10 Things to Watch in 2010 (part 1)

I don’t know anyone who will not be happy to see 2009 in the rear view mirror. To say it was a challenging year is an understatement. Before we take a look at what commercial real estate market participants should be watching in 2010, let’s take a look back at some key events which took place in 2009:

In January, Barack Obama is sworn into the office of president of the United States making him the first African-American president in U.S. history.

In February, the president signs an unprecedented $787 billion stimulus plan which is touted as being necessary to keep unemployment under 8%.

The unemployment rate climbs to 10.2% (the highest it has been in decades) and drops to 10% even after a net loss of 11,000 jobs in November, demonstrating that discouraged people continue to drop out of the job market. They are no longer counted as unemployed and, if counted and added to those working part-time who would rather be working full-time, the unemployment rate is more like 17%.

The country braces for the H1N1 flu epidemic.

As the economy deteriorates, several frauds are uncovered led by the king of Ponzi schemers, Bernard Madoff, who is sentenced to 150 in prison.

To try to stimulate the economy, the government rolls out the “Cash-for-Clunkers” program paying $3,500 to $4,500 for cars which, in many cases, are worth little more than several hundred dollars. The program burns through $1 billion in the first week causing congress to provide another $2 billion to the program. The result is 690,000 cars sold of which only an estimated 125,000 would not have been purchased without the program.

The housing market becomes so stressed that the U.S. reaches a record rate of a foreclosure every 13 seconds.

With Fannie Mae and Freddie Mac hemorrhaging losses, FHA comes to the “rescue” as a new subprime lender requiring down payments of 3.5% or less. Between Fannie, Freddie and FHA, the U.S. government now guarantees 92% of all home loans in the country.

The $8,000 first time home buyer’s tax credit is launched stimulating home sales. The program is subsequently expanded to include a broader group of purchasers. Based upon the average U.S. home price of $178,000, and a 3.5% FHA down payment requirement, the government is “paying” people to buy houses.

Several banks turn very profitable based upon the Fed’s monetary policy, allowing them to recapitalize resulting in many of them repaying TARP money.

Chrysler and GM go belly up and get bailed out by the government. The atypical bankruptcy processes leave many wondering why highly sophisticated bankruptcy law is cast aside (along with thousands of senior secured creditors) for political objectives. Chrysler is taken over by Fiat and GM emerges as a zombie with UAW control and unsustainable  pension obligations which the taxpayers must swallow.

Based upon all of the government spending, the U.S. budget deficit triples in size to over $1.4 trillion.

Yes, it was an eventful year with many firsts and many unprecedented actions in response to uncharted territory. On the commercial real estate front, we saw the lowest volume of sales that we have seen, going back at least to 1984. We also saw prices tumble anywhere from “a lot” to “a real lot” depending on the property type in question. Volume appears to be on the upswing while prices continue to slide in tandem with increasing unemployment.  To figure out where we are headed in 2010, we will be watching 10 key indicators. Let’s take a look at them (in no particular order):

1) Unemployment. For those of you who are regular StreetWise readers, you know that I believe there is no metric that more closely impacts the fundamentals of the residential and commercial real estate markets than unemployment. If people have lost a job or fear losing one, they are not likely to move from a 0ne-bedroom apartment to a two-bedroom and are not likely to move from a rental apartment to a purchased residence. When employers cut staff, they are not likely to be taking more office space and, if anything, may take less space at renewal time. Similarly, those who have lost jobs are less likely to travel, leaving hotel occupancy hurting and they are also less likely to spend freely in retail stores, stressing that sector.

As indicated above, the present official unemployment rate is 10%, down from 10.2% even after a net loss of jobs in November. This indicated that dejected job seekers are dropping out of their search and after 30 days, they are no longer counted as “unemployed”. Currently, the average length of unemployment for those who have lost jobs is in excess of 28 weeks, the longest period ever recorded going back to 1948. 

If we add to these discouraged workers, those that work part-time that would like to be working full-time, the unemployment rate soars to about 17%. It is expected that the official unemployment rate will remain elevated throughout 2010 as discouraged workers begin to seek employment again as jobs are created. Over 7 million jobs have been lost during this recession. Add to this the fact that, simply based upon population trends, we need to add 1 million jobs per year and it is easy to guess that it may be some time before we get back to mid-single digit official rates. Net job creation will be a key towards a recovery in our fundamentals, particularly if it can be sustained.

On the positive side, we have seen productivity increases at typical “coming-out-of-recession” levels of 5%-6% which is, usually, a prelude to resumption in hiring. Similarly, temporary employment is also on the rise which also foreshadows permanent job creation.

2) Corporate Earnings. Corporate performance will be key to watch, especially on the top line. The stock market has rallied from a low in early March of about 6,600 to about 10,500 today. Much of this increase was caused by speculation and above-estimated earnings based upon companies slashing expenses (payroll being the largest of these cuts). While effective in the short run, reducing expenses is not a viable strategy for sustainable earnings growth. Top line revenue must increase and, thus far in the cycle, companies have not seen revenue growth in a tangible way.

3) Credit Markets. In order to make our commercial real estate markets function, we need available debt. In New York, we have been fortunate to have community banks and smaller regional banks that have been consistently lending since we started to feel the effects of the credit crisis in the summer of 2007. In many parts of the country, many of these smaller banks have tied up far too much of their capital in development and redevelopment projects which have been the property type hardest hit. This has resulted in 140 bank failures in 2009. We have not seen a meaningful number of large commercial banks or money center banks actively making commercial real estate loans and their re-emergence would be welcomed.

The TALF and the PPIP programs, did little in terms of direct activity, particularly compared to initial expectations, however, their mere existence brought credit spreads in appreciably. This dynamic could help rekindle the CMBS market which is so desperately needed by our marketplace. The shadow banking sector provided as much as 40% of lending in the bubble inflating period of 2005-2007. The present and near-term demand for refinancing proceeds is staggering. Unfortunately, even if the traditional banking sector and the insurance industry were both operating at full-throttle relative to real estate lending, they do not have the capacity to meet the demand.

Access to public capital is vital. In 2007,  CMBS was a $230 billion market which eroded to $12 billion in 2008 (all of which was in the first six months). From July 2008 thru just weeks ago, the CMBS issuance had been zero. A couple of transactions have now closed and others are in process. We will be keeping a close watch on continued CMBS activity and also on REIT capital raising activity ($20 billion recently) and the newly formed mortgage REITs for signs that public capital is again flowing into our market.

For numbers 4 thru 10, stop back to StreetWise next week….

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

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18 Responses to “10 Things to Watch in 2010 (part 1)”


  1. 1 hummbumm December 29, 2009 at 9:27 am

    I keep hammering on this but there is tons of available data that points why the deficit for this year (which by the way is based on the Bush budget for 09) blew up. The biggest reason is lower tax receipts due to the recession, then we have higher automatic stabilizer payments, unemployment etc.. and the smallest contributor is the stimulus. I think it is important to stick to facts when there are facts. I would also quibble about your take on CM and Chrysler but that is less clear cut.
    Everything else very interesting as always.

  2. 2 George N. Stonbely December 29, 2009 at 11:18 am

    Robert:

    Very astute . . .not surprising, yet sobering view of the protracted recovery that I agree we will experience.

    Your comments on the need for “top-line” growth resonanted loudly as I am concerned that the “new job engines” that brought us out of recessions in the 60’s, 70’s and 80’s are not hovering on the horizon . . .do you see any?
    (In this regard, I am more confident about the immediate prospects for NYC than much of the rest of the country, as our interntional business (love the United Nations) and our Tourist Industry continues to moderate the effects of recession).

    Best Wishes and Happy New Year!

    George N. Stonbely

  3. 3 Carl Todd December 30, 2009 at 7:47 am

    RK
    Things have gotten so bad now that when you buy a toaster they give you a bank.

    Best for the New Year and with constant vigilance, doing your home work before making a decision and be sure of your facts before you act we’ll survive this one to and will be much wiser and more valuable to our family, clients and ourselves.

    Keep up your astute analysis of the current scene.

  4. 4 Elliot Bogod December 30, 2009 at 9:24 am

    Hi Bob,
    As always this is a very interesting article.
    I hope you can discuss in the second part some of these issues:
    We have seen very few commercial sales influenced by troubled sellers such as AIG and Lehman and though volumes in this arena may increase in 2010, the structure of these transactions will be less traditional buyer and seller and rather more likely complicated type of bank structures (debt for debt or debt for equity exchanges, etc.) where distressed sellers can retain equity portions in these projects to maintain upside on a market recovery.
    The residential market however is a completely different animal. Apartment inventory currently exceeds 10,000 units with months on the market at all time highs. The mortgage market has undergone significant change and banks now expect buyers to put down at least 25-30% in equity and show pristine credit stats that showcase their ability to carry the mortgage. However, mortgage rates are at historical lows, though government stimulus has no affect on Manhattan real estate as most homes don’t qualify for the first time buyer’s tax credit. The Manhattan apartment market depends heavily on the availability of Jumbo mortgages because the average price of a residence is approximately $1 Million.
    Mayor Bloomberg was reelected for the third term which is exciting for New York real estate.
    I wish you Happy New Year and all the best wishes for 2010!
    Elliot Bogod

  5. 5 Ray Burt December 30, 2009 at 10:20 am

    Good points all.

    The big question I see is this, how does the market refinance a deal that was a 90% LTV when originated back in 05 – 06, but is something north of a 120% LTV today?

    Even if the CMBS came back big time, would yesterdays deal qualify in today’s market? Not likely. So does the deal go to foreclosure, do the owners come up with the extra cash, or does some yet to be defined solution appear?

    This to me is going to be one of the big mysteries of 2010, the one to watch for.

  6. 6 Barbara Venturi December 30, 2009 at 12:33 pm

    As a broker that exclusively represents Tenants , your comments regarding the enormous demand for refinancing and the lack of available funds to meet that demand require us to carefully review a Landlord’s financial position. We advise our clients that they need to be comfortable with ownership’s debt positions combined with increasing vacancies for the term of the lease commitment. Landlords who are unresponsive to requests for financial information raise a red flag and warrant careful scrutiny.

  7. 7 Chris Terlizzi December 31, 2009 at 8:22 am

    Robert

    I’m looking forward to reading your next blog entry and hoping that your remaining observations have a more positive tone. While everything you noted so far is not news, it takes on a dark tone of desperation when catalogued.

  8. 8 Jeff Green December 31, 2009 at 10:18 am

    This article is a conducive source of information for first time home buyers.

  9. 9 jstamp02 December 31, 2009 at 12:02 pm

    Mr. Knakal, I’ve really enjoyed your blog posts in 2009. This being my first year really engulfed in the NYC commercial real estate market, (as a masters student at the NYU Real Estate Institute) your blog has served a great source of information and discussion. Not to mention your companies website has been helpful with a number of school projects. 2009 was certainly an unprecedented year and out of it will come unprecedented opportunity.

    I could not agree more with your thoughts on unemployment. We cannot begin to think about development until the some 7.7 million jobs are recovered. I’ve heard Peter Linneman speak a number of times and he predicts that the beginning of next year will be flat, but we’ll add 500,000 jobs by midsummer. It’ll take 3 years to get back to where we were.

    He also stressed however, that in order for job creation to occur, consumers must regain confidence. Without confidence, companies won’t grow, consumers won’t shop, and our economy won’t expand. The consumer confidence index currently stands at 53, for a recovery to occur the index must get back to the 90 range.

    I think the prices still have room to fall, but 2010 will mark the beginning of a recovery. I’m looking forward to seeing the rest of the “10 Things to Watch in 2010.”

  10. 10 rknakal January 1, 2010 at 3:10 pm

    Hi Hummbumm, Thanks for your post. I don’t dispute that, during the Bush presidency, government spending was out of control. During those 8 years, GDP grew by 15% and spending grew by 58%. Those numbers are shocking and inexcusable. Clearly, reduced revenue (tax) collections effect the bottom line (and should have been included in my article), however, every dollar of spending reduces today’s balances by a dollar. Even if you consider the velocity of money,the multiplier effect of most of the stimulus spending is not high enough to create tax revenue in excess of the dollars spent, so it does add to the deficit. I believe “stimulus” was needed but would have deployed the money differently. It may not have been the major reason for the unprecedented deficits but we must not make an assumption that it is okay to spend (lose) another dollar just because we have already deeply in a hole having “lost” several other dollars.

  11. 11 rknakal January 1, 2010 at 3:26 pm

    Hi George, Thanks for your post. The industry which will serve as the driver of job creation is not yet clear, but I don’t think it was initially clear in previous recoveries either. Many people talk about “green” jobs but it is not clear how extensive this industry will be in terms of creating jobs. History shows us that something will come along and I remain hopeful that it will be sooner rather than later. Happy New Year to you.

  12. 12 rknakal January 1, 2010 at 3:29 pm

    Hi Carl, Thanks for the post and sharing your good advice with all of us. Thinking before acting is always prudent. I hope all is well with you.

  13. 13 rknakal January 1, 2010 at 3:45 pm

    Hi Elliot, thanks for your post. I have not written this Sunday’s “Part 2” of this article so I will try to incorporate addressing some of the issues you mentioned. Mayor Bloomberg’s re-election is, indeed, very good for New York as we need someone with a business perspective in what is becoming more and more of an entitlement-oriented political landscape. Happy New Year to you and similar best wishes for a great 2010.

  14. 14 rknakal January 1, 2010 at 3:52 pm

    Hi Ray, thanks for your post. The answer is that most of the deals with significant negative equity will not be refinanced. This is a dynamic that will play out not only in 2010 but in 2011 and 2012 as well as the 2006 and 2007 vintage loans mature. Many of these are hanging on by a fingernail because they are either still interest-only, are still operating off of interest reserves or are floating over LIBOR which is miniscule today. Some will be worked out, some owners will come up with additional equity and some will be “recycled” through the foreclosure process. One thing is certain, the marketplace must be de-leveraged and it will be, one way or another.

  15. 15 rknakal January 3, 2010 at 1:03 pm

    Hi Barbara, thanks for your post. You make an excellent point and I would think most office leasing brokers are carefully scrutinizing the financial health of the property and the owner to determine the appropirate candidates for their tenants. Terms of financing can be obtained from the department of finance and can make a big difference in the viability of a property.

  16. 16 rknakal January 3, 2010 at 1:08 pm

    Hi Chris, I wish the news was more positive. The fact is that all of the government intervention we have seen will serve to drag out the recovery to a pace well below what it would have been otherwise. Clearly, the depth of the trough would have been much deeper without the support, but it will serve to keep the economy below trend longer than any of us would like.

  17. 17 rknakal January 3, 2010 at 1:11 pm

    Hi Jeff, thanks for your post. The main message for home buyers is to buy now to take advantage of the tax credit and the low interest rates. And, of course, lock in a 30 year fixed rate mortgage which you will be loving when lending rates are significantly higher.

  18. 18 rknakal January 3, 2010 at 1:18 pm

    Hi Jstamp02, Thanks for your post. I’m glad you find this information useful. Peter is a brilliant economist and I also enjoy hearing him speak. Consumer confidence is on the upswing but, as you mention, has a long way to go.


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