Caution Warranted in Real Estate Market

“We needed this pause in the marketplace,” said real estate industry researcher Kenneth Riggs Jr., ’94. “We needed this wakeup call.” The real estate market had become heavily leveraged and highly risk averse, he said.

Riggs, president and CEO of Real Estate Research Corporation, gave a market overview and released his firm's forecast report “Expectations & Market Realities in Real Estate: 2008, The Caution Flag Comes Out,” at the first annual Real Estate Conference November 5 at Gleacher Center sponsored by the Real Estate Alumni Group.

The packed conference took place amidst continuing fallout from the global credit market crisis and the subprime lending crisis, in which securities backed by the bad debt of some subprime mortgages are devaluing rapidly. Subprime mortgages have been granted at higher than normal interest rates to people who are considered poor credit risks.

Riggs said that if the subprime lending crisis hadn’t occurred, a crisis “just as bad” may have happened in the commercial real estate sector in a year or two.

“The question we ask ourselves is: Why are there these problems? There always will be,” Riggs said. “No matter how sophisticated the market becomes, there’s someone out there trying to beat the market.” 

Riggs used charts from the firm’s report to show how delinquencies of subprime mortgage loans have escalated to nearly 14 percent in the first quarter of 2007 from about 10 percent in the latter half of 2005. Total mortgage delinquencies went up to 5 percent from about 4.5 percent during that same period.

“I think it’s important to understand the movement of all mortgages relative to subprime,” Riggs said. “The most important thing I see in the financial markets today is people trying to sort out how much risk really exists in the market. To me, that is what has the market so afraid and so panicked.”

He noted that earlier that day, it had been reported that Citigroup was anticipating $8 billion to $11 billion in write-downs of subprime mortgage-backed securities.

Riggs displayed a pie chart of outstanding debt by lender in the $3 trillion commercial real estate fixed-income market. It showed that the securitized portion of that market amounts to 23 percent.

“That is the part that is front and center,” Riggs said. “That is the part that the world pays attention to, especially today, and we have to get right,” Riggs said.

The securitized portion of the pie was second only to commercial banks, which account for 43 percent, the chart showed.

While delinquency rates within the commercial mortgage-backed securities sector, at 4 percent, are “very favorable compared to the residential markets.” The changing composition of investors in commercial mortgage-backed securities is a cause for concern, Riggs said.

He noted that hedge funds, collateralized debt obligation issuers, and proprietary trading desks accounted for 35 percent of triple-A rated 10-year commercial mortgage-backed securities, up from 10 percent four years before. And that same hedge fund category accounted for 69 percent of investors in triple-B rated 10-year commercial mortgage-backed securities, up from 27 percent in 2002.

“This is why Wall Street is so worried,” Riggs said.

He said that when trying to gauge expectations, “the question is to ask what do we not know that’s hidden behind these very complex securities?”

Capital market trends factor into the picture, as well.

 “Global credit market volatility debt has clearly spilled into the real estate market,” Riggs said. “We need to sort it out. There are liquidity issues. And there’s a shift from highly accommodative to highly risk averse.”

Still, the U.S. economy seems to be “doing better than expected. It’s holding up quite well,” Riggs said, pointing to a stable inflation rate, relatively low unemployment rate, and an improving trade balance. GDP could grow 2 to 2.5 percent in 2008 if no recession occurs, Riggs said..

Also measuring well are such property fundamentals as vacancy rates and transaction volumes, he said.

Overall job growth, hovering around 1 percent, however, is “slower than anticipated, and a lot of that’s attributable to the residential [real estate] market, [which is] just a drag on the economy.”

– Mary Sue Penn