Baccile: In the early 1990s, the
savings and loans, commercial
banks and insurance companies
accounted for the vast majority
of debt financing. That proportion declined substantially with
the development and growth of
the securitized markets. During
this period, capital aggregated
into hedge funds and other
vehicles that invested in many
forms of debt and equity instruments, including CMBS. The
“shadow banking” community
grew to represent more than 65
percent of the capacity of the
financing markets. During the
current period of de-leveraging,
capital is disaggregating and
going back into bank CDs and
Treasuries.
It’s not coming back to asset-backed markets like CMBS any
time soon, so we are faced with
a long-term reduction in the
capacity of the capital markets,
below the point that could be
supported by sound fundamentals. It is unlikely the banking system can handle all the
refinancing needs commercial
property owners have. This deficit needs to be made up by the
government for some period of
time until investors are no longer
afraid they’ll be burned again.
Even investment-grade REITs
can’t issue corporate bonds right
now at reasonable rates because the
investor community is concerned
about their ability to refinance
Activity should pick up in the second half
of the year, which will help establish
value and narrow the currently wide
bid-ask spreads on most valuations.
mortgage debt. If securitized markets don’t rejuvenate, REITs won’t
have anywhere to turn for their
asset-level debt refinancing needs.
Portfolio: Why can’t the
CMBS market come back on
its own?
Baccile: The number of aggre-
gators that originate CMBS has
shrunk dramatically. Some big
players are either gone or won’t
be ready to jump back in for a
long time. Others belong to new
owners who are also originators,
and thus likely to reduce issuance
below the combined amount the
stand-alone companies formerly
originated separately. You’re
going to need some support from
the system for CMBS to come
back in a meaningful way if we’re
to avoid a bad outcome.
Portfolio: In years to come,
what do you think the history
books will say about 2009?
Baccile: I think of 2009 as the
big clean-up year. After every
calamity, there’s a process we have
to go through that takes time—
working out, selling or foreclosing
bad loans. Similar to the market
disruption of 1990 to 1991, it will
take a few years to fully recover
from and clean up the fallout of
these overleveraged markets. This
time, though, we didn’t overbuild,
we over-borrowed—not just in
real estate, but in every corner of
the investment markets.
On the strategic front, there
will be an opportunity for stock-for-stock mergers among public
REITs, perhaps mergers of
equals, although the volume may
not be spectacular. You’ll probably
see far fewer public-to-private
transactions, but, with the market
caps of some REITs down to very
low levels, financing may well be
available even in these markets for
smaller go-privates.
Activity should pick up in the
second half of the year, which will
help establish value and narrow
the currently wide bid-ask spreads
on most valuations. Performance
expectations are extremely low, so
if earnings reports aren’t as dire
as widely expected, a measure of
confidence will return to the market sooner rather than later. The
pendulum has swung way too far
in the bearish direction. F
Christopher M. Wright is a regular contributor to Portfolio.
