This likely will seem like another Dr. Doom prediction, but I work in the real world of all types of real estate and the capital markets outside the fantasy land of hotel industry conferences, where everyone is told to only say optimistic things.
The universal forecasts for all sectors of real estate other than multi-family, by virtually every experienced senior executive, are ranging from cautious to very hesitant, and are unanimously completely uncertain. Nobody in the banking world or other real-estate product groups, other than multi-family, thinks this year will be anything other than more of the same as it has been since August—slow and rocky, with a real risk it could be worse because of some black swan event. The risk of a major black swan is far greater than the prospect of any sort of wonderful economic or geopolitical news. Nobody has any way to put odds on all of the possible events.
Economists generally believe it will be a slow crawl of 2% gross domestic product growth, with the more optimistic, like Moody’s Analytics’ Mark Zandi, projecting only 2.5%. Housing prices are projected by virtually everyone to continue to decline this year. Foreclosures will rise materially. Mortgages will be less available .
Unemployment will possibly rise again, as the December numbers looking better are simply a combination of 50,000 less people in the active workforce and the usual inaccuracies of seasonal corrections for December. There are already some who say the layoffs after Christmas foretell a possible small rise in unemployment before spring. It is really the total employed number that matters, and not the headline unemployment figure. Real unemployment, or partial employment, remains more than 16%. Workforce active participation is the lowest in recent history; that means a lot of people with no regular income.
The highly volatile stock market has been a predictor of nothing. The debt markets remain very cautious as demonstrated by the massive amounts invested in U.S. Treasuries. All of the wealth management firms are having reduced income due to clients not wanting to invest in anything other than Treasuries.
An attack on banks and other headaches
What few people outside the residential mortgage industry realize is the appointment of Richard Cordray as director of the Consumer Financial Protection Bureau is about to unleash an attack on the banks and residential mortgage servicers that will make the current level of mass attacks and lawsuits on banks by the administration and state attorneys general look like a warm up. It is about to become a situation where nobody who is not platinum credit and with a 20% down payment will be able to get a loan. That will further depress the housing market and the economic recovery. This is a major disaster in the making for housing that is barely understood by most outsiders as yet.
Europe remains a mess and will continue to be so for months. The European Central Bank, with help from the Federal Reserve and the Bank of England, recently saved the European banking system from a true Lehman collapse, but those banks are in no position to lend and are on life support. Greece will possibly stay in the Eurozone, but it will just be a façade. Italy and Spain and Ireland will survive, but will continue in crisis all year. Social unrest in Europe is sure to increase. While Germany will keep the euro alive, its value will decline, further depressing European travel to the U.S.
China will continue to experience very serious banking and housing sector problems, which combined with the European recession will cause a continuing of the slowdown in growth. Because the Chinese can manipulate their economy easily, it is unlikely there will be a complete collapse of Chinese banks or real estate—but it is dicey.
The commercial, mortgage-backed securities market generated slightly more than US$40 billion of issuance in 2011—a drop in the bucket. That number is projected to decline a bit in 2012. In 2012, government-sponsored enterprise paper is projected to be US$15 billion, so there is only US$25 billion, maybe, of all other real-estate paper. Of that, hotels is maybe 10% to 15%, or maybe US$3 billion. That is only about 7% of all hotel CMBS paper outstanding.
There are huge maturities coming in 2012 and 2013. Refinancing is going to be very problematic for many borrowers with ordinary assets, even if your net operating income is better. Selling, or taking in a rescue capital partner is a really good option in 2012 if you have a maturity and a major property-improvement plan and no way to fund the shortfall of equity.
CMBS defaults to continue
Values are not likely to rise in 2012. It is a year when a lot of assets will be coming into the distressed market. That is where the smart money is focused. Fitch Ratings projects a 30% default rate during 2012 for all CMBS paper originated in 2006 to 2008, with many more defaults in 2013.
They further project 60% of all CMBS loans will fail to get a refi in 2012. 2013 is not expected to be much better.
Add to this pending rules from the Dodd-Frank Wall Street Reform and Consumer Protection Act on originators being possibly required to hold 5% reserves on CMBS, the declining earnings for all of banking and Wall Street that will continue, the thousands of layoffs in investment banking that have been announced, the huge pressure on banks to increase capital and reduce risk (loans outstanding), and there is little to be encouraged about in terms of new lending capacity to ordinary hotels in secondary markets.
As much uncertainty as ever
As the author of the recently announced home mortgage refinancing program by the White House, I can tell you first hand that those people have no understanding at all of how commercial or investment banking really works. Now that Bill Daley has been forced out as chief of staff to President Obama, there is nobody in the White House with a clue. U.S. Treasury Secretary Timothy Geithner seems to have drunk the Obama Kool-Aid and is not an advocate of helping the banking sector.
More multi-billion dollar lawsuits against the banks, more huge fines, more lawyers and more overhead to deal with regulators and more earnings pressure means less liquidity for economic growth and less lending to your average hotel.
I have left aside the real black swans that now have a very high possibility of landing right in the middle of the lake: Iran, Greece leaving the euro; continued gridlock in Washington; continued failure of Europe to solve the banking and sovereign problems; Pakistan falling apart; North Korea doing something stupid.
Bottom line is, the level of uncertainty in 2012 is as big as it has ever been. The banking and financial services sector will continue to reduce events and travel as they push hard to reduce all costs. Companies will not be booking far in advance in fear of a major negative event. Consumers will remain cautious with spending. None of this bodes well for material increases in average daily rate. None of this excites investors to the hotel sector, unless they have a real solid long-term view and understand the long-term prospects.
My prediction for revenue per available room remains up 2% to 3% for 2012, barring a black swan event. There is just no way to know. As the year progresses, the year-to-year comparisons become more trying as the RevPAR improvements in 2011 become harder to beat.
As to acquisitions, if you have plenty of cash and if you really know what you are doing as a buyer, and you can buy hotel assets in 2012 at good capitalization rates on trailing-12 numbers (less the cost of the big PIP), and if you are willing to hold for at least five years, you will do very well.
If you are a seller, you will not get what you hoped for, and cap rates are likely to rise a bit more. Development will remain very muted, which is good for long-term buyers of assets at below replacement cost. Cash is king, and discipline in acquiring is key. It is always in the buy and protecting the downside in times like this; the upside takes care of itself.
Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com.
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