Fire or Ice in 2010?

Fire and Ice

Some say the world will end in fire,
Some say in ice.
From what I’ve tasted of desire
I hold with those who favor fire. . . .

— Robert Frost

Happy New Year, everyone!  Over the holidays, I spent some time  reading economic news, trying to figure out what’s happening,  and how it will affect the commercial real estate industry this year.  (As have you, probably.)

A lot of folks think that the federal government’s actions in 2009 and 2010  to “print money” to support the economy ultimately will result in inflation, or even hyperinflation.  Another group predicts deflation, as fewer buyers of various goods and servicers mean less demand, and more competition to make sales.  What if they’re both right?

It’s pretty clear from publicly available statistics that in real terms we did not grow the economy in 2009:   almost all of the GDP growth last year was triggered by the government stimulus, and not by private demand.  At least, that’s the view of a lot of economic pundits, including for example Stephen Pearlstein of the Washington Post, and’s own Robert Knakal.

I’m not an economist, but for what it’s worth, it looks like we might be heading into a period of both inflation and deflation:  inflation in necessities, commodities, interest rates and any supply constrained goods or services(which always seems to include anything I want to buy!); and deflation in the areas where there is an oversupply or room to lower costs.  

And we don’t have much growth coming from the private sector, so “stagflation”, an economic condition of slow growth and high unemployment  prevalent in the 1970’s,  may revisit us.  It was not fun the first time, and, like the color combination of harvest orange and avocado green so beloved then,  probably won’t have improved with age.

Unfortunately, commercial real estate looks like one of the deflationary sectors.  The 2010 prognosis looks poor, even though I expect more deals will get done than in 2009.   It looks like we’re heading into a time of price discovery as CMBS and other loans come due  or default, and owners can no longer fund the expenses of properties whose actual cash flow is coming short of their earlier projections.  (CMBS loans are reportedly at their highest default rate ever, over 6%, as reported by Jon Prior at Housing Wire.)

The last few years of construction may not have looked like overbuilding at the time because consumer sales were driving the economy, burning easy credit (including HELOCs).  But the growing number of hotel, broken condo and retail foreclosures suggests an overvaluation pattern more like the late 1980’s.  Virtually every business’ forecast of the demand for its own goods or services — and the space it would need to sell them — was too high.  These forecasts were based on faulty assumptions about continuing consumer purchasing power and easy credit.   Technology shifts like telecommuting, office sharing, internet shopping, videoconferencing and the like will continue to make more efficient use of commercial real estate, diminishing the need for offices, retail and hotels.

CRE values have sunk — no one knows exactly how far, but 40 – 55% off the peak is mentioned frequently.  Owners and lenders are generally, and understandably, reluctant to do deals at corrected low prices which would cost them money (or in the case of lenders force recognition of losses).  Still, eventually owners get tired of carrying properties, and loans come due.  Barring massive additional government stimulus directed at CRE,  circumstances will slowly forcibly close the bid-asked gap, at least on some deals.  That’s when price discovery will occur, and buyers and investors will become more likely to act. 

For players in the industry, the slow freeze of 2009, where so few deals were done, should thaw somewhat in 2010.    As time forces sellers’ hands, we’re starting to see more deals:  smart sellers with multiple properties are making triage decisions about which ones to hold on to, and which to sell to generate cash (or staunch the bleeding cash flow) so that they can survive this great recession.  Buyers are starting to buy properties and notes — though with significant discounts to face value, and at prices where a return is virtually guaranteed (even factoring in the cost of foreclosing in note sales).  Careful underwriting is back, and unlikely to change for some time.

On the legal side, this shift from a seller’s to a buyer’s market is leading to more careful  negotiation of deal terms, more attention to completing careful diligence, longer time periods for diligence and stronger representations, warranties and indemnities from sellers.  Perhaps as an industry we’re all shutting the barn door after the horse already ran away, but it’s an understandable reaction to the excesses of the last few years.

So, freely acknowledging my lack of an economics degree, I will put on my mystical “Deal Doer” turban instead, and predict that 2010 will be  a lot like 1992 was in California.  We’ll see  some deals, mostly heavily distressed/discounted, and the deal volume gradually will increase as the new reality of lower prices sinks into everyone’s consciousness.   The big unknown is what steps the government might take, if the downturn in CRE values appears to threaten the stability of the banking system or starts to cause a second downturn.  Fundamentally, and unfortunately, governmental intervention in real estate generally seems to be designed to keep real estate prices inflated even if that means rewarding folks who took inordinate risks.  The argument is that such support provides a slower and arguably softer landing, but it risks serious stasis, as in Japan and our own 1970’s stagflation, and I think is misguided.  Ultimately, just like the sun comes out after the rain, the CRE industry will eventually bounce back after price discovery.  Assets will find new prices, and new uses — people and businesses still need roofs over their heads.  Many owners and lenders will realize their losses.  Some sharp buyers will snap up deals.   But all of that can’t happen until the market is allowed to work to reset prices down to rational levels, and the overall business climate improves.

UPDATE:  Thursday January 7, 2010:

I just attended the Jones Lang LaSalle Forecast 2010 event in downtown LA this morning.  JLL fielded a strong array of speakers who have a considerably  more optimistic view of current economic conditions than I do. 

Notably, JLL’s Global CEO, Colin Dyer, informed the gathered real estate luminaries that JLL’s worldwide offices are seeing (1) a strong recovery in most Asian CRE markets driven by the economic expansion there; (2) a slower recovery in Europe, led by the historically strong commercial areas in London and Paris; and (3) the US CRE markets generally lagging, but picking up in coastal markets first.  Bob Hertzberg, former speaker of the California State Assembly, pointed out that 7 of the worst markets in the US are in California.

Richard Weiss, EVP and Chief Investment Officer of City National Bank was also generally positive, opining that the US economy is in recovery mode, and predicting that the recovery would be strong enough that the Fed would allow interest rates to start rising in April. 

Generally, the consensus view from the speakers at the JLL 2010 Forecast was that perhaps the lack of pressure on banks to recognize losses and foreclose, coupled with massive governmental stimulus, might in fact be creating a relatively soft landing — with CRE prices falling 35 – 55% from peak, but without an overcorrection.  Time will tell.


8 Responses to “Fire or Ice in 2010?”

  1. 1 Dave Collins January 8, 2010 at 5:30 pm


    For the last year, I have been an avid reader of all the columns and comments by “pundits and experts” on the CRE market. I must say that your comments strike me as on point. Remember, all of the experts that your heard at the JLL conference were the same folks who were happily investing clients money at the peak of the boom. My advice–ignore all advice! Buy solid real estate based on fair pricing on realistic underwriting assumptions and ignore everything else.

    • 2 mauraboconnor January 13, 2010 at 5:33 am

      Thanks for your comments, Dave. I agree with your opinion that buying solid real estate based on realistic underwriting assumptions — and I’d add, after careful diligence — is the best way to go in all markets. That approach always is safest in the long run, though not that much fun to do in a boom like the last several years.

      Best regards,


  2. 3 Robert Hernandez January 24, 2010 at 4:24 pm

    Hi Maura,
    I do agree with your “economic” outlook. While experts feel they have a grip on things at times, it always amazes me to see the reality play itself out. I am the consumate optimist. I always tend to see the glass as half full rather than half empty. As a Real Estate investor since the early 1980’s I can say for a fact that it will be a long time coming before we see these types of deals hitting the market. Specifically in larger multi-family projects. In one particular market I am amazed to see something so rare — income properties pricing dropped down to early 1990’s prices, yet rent rates remained higher in the 2009’s pricing with a strong rental market in place. This is a basic recipe for strong cashflow and great returns. It is my prediction that we will see a larger than usual volume of multi-family purchases taking place this year as the private investing sector wakes up the the real potential in this area. While commercial lenders struggle to stay alive and try to lend, it will be private competition that will help pave the way to adjusted regulation that allows commercial lenders to open up the financial faucets a little more! Anyway, thanks for your article it was a very pleasant read!

    Robert Hernandez
    Royalmark Management, Inc.
    Real Property Performance

  3. 4 Greg E Schecher February 1, 2010 at 5:57 pm


    The markets are segmenting into quite distinct categories delineated by basic underwriting fundamentals. Assets that are well located and posess a viable leasing franchise will be rewarded with capital. The lesser assets( for the most part) will have limited acsess to third party capital. Therefore the divide between good and bad will widen considerably until the economy improves and unemployment decreases.Eventually the divide will narrow as demand increases and capital is prevelant in the markets once again. During the interim transactions will ocurr from the top down. This process could very well take 5 years to stabilize. If goverment continues to interfere then the time it takes to recover will be extended. The name of the game is to play under the hoop as long as you can.

  4. 5 tony wood February 3, 2010 at 8:26 am

    Maura: Your Fire and Ice article does an excellent job presenting an overview of what we have in store. Unfortunately, the new mantra of CRE investment “get back to the fundamentals” is only available to the few who are left. Many have been taken out of the game permanently and it’s too late for them to heed that advice. Everyday I am contacted by yet another owner who purchased or developed over the last five years who is drowning in a sea of debt with few options available to them and none that will result in recovery of their lost equities. The lenders I work with are still holding out as long as possible with their special assets and REO dispositions for obvious reasons.

    So many will be burned by that proverbial fire; the countless CRE investors and developers who have lost everything; the lenders whose indulgences are resulting in hundreds closing their doors permanently over the next few years and finally, the taxpayers after the next round of inevitable bailouts this time for the commercial real estate industry. Much of the activity this year will be limited to the buyers of distressed assets (properties and debt). I know the institutional investors will find a way, but the smaller CRE investors and the owner-users who own the buildings they house their businesses in; they will feel the heat of this fire the most for years to come.

    Tony Wood, Sr. Vice President
    TRI Commercial Real Estate Services

    • 6 mauraboconnor February 23, 2010 at 6:09 am


      Thanks for writing. Everyone, Tony has a book on the crisis in CRE lending coming out in April called “The Commercial Real Estate Tsunami”, which is being published by Wiley (the “For Dummies” publisher). I hope to profile it shortly in the blog.

      Best regards,


  5. 7 Don't Kid Yourself February 9, 2010 at 10:25 am

    “But if it had to perish twice,
    I think I know enough of hate
    To say that for destruction ice
    Is also great
    And would suffice.”

    Robert Frost, Fire and Ice

    When it comes to this downturn, don’t forget all the currency manipulations that are going on globally (Think China) and don’t kid yourself that there are others who are at war ($$$$$) with us other than those in Iraq and Afghanistan.

  1. 1 uberVU - social comments Trackback on January 18, 2010 at 12:00 am

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Attorney Advertising. This blog is a periodical publication of Maura O'Connor, a partner of Seyfarth Shaw LLP and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. You are urged to consult a lawyer concerning any specific legal questions you may have. The contents are intended for general information purposes only and represent the individual views of Maura O'Connor only. Any tax information or advice contained herein is not intended to be and cannot be used by any taxpayer to avoid tax penalties that may be imposed on the taxpayer.

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