Positive Leasing Signs May Ease Fire-Sale of Distressed Assets

Robert Bach (Grubb & Ellis - Chief Economist), in a piece re-printed below, provides an interesting analysis on whether distressed asset sales will be a flurry of quick activity or something more controlled.

A Ray of Sunshine?

Oct 07, 2009 By: Robert Bach, Grubb & Ellis Co.

The capital markets are on hold right now. The news is all about the lack of debt capital to refinance maturing loans and, on the flip side, the growing pool of equity capital waiting to invest in distressed assets, primarily debt. At the upcoming ULI Fall Meeting, the Research Forum roundtable topic of discussion will be, “Are pending debt events really equity events?” The standoff is because sellers don’t want to sell into the biggest buyers’ market since the early 1990s, and they are being enabled by banks (pretend and extend) and the IRS, which has relaxed the rules for amending the terms of CMBS loans. So the volume of sales remains very low--down 75 percent compared with the first eight months of 2008. Yet distressed assets continue to pile up – totaling $138 billion at the end of August, according to Real Capital Analytics. At some point these and many more assets will begin to change hands, but whether that process resembles a dam breaking or a steady flow is uncertain.

For a ray of sunshine, we must look to the leasing market. Preliminary third-quarter data from Grubb & Ellis show an abatement in the pace of deterioration compared with the past two quarters. The national office vacancy rate looks to be about 50 basis points higher than in the second quarter, which would take it to just above 17 percent. By comparison, vacancy in the first and second quarters increased by 80 and 100 basis points, respectively. Net absorption and sublease space also appear to be moderating.

With job losses accelerating last month, what could explain a slowdown in the rate of decline for the leasing market? One theory among economists is that panicked employers “over-fired” after the credit markets froze in September 2008. The faster pace of deterioration in the leasing market during the first and second quarters likely reflected this panic. Now that the recession appears to be ending, tenants may feel less of a need to further slash their space requirements.

The ultimate recovery of the investment market depends on a rebound in the leasing market. The leasing market is unlikely to embark on a recovery until a quarter or two after the labor market begins to create jobs again, which may not occur until the first half of 2010. But until that happens, a decline in the pace of deterioration is a hopeful sign--if not an actual ray of sunshine.