Back when S.L. Clemens was piloting riverboats in the murky fog of the Mississippi night, his deckhand tossed a marked “sounding line” and stone overboard attempting to locate the river bottom and measure the depth for passage. A riverboatman would cry out the depth in marks for safe passage with “twain”, two fathoms, meaning sufficient depth to pass safely. Along the Mississippi, where shoals shift nightly and light plays in the murky currents, knowing where the bottom lay and how to avoid it separated successful riverboat captains from those wrecked with cargo scattered along the river bank.
And so too goes navigation in the murky waters and shifting currents of the real estate market. Some of those shoals are represented by Commercial Mortgage Back Securities – a type of mortgage-backed security backed by mortgages on commercial real estate. These securities represent many single mortgage loans pooled into a single trust which issues a series of bonds of varying yield. In the last year, the number of distressed resolutions grew to 33%, leaving note holders with 43 cents for every dollar invested. In 2009, CMBS loss severities rose to 57% and “are expected to remain above the current cumulative average through 2011,” said Fitch managing director Mary MacNeill in early June 2010. Fitch Ratings expects higher loss severities for all property types this year. Annual loss severities by property type for last year were 81.9% in Hotel; 58% in Multifamily; 56.9% in Office; 48.8% in Industrial, and 48.2% in Retail and Fitch expects them to be more severe in 2010.
Real estate values are the sounding lines for loss in Commercial Real Estate debt and for the overall real estate economy. Stressed CMBS resolutions, post deal appraisal reductions and stalling servicer loan modifications mark shallowing water for the real estate economy. Not until the market gets past this phase of overall value readjustment will it begin to stabilize. Unfortunately, stabilization means reduced returns for existing investors, but it may mean increasing value confidence for new investors. Even with a seemingly rebounding economy, unpredictable shoals created by roiling value currents remain in the wake of this massive recession. Look for the signs of clear sailing to begin in early 2011 – increasing loan modifications, enhanced by the previously mentioned Revenue Procedure-2009-45; stabilizing valuations leading to increasing real estate activity and growing confidence.
We are not there yet. The good news is that the water is rising. In time, we will find safe passage.