The real estate industry in general is facing a number of difficulties to come back to health. In no particular order of importance here is a lists of challenges, difficult economic conditions, lack of credit, significant decline in values, institution owned properties, decline in personal income etc… While a number of these problems have been discussed there is one, institutions owned properties, that is in general not explored. As those of us who have spent sometimes trying to work with these institutions know, on behalf of investors, it is clear that there is still a major challenges ahead of us.
On the residential front, between banks, Fanny Mae and Freddie Mack it appears that institutions own 1M properties. These properties are held by institutions and not being listed on the market. When somebody asks me is it a good time to buy? Or are we at the bottom of the price decline? I am puzzle on what to answer. Today, I read that home prices declined by 0.1% in July after an increase of 0.2% in June which is still 7% higher than in April 2009. Imagine if the properties held by institutions were put on the market the consequences on pricing. The bottom line is that the increase, year over year, in price is artificial and that value of residential properties is questionable today.
Looking at the commercial real estate sectors, the picture is not much brighter. For the past two years values of commercial real estate properties have significantly declined, banks have had to foreclose on a large number of them and cannot decide what to do with these assets. Related to the problem of foreclosed properties, is the amount of debt on these properties. Banks have not recognized their losses on foreclosed assets, and it may take years for them to do so. In most cases institutions are keeping them on their books so that their losses will be lower. If by keeping a property for a year or two can permit an institution to sell it few millions less in losses then it is a good bargain. However, this is betting on the economy recovering and the market improving. Since the economy is taking longer than most people expected to recover, and that the recovery maybe much slower then problems will linger. Institutions bet on holding foreclosed asset may not solve anything and potentially create more problems.
Another major difficulty is the amount of debt on performing asset, which in most cases is too high based on current values and income. With performing assets financial institutions are taking a different approach. As long as the loan is performing, even if the value of the property has decline, they will either extend financing that is due or re-write a new loan without lowering principal. In both cases institutions are waiting to see if the market recovers enough and hoping that in the next five years, better credit conditions will allow the property owner to secure new financing. They hope that the new financing, from another institution, would match the debt they are owned so that they don't have to recognize losses.
The way institutions are dealing with their problems today is by delaying recognizing losses. This means that we most likely will continue to see credit problem and a soft market in commercial real estate until banks have cleaned their books. As we discussed this may take few more years and maybe up to four or five years before we start seeing a more stabilized commercial real estate market. As with everything some market most likely will recover faster than other, but clearly there is a long road ahead.
