buy a house?  Me too!  And the above chart relates to my strategy... invest in gold and silver throughout this crisis and then convert part of your earnings into a down payment once the markets have A.) fully valued gold to $1,650 or beyond, and B.) Mean home prices in dollar terms have come down considerably from present levels.

The above chart is, of course, quite outdated.  Gold is now over $1,000 and the mean home price has come down a bit... but do the extrapolation for yourself... Once again, this has much further to play out before I can recommend that anyone consider buying a home.  Gold and silver are the safest asset classes, in my opinion, in which to wait for the right time to buy.

Are You Ready for Round II of the Mortgage Meltdown?

Even Moody's chief economist Mark Zandi, who believes that "the bottom of the housing downturn is within sight," expects a further 11% decline in home prices nationwide.

Pondering the potential consequences
In the scenario implied by this report, however, I believe that both of Zandi's projections would prove overly optimistic. The same conditions seen placing existing loans at risk should also lower the number of able buyers, leading to falling demand and further oversupply concerns. That would significantly prolong the pain for homebuilders like Toll Brothers (NYSE: TOL), and could domino onto the bottom lines of related material makers like USG (NYSE: USG), further challenge related freight volumes for railroads like Norfolk Southern(NYSE: NSC), and so on.

Wave 2 of the Credit Collapse Approaches (July 2009) [It still looms!]

Throughout 2008 you'll recall one of my primary focuses was on correcting the prevalent notion that critical losses would be contained to Subprime or even Alt-A mortgages. I blogged repeatedly about the series of dominoes that unfortunately had to fall in succession as a result of the broader deleveraging event... including commercial real estate, credit card debt, auto loans, student loans, and even state and municipal debt. Commercial real estate is now preparing to fall with a resounding thud, which is both indicative of severe corporate malaise in general (reduced demand) as well as a harbinger of renewed pain for the financials. The financials have originated tons of new derivatives on new debt issued over the past year, adding fuel to the next fire.

Round 2 of the financial crisis will be more damaging than round 1, in part due to the scale of the response initiated to combat round 1. Buckle-up and hunker down, Fools.... here we go again.

A Contrarian View on Housing

JP Morgan analyst Michael Rehaut may be counting on such an extension. The analyst lifted his homebuilding sector outlook Friday from negative to positive, and issued overweight ratings on builders Toll Brothers (NYSE: TOL) and KB Home (NYSE: KBH). Rehaut believes the sector is "solidly past its trough," and sees "further upside to the current rally" over the next two years after a potentially bumpy start. I sure hope he's right, but unfortunately I continue to track a wide range of issues that present sweeping obstacles to continued momentum in the residential housing sector.

Worst Stocks for 2010: Bank of America

Credit risk has not bottomed. Rising foreclosure rates, credit card delinquency rates, persistent distress in the labor market, and deterioration in commercial real estate loans tell a staunchly contrarian story.

Bury This Quarter in a Time Capsule (Cemex)

Preserving the bad with the good
Why on earth would anyone want to preserve this sort of a monstrous earnings result in a time capsule? Well investors the world over are continuing to exhibit confidence in global equities, as recovery talk reaches new heights of relieved enthusiasm. If widespread presumptions of a sustainable economic recovery underfoot in the U.S. prove correct, then this laggard from the construction sector will provide a fascinating snapshot of a miraculous recovery forged in the notable absence of either meaningful job growth or a reversal in the multiyear decline of the construction sector.

If, on the other hand, my concerns about the potentially fleeting nature of a synthetic, stimulus-fueled reboundCommercial Metals (NYSE: CMC) observed "no effective stimulus for construction." If stimulus spending is indeed starting to kick in, I believe it has begun to do so only very recently. prove well-founded, what we will have preserved will be a record of the missing link in the formula for sustainable recovery. You see, even within Cemex's dastardly results, the primary driver of remaining demand came from infrastructure projects rather than commercial or residential construction. Fools will recall that, just last month,

Nifty Nucor Notches a Victory

South Korean steelmaker POSCO (NYSE: PKX) recently showed us what real recovery looks like, but if we squint really hard to ignore the pronounced weakness in domestic construction markets, we might just be forging a separate, albeit substantially longer path to a more palatable image of this "new normal" that we keep hearing about. We've also heard a lot about a jobless recovery, but is there a sub-category available for a "houseless recovery"?

Unfortunately, my doggedly pragmatic eyelids lack the squinting strength to block out the more foreboding image of widespread state and municipal budget shortfalls and those most threatening bullies of our economic playground: federal debt and inflation. I find tremendous relief -- and hope -- in the rapid improvements observed recently by key bellwether companies like Arch Coal (NYSE: ACI), and I welcome the proclamation by AK Steel (NYSE: AKS) that the company is "firmly on the road to recovery." Until we can draft a topographical map of that road, however, this Fool remains only a cautious participant in the improving industrial outlook.

Do the Double Dip Double Take

Even when U.S. steelmaker Nucor (NYSE: NUE) revealed remarkably positive first-quarter results last April, I could not shake my skepticism toward a recovery that would have to be not only jobless under the circumstances ... but also "houseless." Although I cannot say with certainty that renewed weakness in housing and other key indicators presages a full-blown double-dip recession, I will suggest that Schnitzer Steel's outlook for deteriorating steel sales volumes and tightening operating margins is not the sort of positive indicator that this Fool pined for to counteract a spate of disconcerting signals.







2 Comments – Post Your Own

#1) On July 14, 2010 at 11:44 AM, catoismymotor (< 20) wrote:


I'm in complete agreement with you about commerical real estate. The general public is totally clueless about this bubble that is bound to burst. For the owners of the property this is a pending disaster. A benefit that see from a prospective business owners point of view is the property might cost less to buy or lease, making that expense less. Right now I have my eye on some offices for rent. I will check them occasionally to see if the cost of rent is decreasing. I just started collecting flyers and retail rental websites for this purpose. Oh, and to clear up a point: I am a small business owner. I run it out of my house/P.O. Box. My wife and I are looking to set her up in businees, will need an real office for it.

Residential real estate is also due for another downward correction due to all the shadow foreclosures that will enter the market and the fact that homes will not move if no one is willing to lend. The value of our home has dropped around 10% since March, when we closed on our refi. Scary, eh? The reason is all the foreclosed houses in our neighborhood and the surrounding area than are entering the market, driving down the average price. Aye, it sucks. And will suck worse before long.


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#2) On July 14, 2010 at 11:49 AM, catoismymotor (< 20) wrote:

P.S. - I think a double dip is on the way and have planned accordingly. Lessons learned the hard way in 2008 are being put into action. :)

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