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U.S. Commercial Real EstateProject
PIMCO
In 2005, PIMCO’s Investment Committee dispatched the firm’s
mortgage team to the top 20 U.S. housing markets in a boots on
the ground effort to assess the leverage-fueled housing boom.
The Housing Project was born and it led to our forecast for an
unprecedented decline in residential home prices. What we
learned was critical to PIMCO’s navigation of the credit crisis
on behalf of our clients.
The commercial real estate market shares most of the sins of
its residential cousin – extremely weak loan underwriting,
excessive leverage and the absence of risk management from
both banks and rating agencies. So PIMCO undertook
the Commercial Real Estate Project to understand
local real estate dynamics on the
front lines in ways not revealed
in the published data, to better
understand how the current cycle
is different from previous cycles
and to inform asset selection in
local markets.
June 2010
PIMCO U.S. Commercial Real Estate Project
2June 2010 3
Recognizing that commercial real estate (CRE)
property-level fundamentals continue to decline and
capital markets are changing rapidly, PIMCO portfolio
managers and analysts fanned out across 10 cities to
conduct on the ground research. Our teams met with
over 100 industry representatives, including local
investment sales advisors, leasing brokers, CRE lenders,
special servicers, real estate developers and property
owners across the largest commercial sectors – office,
industrial, retail, hotel and multifamily. Through
these meetings, we developed a real-time view of local
conditions and insights into key assets.
Summary of Key Findings: 1. Capital is clearly returning to commercial real
estate, helping to stem the value decline in the
sector. But optimism should be tempered, because
national price indices are misleading when
transactions are limited and fail to reflect the
significant uncertainty around property valuations.
2. Changes in the structure of capital markets –
notably the proliferation of complex securitizations
since the last CRE crisis in the early 1990s – will
lengthen the deleveraging process and suppress
a recovery. The impaired ability to transfer CRE
risk out of the banking system relative to previous
cycles makes a stable, let alone a V-shaped, recovery
unlikely. Instead, many CRE assets likely will not
return to 2007 prices until the end of this decade.
3. Macroeconomic headwinds such as limited GDP
growth in the U.S., elevated unemployment,
potential re-regulation and a secular increase in the
savings rate will force the market to re-evaluate the
assumptions it has used to price CRE. These trends
severely affect the outlook for rents, vacancies and
capitalization rates, highlighting the downside
risks that remain in CRE.
We believe that the CRE market faces significant
uncertainty around valuations that will affect the
prospects for recovery. Investors therefore should
proceed with caution when examining the complex
opportunities that are surfacing. Considering the
complexities introduced by capital markets since
the last CRE crisis, any approaches to analyzing
and investing in this market will need to depart
significantly from those of previous cycles.
All That Glitters Is Not Gold Capital has returned to CRE and high levels of bidding
activity in certain sectors have made many observers
and participants optimistic. Transactions have
generally been limited and capital flows have been
concentrated in trophy properties and in properties
where below-market Agency financing is available.
This has provided a false sense of clarity on the real
level of property values. A significant volume of weaker
and distressed assets has yet to be liquidated and this
foreshadows further pressure on values. Against this
backdrop, we caution against the presumptions that a
rapid broad-based recovery is underway.
Capital is BackAccommodative monetary policy and increasing levels
of liquidity have ushered in the return of both equity
and debt capital to the commercial real estate sector.
Not surprisingly, capital has returned to the most liquid
sectors of CRE first – public equities through Real Estate
Investment Trusts (REITs) and commercial mortgage
backed securities (CMBS). REITs were successful in
raising over $24 billion of equity and issuing $10 billion
of debt in 2009. As shown in the chart following, from
the first quarter of 2009 to the first quarter of 2010, the
inflow of capital into REITs and CMBS drove REIT prices
up over 96% and tightened super senior CMBS tranche
spreads (the most senior class of CMBS) by nearly 70%.
3
Capital is Chasing CRE Assets
Spre
ad to
Sw
aps
(bps
)
Inde
x Va
lue
CMBS Super SeniorDJ Equity REIT Index
1,000
900
800
700
600
500
400
300
200
215
190
165
140
115
90
Mar-09
May-09
Apr-09
Jun-0
9
Jul-0
9
Aug-09
Sep-09
Oct-09
Nov-09
Dec-09
Feb-10
Jan-1
0
Mar-10
Apr-10
May-10
Source: Bloomberg, PIMCO
On the debt side, insurance companies are actively
looking to finance quality properties, former Wall Street
investment conduit groups are re-forming and several
private debt vehicles are raising capital.
Transaction activity has resumed in earnest for
relatively liquid assets such as stable, trophy properties
in major markets. Investors and lenders have
aggressively returned to major markets, including
Manhattan and Washington, D.C., where demand
from foreign capital has led to recent office trades that
have been completed at capitalization rates (annual net
operating income divided by property value, or in other
words, the current yield at which a property trades) and
per-square-foot values close to the peak prices seen in
2006 and 2007.
Buyer demand has also returned for multifamily
properties financeable through Fannie Mae and Freddie
Mac’s longstanding lending programs. While loan
terms have become significantly more conservative in
CRE over the past two years, Fannie Mae and Freddie
Mac continue to offer financing terms reminiscent of
those offered in 2007. This attractive financing has led to
transactions pricing at 2005-2007 levels in the 5% to 6%
cap rate range.
Values Bottom, But Recovery Will Be SlowIn response to the recent surge in bidding levels for
lower-risk “trophy” CRE assets, both equity and debt
capital have begun to migrate along the risk curve
in search of yield. Indeed, well capitalized REITs
are once again looking to acquire assets and several
private equity funds are actively searching for new
acquisitions, even in challenged markets.
Today, buyer yield requirements imply that CRE asset
values have generally declined 35% to 45% from their
peak levels in 2007 - a marked improvement over early
2009, when buyer yield requirements spiked to levels
that implied a value decline of over 50% from 2007. We
caution against the presumption, however, that this
implied improvement in CRE asset values portends
a rapid recovery in actual CRE asset prices. Instead,
as over $500 billion of over-leveraged CRE properties
slowly reach the market through lender dispositions or
restructurings, we expect general CRE asset prices to
remain 30% to 40% below 2007 peak pricing levels for
three to five years.
PIMCO U.S. Commercial Real Estate Project
4June 2010 5
Have We Reached Bottom?
Moo
dy's
CPP
I Lev
el, D
ec 2
000
= 10
0
90
110
130
150
170
190
210
Source: Moody’s CPPI, Real Estate Analytics LLC as of 5/31/10 Dec
-00
May-01
Oct-01
Mar-02
Aug-02
Jan-0
3
Jun-0
3
Nov-03
Apr-04
Sep-04
Feb-0
5
Jul-0
5
Dec-05
May-06
Oct-06
Mar-07
Aug-07
Jan-0
8
Jun-0
8
Nov-08
Apr-09
Sep-09
Feb-1
0
The point here is that transaction activity in trophy
properties and Agency-debt eligible multifamily
properties should not be considered a leading indicator
of a broad-based recovery in CRE asset values. Recent
transactions imply a rapid recovery to 2007 pricing
levels; however, these asset classes face risk of future
value declines. In the case of the aforementioned
Washington, D.C., office properties, for example,
PIMCO met with several local investors who were
perplexed by the extent of non-U.S. capital funneling
into their market. This reliance on non-U.S. capital
for rapid appreciation highlights the potential for
exogenous factors to drive CRE values at the local level.
For multifamily properties, a small change in loan
terms would have an immediate effect on multifamily
asset prices given the significant reliance on Fannie Mae
and Freddie Mac for financing.
Misleading Indices National price indices such as the Moody’s Commercial
Property Price Index (CPPI) can provide misleading
indications of a recovery in CRE asset price levels. Since
November 2009, the index has rebounded 3%.
While it is natural to draw comparisons between the
CPPI and the S&P/Case-Shiller index used to gauge
residential home prices, we caution that indexes such as
the CPPI are relatively meaningless in today’s limited
transaction environment – commercial real estate
transaction volume fell nearly 90% from 2007 to 2009.
Our ride along meetings highlight another limitation
of the CPPI. Based on repeat transactions, the index
excludes the truly distressed or overpriced properties
acquired in the past few years that have yet to trade, and
is instead skewed by the high proportion of trophy asset
and Agency-financed multifamily transactions. In fact,
for every broker story regarding a bidding frenzy for a
trophy asset or multifamily property, our team heard
of multiple instances of owners embroiled in workouts
5
on properties they believe to be worth less than 50%
of peak valuations. When these distressed properties
finally do trade, they will have a disproportionate
effect on the CPPI. For example, the CPPI index price
change in March 2010 was based on only $1.7 billion
of transactions. By contrast, a single deal, the highly
publicized Stuyvesant Town property in Manhattan,
sold for $5.4 billion in 2006. If this property were to
liquidate today (the property is currently in default),
many estimate that it would sell for 60% less than its
2006 purchase price.
The Long, Long Road to RecoveryThe development of increasingly complex capital
structures since the 1990s without accompanying
policies to efficiently resolve conflicts implies that the
deleveraging process will take far longer to play out in
this cycle. In addition, as regional banks are forced to
recognize losses on their construction loan portfolios,
eventual dispositions will do little to speed a recovery
or clarify property values. The drawn out resolution
process for both complex securitization structures and
regional loan portfolios makes the prospects for a quick,
V-shaped recovery unlikely. Instead, many assets may
not return to their peak 2007 values until the 2020s.
Deleveraging: A Messy Unwind The often byzantine debt and equity structures that
evolved over the last decade will take significantly
longer to unwind than the distressed CRE inventory
of the 1990s, because securitization has changed
the primary holders of CRE risk. This prolonged
deleveraging process is expected to result in a sustained
period of limited price transparency and risk aversion.
In the last major crisis, CRE was relatively isolated from
the broader economy. The rally and subsequent fall
was spurred by tax-driven oversupply. Furthermore,
CRE capital structures were straightforward,
consisting of senior lenders (savings and loans, thrifts
and banks) and private borrowers. Considering the
relative isolation of CRE risk holders, the FDIC was
able to contain the fallout. The FDIC spearheaded the
rapid transfer of CRE risks through the creation of
the Resolution Trust Corporation (RTC), which used
tools such as bulk sales, equity partnerships with a
private sector partner and, ultimately, securitization to
restructure and sell risk.
Flash forward: the evolution of CMBS, large loan
syndications, mezzanine debt vehicles, collateralized
debt obligations (CDOs) and private equity funds has
greatly added to the complexity of the capital landscape.
As such, the risk holders on a property today frequently
include hundreds of direct and indirect owners across
the capital structure, often with conflicting interests.
In CMBS, for example, subordinate bond classes have
approval rights regarding loan workouts that lead
PIMCO U.S. Commercial Real Estate Project
6June 2010 7
to a preference to extend loans rather than initiate
foreclosure proceedings. Conflict arises when a
foreclosure would maximize recovery to the trust but
would wipe out the subordinate bondholder’s principal.
All of this will serve to limit the speed and effectiveness
of previous deleveraging strategies, dragging the
unwinding process out for years and limiting visibility
on the level of a bottom in property values. Indeed,
many of the CRE law firms that we met with said
their loan restructuring assignments have become
significantly more complicated than previous cycles due
to the higher number of participants within a property’s
capital structure.
Higher Cap Rates Here For the Long TermWe expect that the spread between cap rates and 10-year
Treasuries will remain above its average of 265 basis
points seen since 1995, as the litigious deleveraging
process leads to a sustained period of risk aversion in
the sector.
As shown in the accompanying chart, the 10-year
forward curve implies that 10-year Treasuries will
approach 5% over the next several years. If cap rate
spreads remain above their average, the market can
expect long term cap rates near or above 8%. In this
case, even if properties with floating rate debt can
successfully avoid defaults in the short term, rising
longer term rates will create a floor for cap rates and
limit recoveries.
Small Loan Dispositions Offer Little ClarityWhile evolving U.S. guidelines and a low fed funds rate
allow banks to employ a “pretend and extend” strategy
for the resolution of troubled commercial loans, large
volumes of construction loans are expected to force
a day of reckoning for many regional banks. Banks
cannot keep listing construction loans as performing
when the reserves they must carry against them are
depleted and borrowers refuse to contribute new
capital. Similarly, CMBS special servicers will likely
sell portfolios of small non-performing CMBS loans, as
these loans are not profitable for the servicer to resolve.
Loan portfolio dispositions will likely lead to an
increase in transaction volume relative to 2009;
however, portfolio sales of small, non-performing loans
give little clarity to values overall. For example, in an
FDIC sale that took place in early 2010, only 41.5% of
a $1 billion portfolio consisted of loans backed by
traditional commercial real estate properties. The rest of
the loans were backed by assets such as land, car washes,
churches and funeral homes – not exactly a useful
comparable for assessing the value of office buildings.
A Brief Comparison to JapanThe broader success of transferring CRE risk out of the
banking system will also drive the timing of recovery.
Consider Japan, where zombie banks – financial
institutions that continue to operate despite severely
impaired balance sheets – held on to underwater loans
for years because they were not forced to mark to market.
This led to a sustained period of limited price discovery
and a prolonged downturn where values did not bottom
for more than 10 years after the decline began.
Higher Expected Treasury Yields Put a Floor on Cap Rates
Perc
ent (
%)
Cap Rate 10-Year UST Yield
Source: Bloomberg, Property and Portfolio Research
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
1995
Q1
1997
Q1
1999
Q1
2001
Q1
2003
Q1
2005
Q1
2007
Q1
2009
Q1
2011
E
2013
E
2015
E
2017
E
2019
E
7
Where’s the V?
Inde
x Le
vel
0
50
00 01 02 03 04 05 06 07 08 0910E11
E12
E13
E14
E15
E16
E17
E18
E19
E20
E21
E
83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
100
150
200
250
200
Source: Moody’s, MTB-IKOMA Real Estate Investment Index, ESRI, Bank of Japan, PIMCO as of Q4 2009
U.S. Timeline
Japan Timeline
Bearish Projection - Japan style recovery
Bullish Projection - 1990's U.S. style recovery
U.S. CPPI Index: Actual 2000-2007 (bottom axis)
Japan MTB-IKOMA CRE Index: Actual 1983 - 2004 (top axis)
We hope that the lessons learned from the Japan crisis
will help the U.S. avert some of the fiscal and tax
policies that led to Japan’s “lost decade.” Parallels can
certainly be drawn, though, between Japan’s policies
regarding bank recognition of CRE loan losses and the
U.S. government’s recently relaxed bank guidelines.
As we learned through meetings with CRE brokers
and consultants, many regional banks continue to find
ways to avoid marking loans to their current value.
For example, several brokers told our analysts of cases
where a bank loan officer would specifically direct a
broker to provide only a verbal opinion of value on a
property financed by the bank, presumably to avoid any
documentation that would force recognition of a loss.
The accompanying chart extrapolates and compares
a recovery that mirrors Japan’s CRE lost decade cycle
versus a recovery scenario based on the U.S. recovery
in the 1990s, where the FDIC forced a rapid transfer of
CRE risk through the Resolution Trust Corporation.
Interestingly, as veterans of the 1990s will attest, even
that recovery was far from V-shaped in CRE.
Avoiding the PitfallsThe credit crunch of 2007 and 2008 encompassed a
large set of problems – corporate, residential, consumer
lending and, of course, commercial real estate. As
a result, CRE will most likely not benefit from the
surge of economic growth that typically follows a
cyclical downturn. Instead, the market – and indeed
the broader economy – will be exposed to a whole
new set of obstacles to recovery on the path to a New
Normal: limited GDP growth in the U.S., a stubbornly
high unemployment rate, potential re-regulation and a
secular shift in the savings rate that results in reduced
consumption. Accounting for and understanding the
effect these macroeconomic
trends will have
PIMCO U.S. Commercial Real Estate Project
8June 2010 9
Of�ce/Industrial Net Operating Income Lags GDP
Qua
rterly
NO
I Gro
wth
(%)
Qua
rterly
GD
P G
row
th (%
)
85-Q
487
-Q4
89-Q
491
-Q4
93-Q
495
-Q4
97-Q
499
-Q4
01-Q
403
-Q4
05-Q
407
-Q4
09-Q
4
1.5
1.0
0.5
0
-0.5
-1.0
-1.5
-2.0
2.5
2.0
1.5
1.0
0.5
0
Quarterly NOI Growth (2yr lag) Quarterly NOI Growth Quarterly GDP Growth (RHS)
Source: Bloomberg, Property and Portfolio Research
Source: Property and Portfolio Research
National AverageYearly Rent - 2007
National AverageYearly Rent - 2009 % Change
Apartment (per unit) $16,238 $15,142 -6.8%
Office (per square foot) $26.99 $24.28 -10.0%
Retail (per square foot) $20.02 $17.76 -11.3%
Industrial (per square foot) $5.26 $4.63 -12.0%
on rents, vacancies and cap rates will be key to avoiding
the pitfalls to recovery in CRE, where many assets will
continue to decline in performance and value over the
next three to five years.
Rents Are Down More Than Reported…Market reports on industry fundamentals such as
vacancy rates and rental rate changes are misleading
in a limited leasing environment. PIMCO’s interviews
with leasing brokers and property owners across the
country paint a significantly more sobering picture of
the rental environment than market reports show.
Property and Portfolio Research (PPR) reported
meaningful declines in nationwide asking rents,
shown in the accompanying table. These clearly
illustrate a decline in performance across all real estate
sectors; however, these measures fail to capture the
extent of the concessions landlords are offering to
attract and retain tenants.
Effective office rents, (rents net of concessions such as
free rent and temporary rent breaks) have dropped
much further than asking rents. According to Reis Inc.,
a commercial real estate information provider, asking
rents in the Manhattan office market were down more
than 20% at the end of 2009 from the peak in the fall
of 2008. However, our interviews with leasing brokers
suggested that effective rents in those same areas have
declined by as much as 40%. Not surprisingly, landlords
are hesitant to disclose concessions because doing so
could incentivize savvy tenants to negotiate better
terms. This makes accurately tracking effective rents
nearly impossible.
…With More Declines to ComeAlthough nominal GDP growth turned positive during
the third and fourth quarters of 2009, property cash
flows are poised to decline for the next one to two years
as expiring leases reset at lower levels. This lag effect is
evident in the office and industrial sectors, where the
strongest historical correlation between nominal GDP
and cash flows occurs on a two year lag.
In addition to the demonstrated lag effect between
GDP and CRE cash flows, severe real estate value
corrections can create other, less obvious sources of
rent pressure. For example, sophisticated tenants have
become increasingly concerned about zombie buildings
where the current owner has negative equity and little
incentive to maintain a property. In fact, several leasing
brokers told us that, for the first time in their careers,
they are seeing tenants demanding detailed financials
on the landlord. Over-leveraged properties financed
with CMBS loans are particularly vulnerable to being
deemed as zombies, because brokers representing
9
Annual Rent Growth Rises as Vacancies Fall
15
10
5
0
-5
-10
-158 10 12 14 16 18 20 22
Offi
ce R
ent G
row
th (%
)
Vacancy Rate (%)
Vacancy Rateas of 1Q 2010
Vacancy Rate15-year Average
Source: Property and Portfolio Research top 54 MSA rent and vacancy averages
large tenants are able to access the specific financial
information for these assets. Thus, potential tenants
will be able to actively avoid these buildings, further
pressuring property values.
Should foreclosures accelerate and more landlords give
back the keys on underwater properties, the lower cost
basis for buyers of these distressed properties would
reduce the rent required to generate desirable returns.
These basis resets would have a marked effect on local
area rents, requiring special attention to potential
property value shocks and a detailed knowledge of
equity positions in nearby properties.
Interviews with retail property owners also highlight
the continued challenges landlords face. Retail owners
may have been able to prop up occupancy levels by
converting struggling tenants to a percentage rent
structure; however, performing anchor tenants will
eventually demand rent reductions as well. Several
retail owners that we met with indicated that even
performing anchors are attempting to negotiate lower
rent structures, as these tenants recognize that they are
often the key to a property’s viability.
Elevated Vacancies Lean on ValuesGiven the sharp drop in real estate values, commercial
real estate development (i.e., new supply) is expected
to remain limited for several years. Long term changes
in employment will result in depressed demand as
well, stifling absorption of vacant supply. In markets
such as Phoenix, finance- and real estate-led growth
in office employment will remain muted for years, as
many of these jobs were ancillary to the construction
industry. Thus, secular changes in office-using
employment will keep vacancy rates above historical
averages for several years, even in a limited
supply environment.
According to PPR, vacancy rates in the first quarter of
2010 were almost 20% on a national level, the highest
level in 20 years and well above the average 15% rate
seen over that same period. Even with limited new
supply, we expect vacancy rates to stay consistently
above trend, ultimately limiting office rent growth
over the secular horizon. As the accompanying table
highlights, rental growth doesn’t meaningfully increase
until vacancies fall well below the historical average.
A Rising Tide Will Not Lift All Boats Long term changes in consumption and savings
patterns have specific implications for properties tied
to consumer spending, such as the luxury hotel and
upscale retail sectors. PIMCO’s expectation for a long-
term increase in the savings rate suggests the potential
recovery for these asset classes will be constrained as
consumers reduce discretionary spending habits.
Despite recently reported increases in hotel revenues
relative to the first quarter of 2009, many luxury hotels
may not see their room rates reach 2007 levels for
several years and many full-service hotels will
struggle to maintain profitability in low margin
business lines such as spa and restaurant services.
PIMCO U.S. Commercial Real Estate Project
10June 2010 11
* EstimateSource: SEC
2008 2009 YOY
ChangeYOY
Change
Saks Inc.
Tiffany & Co.*
Nordstrom, Inc.
Macy's
Retailer Sales per Square Foot
-14.4%
-9.6%
-5.2%
-5.0%$152
$368
$2,759
$351-6.6%
-10.7%
-10.8%
-5.3%$160
$388
$3,051
$410
To the extent hotel revenues decline further, the
negative effects on property net cash flows will become
increasingly amplified as fixed costs consume a greater
proportion of operating expenses. Many of the full-
service hotel operators that we met with confirm that
they have already “squeezed out” most of the possible
fixed cost savings in 2008 and 2009, as certain costs
such as insurance and real estate taxes cannot be
reduced further.
Certain retail properties could also struggle in the New
Normal. Many retail properties built in anticipation
of large housing developments will simply suspend
operations, because sustained reductions in the home
ownership rate mean that many planned housing
developments will not restart for years.
Luxury retail properties may also struggle in this
environment. Retail rents are often structured to
include a base rent and a percentage rent (overage) that
is tied to store sales. This direct link between rental
rates and store sales highlights the sensitivity of luxury
retail properties to both short term drops in sales
and long term reductions in discretionary spending.
The chart below illustrates the challenges that luxury
retailers faced in 2009.
Re-regulation: Another RiskAn increasingly uncertain regulatory environment may
also constrain the recovery of CRE values. Recently
proposed regulatory and accounting rule changes
(such as FAS 166 & 167, which impact the off-balance
sheet treatment for securitized assets) may reverse, or
at least limit the re-emergence of traditional conduit
lenders. Federal proposals to date have not clearly
addressed risk retention requirements for CMBS
issuers and the uncertainty around future regulatory
pressures may negatively affect the economics of new
securitization. Without further clarity on these issues,
limited securitization will deprive CRE markets of an
important source of capital.
Spotting the Opportunities As the deleveraging cycle unfolds, attractive
opportunities are likely to be available to investment
platforms with the flexibility to access CRE
opportunities across the capital landscape and who can
provide liquidity over the long term. The slow recovery
cycle, however, favors patient investors who understand
the relative value dynamics of both capital structures
and asset profiles.
We conclude by looking at some of these opportunities:
FDIC Dispositions – Regional and community
banks are particularly sensitive to both national and
local economies and have been acutely affected by
the distress in residential and commercial real estate
markets. There were 140 bank failures in 2009 and
an additional 78 through May 2010, representing
approximately $240 billion in assets.
Troubled banks have suffered losses on their CRE loan
portfolios and eventually will be forced to transfer
these risks off their balance sheets either through
11
FDIC assisted transactions or voluntarily ahead of
receivership. Historically, intensive risk transfer
environments have provided opportunities for
investors to acquire distressed loan portfolios. Recently,
the FDIC has also indicated that it will consider
securitizations of bank CRE loan portfolios.
While bank loan dispositions may offer compelling
opportunities to acquire loan pools at discounts, we
caution that these opportunities are complex. The
limited transaction time frames and non-institutional
nature of the underlying collateral requires investors
to have both the experience and infrastructure to
underwrite and manage large pools of loans efficiently.
Restructuring of Large CRE Loans – Most of the
private-equity-fueled mega deals of 2006 and 2007 are
just beginning to unwind. As large CRE loans mature,
lender syndicates that own the debt will look to exit or
restructure. Property recapitalizations, including loan
restructurings (where a new investor contributes capital
in exchange for a reduced senior loan principal balance
and a preferred equity position), can provide investors
with a lower cost basis and a share of the upside
returns. However, these types of restructurings are
complex transactions that will require investors to have
substantial capital to participate in larger deals, as well
as relationships with both lenders and borrowers.
CMBS Opportunities – Many traditional buyers of
subordinate CMBS tranches, including mortgage
REITs and special servicer affiliates, have disappeared,
creating an opportunity for new investors to acquire
discounted subordinate positions and potentially
influence the outcomes of CMBS-securitized loans.
Also, constantly shifting spreads among bond classes
create arbitrage opportunities for investors who
understand the relative risks between various bond
classes and CMBS deals.
Relative Value Opportunities – Capital flows alone
should not be a gauge of where attractive investment
opportunities lie. As mentioned earlier, many owners
in primary markets are perplexed by the extent of
non-U.S. capital flowing into their markets. With this
in mind, new investors should not expect a continued
rapid appreciation in pricing for trophy assets in these
markets. Conversely, owners of grocery-anchored
retail assets in smaller markets express frustration in
securing financing today, despite strong tenant profiles
and positive demographics. As capital returns to CRE,
we expect this yield spread (as reflected by cap rates)
between trophy assets and less liquid, quality assets in
smaller markets to eventually tighten.
As with any market that is undergoing unprecedented
change, attractive opportunities will exist for the
prudent and disciplined investor. Though difficult
to measure in a limited transaction environment,
commercial real estate valuations have clearly returned
to more rational relationships with property-level
fundamentals. However, the deleveraging cycle and
structural headwinds will result in a slow recovery
with pockets of volatility to be expected. Extreme
discipline in assessing both the asset level and
macroeconomic risks will be critical to making the
right investment decisions.
840 Newport Center Drive Newport Beach, CA 92660 949.720.6000
Past performance is not a guarantee or a reliable indicator of future performance. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor there is no assurance that the guarantor will meet its obligations. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. Investing in distressed loans and bankrupt companies are speculative and the repayment of default obligations contains significant uncertainties.
This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2010, PIMCO. CRE001-051410
Commercial Real Estate TeamPIMCO
John Murray, Commercial Real Estate Portfolio Manager and PIMCO’s CRE/CMBS Team:
Dan IvascynScott SimonJosh AndersonJohn MurrayChristian StrackeJon Yip
Kent SmithStefanie EvansRussell GannawayJesse BrettingenBryan TsuSean McCarthy
Josh OlazabalJennifer BridwellCarrie PetersonRyan MurphyJoyce Chang