PEPennington & Co Property Tax News

The Wall Street Journal Reported on March 13,”…The credit-ratings agency has a report out saying that sub-prime write-downs will total about $285 billion when all is said and done, putting the market “past the halfway mark,” as they title their report. ” Today Reuters reported, “The U.S. sub-prime housing crisis will not peak until 2009, rating agency Standard and Poor’s said on Tuesday, adding it had underestimated the extent of fraud in the industry.”

Today The New York Times reported that Senator Clinton gave a speech regarding the Sub-prime Crisis in which she stated, …”The housing crisis soon spread from sub-prime to traditional mortgages. And in August of last year, I warned the administration that the housing mortgage crisis would soon ripple out through the entire economy. ”

Clinton’s assertion is correct that the Sub-prime Crisis has spilled over into traditional mortgages and into whole economy.  The point being missed by Clinton and other pundits is however that there is another wave of bad news which might be coming.  This would be a crisis in commercial real estate valuations.  Ken Mannina with Senior Vice President with the SBA and Commercial Mortgage Banking Division of Bridge Bank wrote, “A slowing economy means that the feasibility of projects today is not what it was twelve months ago…the question about any project’s feasibility remains.”  Look at the example of the Manhattan developer (Harry Macklowe) who purchased seven office building in Manhattan for $6.8 billion in 2007.  According to CNN, “There was plenty of easy money available. Macklowe put up only $50 million of his own cash, financing the rest of the acquisition with $7 billion in loans, due in February, from Deutsche Bank and Fortress Investments…That’s a huge amount of short-term, high-risk debt. Once the sub-prime crisis unfolded, Macklowe couldn’t refinance. Now he is handing the keys to those buildings back to Deutsche Bank and other lenders to which the bank has sold some of the debt.”

Matt Hudgins with National Real Estate Investor wrote, “…the dollar amount of delinquent loans is increasing, and recent years of excess are contributing a growing portion to the delinquent pie. Total delinquent CMBS increased 19% to $2.279 billion in the fourth quarter from $1.915 billion in the third quarter, Standard & Poor’s found. Of that year-end amount, nearly half came from loans originated in the past three years.”

“2005, 2006, 2007 vintage years now comprise 45% of all delinquencies,” says Larry Kay, director of structured finance ratings at Standard & Poor’s. “These years were characterized by relaxed underwriting, high leverage and little loan amortization.”  Now the notion of relaxed underwriting, high leverage and little loan amortization sounds like the same verbage we heard when we discribe the Sub-prime Crisis.

I believe it is a safe assumption that even if appraisal districts do not generally increase their 2008 residential home valuations, that the number of residential appeals will increase.  Some might argue that if a homeowner’s value stays the same they will not appeal.  I disagree.  Homeowners have seen homes in their neighborhood being foreclosed, sellers struggling to sell their homes,  and they are inundated with bad sub-prime news everyday from the media.   I believe homeowners are aware that the value of their homes have declined from 2007 and will pursue relief through an appeal.  In some cases the homeowners will argue that they are upside down.  That is to say, that their debt exceeds the market value of their home.  It will be very interesting to see how appraisal districts deal with this issue.

Bear Sterns is taking a hit reportedly for insolvency issues caused by investments tied to MBS (Mortgage Backed Securities).   The problem are bond funds backed by mortgages, which in some cases they (the funds) do not know the value of the mortgage portfolios.  Earlier this week we discussed the case of Carlyle Group which defaulted earlier on $16. 6 billion of residential mortgage backed bonds, which could grow to $21.7 billion in the near future.

Yesterday S&P said that they feel that banks and other institutions have accounted for the Subprime Crisis with $285 billion in write downs.  Are the write down accurate?  Does S&P statement include brokerage houses such as Bear sterns?  Only time will tell.

The Fed’s action is seen as an attempt to promote liquidity in credit markets and help sure up MBS.  As a result the stock market was up 416 points yesterday.  For a day everyone seems to be happy.  However, when I listen to various professionals and speakers and they give their take on the state of commercial real estate several thing s are being very clear in the long term:

1. There seems to be no doubt anymore that the Sub-prime crisis spelled over into commercial real estate.

2. Global investors can take the hit created by the Sub-prime melt down.  It is however an entirely different question if they could handle both a residential and commercial real estate hit in the U.S.

3. We are seeing the beginnings of a double digit loss of value in commercial properties on the West coast and Florida.

4. The real estate credit crisis will be worse with a recession.

5. We are seeing investors looking to purchase troubled properties, development is slowing.  Residential development is near dead.

6. There is a general perception in the real estate community that Texas will escape the effects of the financial crisis.  Some how Texas will be a island of stability in a possible global credit crunch.  (I personally don’t agree.  I believe some areas of the country may fare better than others however I think everyone will be affected.)

I am of the opinion that the intervention by governments may or may not be a good thing for real estate.  Investments have risk and I believe the market should work its issues out not the government.  However with that said, that is not the world we live in.  Our government seems to be reactionary and not proactive.  Do they not believe in real time oversight?  Red flags occurred when residential loans were made to people with bad credit histories.  Lenders should not have not have made those loans and MBS should not have bought those loans.  Further, appraisers failed the system when their appraisals reports were produced to make the loans go through rather than report market value.  Mortgage companies should not been allowed to have any business relationship to appraisal firms, such as subsidiaries that provide appraisal services.  Look for the Federal Government to increase the regulations of appraisers as they did after the S&L Crisis.  We are currently seeing the State of New York taking such actions. 

Associated Press reported “The listed mortgage-bond fund managed by private equity firm the Carlyle Group failed to meet margin calls with four banks last week, raising fears that its entire portfolio recently valued at $21 billion could be sold off. A collapse at Carlyle would eat away at the value of fixed-income securities, which have already dropped sharply as banks pull back on their lending, and force asset sales. “  If we see large scale default of mortgage-bonds funds then I believe we’ll see a significant commercial real estate crisis.  It might not be as bad as the S&L Crisis of the 80’s however it will result in the loss of value of real estate assets and force foreclosures.  Analyses are watching the CNBX index which tracks bonds backed by commercial mortgages.  The index is sending very sobering signals relating to the commercial real estate.

Ethan Harris chief economist with Lehman Bros. stated that the economy is in a recession.  “The economy is likely to experience an extended period of very weak growth, a rising unemployment rate and significant further Fed rate cuts.” 

Additionally, Banks have borrowed 160 billion in Term Auction Facility from the Fed since mid-December.  This borrowing has been done to address “heightened liquidity pressures in term funding markets.”

If we repeat a melt down such as the S&L Crisis of the 80’s then we should see banks fail as result of massive defaults on loans.  I haven’t seen anything that indicates this is about to happen, however each day is bringing more and more bad news.  My interest is what effect all on this negative news is having on commercial real estate.

Based on our previous blogs we at P.E.Pennington & Company, Inc. believe property tax valuations should level off and / or drop in tax year 2008.  We believe it is save to say that appraisal districts will not agree with our opinion with the exception of single family residential  valuations.  Appraisal districts are well aware of the Sub-Prime Crisis and in-general believe that residential values are declining.  In our opinion however appraisal district’s will argue that their sales information does support the assumption that commercial real estate markets are cooling off.  They will argue that if any cooling off occurs it will appear in sales which occur in tax year 2008.  Thus it will be reflected in their 2009 valuations.

You might ask why would appraisal district’s be reluctant to accept the current state of the commercial real estate.  To answer this question you must ask who do appraisal districts answer to?  They answer to the counties; cities and school district are heavily dependant on the tax rolls provided by the appraisal districts.  These entities adopt budgets and establish tax rates.  Then they assess the valuations on the tax rolls which generates revenues for the municipalities use to provide services.  Thus, it is not in the appraisal districts interest to recognize timely shifts in real estate markets.

The Associated Press reports that the service sector (retail, health-care, construction, etc…) took a nose drive in January and February. Additionally, the Sub-prime fallout continues, inflation is up, the dollar is weak and the stock market is sinking. I have been following these developments as they relate to commercial real estate for some time now. I have written that the Sub-prime Crisis was bleeding over into commercial real estate sector back in August 2007.  I believe most people see a recession either as looming or having arrived. If the economy continues to fall, commercial real estate owners will loose tenants, rental rates will fall and new construction will be postponed. This will result in the lack of appreciation in real estate values and more likely will result in the loss of asset value.What have we seen thus far? We’ve seen in North Texas the number of transactions drop. We have seen owners place property’s on the market only to see them to take them off and wait for the things to get better. Additionally, we have seen new projects come on-line and not lease up as quickly as anticipated. Now, as I see it three things could happen:

1. Things could get better and values could continue to go up.  We believe the Boom is over and based on everything we’ve seen that doesn’t seem likely. I have heard experts tell me that we have gone from a seller’s market to a buyer’s market now a lender’s market.  2. There could be a period of no growth in real estate value. This seems likely if the economy in general does get worse here in North Texas. 3. We could see real estate values go down. This is possible; however we have not seen a large number of foreclosures which typically occurs when we see values drop.What about those who tell us things are fine? It is always important to filter your information. If real estate broker’s put out information about the market remaining strong you should question their motive. If they are in the business of selling real estate they will paint a picture that benefits them. Further, lenders only make money when they make loans. Don’t look for them to admit that their loans have lost value. The list goes on but the important point is understanding your source of information and do they have a biases.

“During this first quarter of 2008, a massive real estate resetting and deleveraging is occurring. Some say it is due directly to sub-prime and single family housing troubles. This is not entirely true. The commercial and residential markets are not linked but for three items: 1) space demand is linked by the health of the economy; 2) lending is linked through the capital markets; and, 3) bond pricing is linked through the investor base (supporting the capital markets). Otherwise, no other links exist. “

“Bad news abounds from recent capital markets conferences in January and February that confirms for the time being, capital in enormous quantities has virtually evaporated for commercial real estate debt. This is an unfortunate wake up call as our industry needs to recognize that times have finally changed. “

“The industry old timers are constantly asked if our current industry woes are reminiscent of 1998 or even 2001. Our view is that this is more reminiscent of the early 1980’s, the late 80’s, and the early 90’s.”