An Evolution Of The Credit Crisis

5/8/2009

A Brief Evolution of the
Coming Commercial
g
Real Estate Crisis

Tim Hatlestad, CCIM
RE/MAX Achievers and
RE/MAX Commercial Investment

© Tim Hatlestad, CCIM Tim@InvestAZ.com 1

5/8/2009

How we got in this mess

2


5/8/2009

Yield Curve

Jun‐02 Jun‐03
8.00

Fed Funds Rate: 1.75
7.00
11/6/2002: to 1.25
6.00 6/25/2003: to 1.00

5.00

4.00

3.00

2.00

1.00

0.00
3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 30 yr


5/8/2009

Yield Curve

Jun‐02 Jun‐04
8.00

6/25/2003: to 1.00
7.00
6/30/2004: to 1.25
6.00

5.00

4.00

3.00

2.00

1.00

0.00
3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 30 yr


5/8/2009

Yield Curve

Jun‐02 Jun‐05
8.00

6/30/2004: to 1.25
7.00
6/30/2005: to 3.25 (8x.25)
6.00

5.00

4.00

3.00

2.00

1.00

0.00
3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 30 yr


5/8/2009

Yield Curve

Jun‐02 Jun‐06
8.00

6/30/2005: to 3.25
7.00
6/29/2006: to 5.25 (8x.25)
6.00

5.00

4.00

3.00

2.00

1.00

0.00
3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 30 yr


5/8/2009

Yield Curve

Jun‐02 4/2/07
8.00

7.00

6.00

5.00

4.00

3.00

2.00

1.00

0.00
7
3 mo 6 mo 1 yr 2 yr 5 yr 10 yr 30 yr


5/8/2009


5/8/2009

ARMLS Total Number of Active Listings - Single Family and Condominium

When did the Phoenix/Scottsdale
50,000

Residential Market Peak?
45,000
9
40,000

35,000

30,000

25,000
25 000

20,000

15,000

10,000

5,000

0
Jan-02

Mar-02

Jul-02

Sep-02

Nov-02

Jan-03

Mar-03

Jul-03

Sep-03

Nov-03

Jan-04

Mar-04

Jul-04

Sep-04

Nov-04

Jan-05

Mar-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

Jul-06

Sep-06

Nov-06

Jan-07
May-02

May-03

May-04

May-05

May-06


10

0%

-10%
10%
20%
30%
40%
50%
60%
Jan-03

Mar-03

May-03

Jul-03

Sep-03

Nov-03

Jan-04

Mar-04

May-04

© Tim Hatlestad, CCIM Tim@InvestAZ.com
Jul-04

Sep-04

Nov-04

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06
Year over Year Median Sale Price Delta

May-06

Jul-06

Sep-06

Nov-06

Jan-07

10
5/8/2009

5/8/2009

Nationwide Commercial Transaction Volume
When did the Phoenix/Scottsdale(Trailing 12 Months in Millions)
CCIM Institute Investment Trends Quarterly (CCIM & RERC)
Commercial Market Peak?
$600,000
11

$500,000

$400,000

$300,000

$200,000

$100,000

$‐
Q4 2006
Q1 2007
Q2 2007
Q3 2007
Q4 2007
Q1 2008

Office Industrial Retail Multi‐Family Hotel


5/8/2009

Nationwide Cap Rates by Property Type
CCIM Institute Investment Trends Quarterly (CCIM & RERC)
Weighted Average Trailing 12 Months Data
8.0%
12

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%
Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008

Office Industrial Retail Multi‐Family


5/8/2009

Relative Return: Cap Rate Spread to 5‐Year Treasury
CCIM Institute ITQ (CCIM & RERC)
Cap Rate: Weighted Average Trailing 12 Months Data, Q End Treasury
4.5%
Buy
4.0%
4 0%
Low
3.5%

3.0%

2.5%

2.0%

1.5%

1.0%
Sell
0.5%
High
0.0%
Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008
13
Office Industrial Retail Multi‐Family


5/8/2009

Fannie and
Freddie buy
$81B in
03/00 Mortgage
subprime
NASDQ defaults
securities
peaks at commence
5049
Home
Declining ownership
Dot Com interest hits high
Bubble rates of 69.2%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Extremely Low Interest Rates Dramatic Housing
increase in prices begin
home prices to fall

43% of first time
homebuyers use “no
money down” loans
14


5/8/2009

Average US home 12/16
prices 20% less than Fed Funds drop to
in 2006 0.00 – 0.25% 02/25
Collapse of AIG in talks for 3rd
09/17
Bear Sterns bailout
$85B bailout
Household debt at 12MM
of AIG
127% of annual Homeowners 02/27
disposable income have negative US acquires control
i tl
09/15
equity of Citigroup
Lehman Brothers
declares bankruptcy
07/11 11/10
Oil tops $147 a AIG gets another
barrel $150B

2008 2009
J F M A M J J A S O N D J F M

8MM 09/15
02/17
07/11
homeowners BofA announces
$782B American
$32B
have negative purchase of Merrill $307B Recovery and
IndyMac Bank placed
equity Lynch WaMu Reinvestment Act
in conservatorship
h
seized by signed into law
09/08 OTS
10/03
Federal takeover of Fannie
$700B Emergency
Mae and Freddie Mac
Economic Stabilization
Act of 2008 (TARP)
signed into law
15


5/8/2009

Bank Capitalization Requirements
The Capital Ratio is the percentage of a bank’s
capital to its risk weighted assets
risk-weighted assets.

16


5/8/2009

Bank Capitalization Requirements
Capitalized
•Adequately
Tier I capital ratio of at least 4%
•

Combined Tier I and Tier II capital ratio of at least 8%
•

Capitalized
•Well
Tier I capital ratio of at least 6%
•

Combined Tier I and Tier II capital ratio of at least 10%
•

17


5/8/2009

Mark to Market Requirements
Soft Market with few Buyers

$300k $300k $300k $300k $300k
Home Home Home Home Home

18


5/8/2009


Catastrophe forces “fire sale”

$300k $300k $300k $300k
$150k
Home Home Home Home
Home

19


5/8/2009


Catastrophe forces “fire sale”

All assets “marked to market”

$150k $150k $150k $150k $150k
Home Home Home Home Home

20


5/8/2009

Actual Mark to Market Example

Expected Loss vs. Mark to Market Write-Down
•Bank holds a pool of MBS totaling $3.65 billion
•Underlying loans are NOT subprime
•Generally good quality, 17 months of seasoning, original FICO score of 749
•Subordinated collateral of $172 million exceeds worst-case loss projections

Losses on MBS Held By Bank
(in millions)

$913MM

$100MM
$1.8MM
21


5/8/2009

Mark to Market Accounting
“MTM accounting has destroyed well over $500
billion of capital in our financial system. Because
p y
banks are able to lend up to ten times their capital,
MTM accounting has also destroyed over $5 trillion
of lending capacity.”

William M. Isaac, Former Chairman, FDIC

22


5/8/2009

Glass-Steagall Act of 1933
the FDIC
•Established

•Separated commercial banks from investment banks
S d lb k f bk

23


5/8/2009

Repeal of the Glass-Steagall Act
Act of 1999
•Gramm-Leach-Bliley

24


5/8/2009

Traditional Lender Model
Deposits Financing

Depositors Lender Borrower

Interest Debt Service

Loan is Retained
25


5/8/2009

“New” Lender Model
Deposits Financing

Deposits Lender Borrower


RMBS Loan is Sold CMBS
26


5/8/2009

Residential Mortgage Backed Securities

Waterfall
Low Risk
Low Yield Prime Prime Prime $$$$
Tranche

A-1 A-1 A-1
Tranche $$

Sub- Sub- Sub- $
High Risk
Tranche Prime Prime Prime
High Yield

27


5/8/2009

Performing Banking Relationship
Real Estate
Bank
Fully Property
Capitalized Value
Core Capital
20% Equity
(Equity 10%)

Other Bank $0 Loan
Assets: Loss
Reserves 80% Debt
Stocks
(Performing)
Bonds
Loans
Real Estate

28


5/8/2009

Non-Performing Banking Relationship
Real Estate
Bank
Under Property
Capitalized Value
Core Capital
No Equity
(Equity <10%)

Other Bank $$ Loan
Assets: Loss
Reserves 100% Debt
Stocks
(Non-Performing)
Bonds
Loans
Real Estate

29


5/8/2009

Foreclosure and Real Estate Owned
Real Estate
Bank
Under Original
Capitalized Value
Core Capital
(Equity <10%)

Other Bank Appraised
$$$ Loan
Assets: Value
Loss
Reserves
Stocks Foreclosed Real
Bonds Estate
Loans
Real Estate

30


5/8/2009

“Broken” Lender Model
“New”
Deposits Financing

Deposits Lender/Servicer Borrower


RMBS Loan is Sold CMBS
31


5/8/2009

CMBS Issuances ($Bil.)
45.0
($Bil.)
6 per. Mov. Avg. (($Bil.))
40.0

35.0

30.0

25.0

20.0

15.0

10.0
10 0

5.0

0.0 32
Mar‐99 Mar‐00 Mar‐01 Mar‐02 Mar‐03 Mar‐04 Mar‐05 Mar‐06 Mar‐07 Mar‐08


5/8/2009

Subprime Mortgage Crisis

Housing Market

Cause of
Excess Housing Inability Negative
Mortgage
the
Housing Prices to Effects on
Defaults &
Housing Foreclosure
Inventory Decline Refinance Economy
Bubble

•Housing bubble •Poor lending and •Home
bursts borrowing building
•Household decisions declines
wealth declines •ARM adjustments •Rising job
Mo gage
Mortgage
losses
l
Cash Flow •Household
Declines wealth
declines

33


5/8/2009

Mortgage
Cash Flow
Declines
Financial Market

•Downward
Negative Liquidity Bank
pressure on
Bank Bank
Effects on Crunch for Capital
business
Failures Losses
investments Depleted
Economy Businesses
•Increasing
unemployment
•Stock market
•Harder to get •Washington Mutual •Loss on mortgages retained
declines
loans •Wachovia •Loss on MBS
•Reduced
•Higher interest •Lehman Brothers •Impact of Mark to Market
household
rates •IndyMac •High bank debt levels
wealth
•Stiff
Stiff •Many others
M th
underwriting •Many more to come

34


5/8/2009

Negative
Effects on
Government & Industry
Economy
Responses

Central Fiscal Home
Federal Systemic
Bank Stimulus Owner
Bailouts Rescue
Actions Package Assistance

•Lower interest •Economic •Hope Now •Fannie & •Emergency
rates Stimulus Act of Alliance Freddie Economic
•Increased 2008 •Housing & •Bear Sterns Stabilization Act
lending Economic •AIG (TARP)
Recovery A t of
R Act f •Citigroup
Citi •Public-Private
P bli P i t
2008 Investment
Program
•Global bank
recapitalization

35


5/8/2009

The government’s response

36


5/8/2009

Comparing Costs of the Credit Crisis
Government Expenditure Original Cost Inflation Adjusted Cost
Marshal Plan $12.7 billion $115.3 billion
Louisiana Purchase $15 million $217 billion
Race to the Moon $36.4 billion $237 billion
S&L Crisis $153 billion $256 billion
Korean War $54 billion $454 billion
The New Deal $32 billion $500 billion (est.)
Invasion of Iraq $551 billion $597 billion
Vietnam War $111 billion $698 billion
NASA $416.7 billion $851.2 billion

TOTAL : $3.92 TRILLION

Source: Bianco Research 37


5/8/2009

How Big is the Response?
Date
D Program
P Allocated
All d Spent
S
December 2007 Term Auction Facility $600 billion $468.6 billion
February 2008 Economic Stimulus Act of 2008 $168 billion $168 billion
March 2008 Bear Sterns Bailout $29 billion $26.2 billion
March 2008 Term Securities Lending Facility $200 billion $88.6 billion
March 2008 Primary Dealer Credit Facility n/a $61.3 billion
May 2008 Student Loan Guarantees $130 billion $9 billion
September 2008 Fannie Mae and Freddie Mac Bailout $400 billion $59.8 billion
September 2008 Foreign Exchange Dollar Swaps Unlimited $327.8 billion
October 2008 FHA Housing Rescue $320 billion $20 billion+
October 2008 Auto Industry Energy Efficiency Loans $25 billion $0
October 2008 Troubled Assets Relief Program $700 billion $323.4 billion

Source: CNNMoney.com 03/29/09 38


5/8/2009

Date
D Program
P Allocated
All d Spent
S
October 2008 Money Market Guarantees $659 billion $15 billion
October 2008 Commercial Paper Funding Facility $1.4 trillion $241.3 billion
November 2008 Unemployment Benefit Extensions $9 billion $8 billion
November 2008 Citigroup Loan Loss Backstop $245 billion $0
November 2008 Term Asset-Backed Securities Loan $1 trillion $4.7 billion
Facility (TALF)
November 2008 GSE Mortgage-Backed Securities $1.25 trillion $236.2 billion
Purchases
November 2008 GSE Debt Purchases $100 billion $50.4 billion
November 2008 FDIC Temporary Liquidity Guarantee $1.5
$1 5 trillion $297.1
$297 1 billion
2008 FDIC Bank Takeovers n/a $18.5 billion
February 2009 Foreclosure Prevention $25 billion $0

Source: CNNMoney.com 03/29/09 39


5/8/2009

Date
D Program
P Allocated
All d Spent
S
January 2009 Bank of America Loan-Loss backstop $97 billion $0
January 2009 Credit Union Deposit Insurance $80 billion $0
Guarantees
January 2009 US Central Federal Credit Union $1 billion $1 billion
Capital Injection
p j
February 2009 American Recovery and Reinvestment $787.2 billion n/a
Act
March 2009 AIG $182 billion 129.3 billion
March 2009 US Government Bond Purchases $300 billion $7.5 billion
2009 FDIC Bank Takeovers n/a $1.9 billion
TOTAL: $10.5 TRILLION $2.6 TRILLION

Does not include $500 billion - $1 trillion for Public-Private Investment Program

Source: CNNMoney.com 03/24909 40


5/8/2009

Commercial Property Outlook

41


5/8/2009

Office
in job market continue to reduce demand.
•Losses

•Vacancies to rise to 16.7% in 3Q09
Vacancies 16 7% 3Q09.
•Annual rent is expected to decline 4.2% in 2009.

•Negative absorption of (77.4) million SF in 57 markets.

•> Sublease Space to compete with Direct Space

Source: NAR Commercial Real Estate Outlook , 12/08 42


5/8/2009

43


5/8/2009

Industrial
demand for exports starting to impact industrial.
•Reduced

•Vacancies are forecast to rise to 12.2% in 3Q09
Vacancies 12 2% 3Q09.
•Annual rent is estimated to decline 4.1% in 2009.

•Negative absorption of (148.1) million SF in 58 markets.

•Very little new construction is anticipated.



5/8/2009

45


5/8/2009

Retail
consumer spending has hit retail hard.
•Sluggish

•Vacancies will rise from 9.8% to 13 4% in 3Q09
Vacancies 9 8% 13.4% 3Q09.
•Average rents expected to fall 9.0% in 2009.

•Negative absorption of (49.8) million SF in 2009.

•Very limited new construction.



5/8/2009

47


5/8/2009

Investments
and investment fundamentals are out of balance.
•Financing

•Some areas experiencing modest stability.
Some
•Risk premiums are raising interest rates and lowering
prices.
•Expect lower loan-to-value ratios.

•Increasing debt service coverage ratios.

•Shorter loan durations.

•Heightened tenant scrutiny and underwriting.



5/8/2009

49


5/8/2009

50


5/8/2009

Transaction Opportunities
(IRS, Treasury, banks, others)
•Auctions

L
•Leasing

bids
•Sealed

•Traditional brokerage

•Loan acquisitions
Loan
•Private lending



5/8/2009

OPPORTUNITIES
CCIM 101 Financial Analysis Course
•

Scottsdale Area Association of REALTORS®
•

August 10-14, 2009
•

Go To CCIM.com to Register
•

52


5/8/2009

Questions & Answers
Tim Hatlestad, CCIM
RE/MAX Achievers and RE/MAX Commercial Investment

Tim@InvestAZ.com
480-922-2850

53


An Evolution Of The Credit Crisis

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