Updated with correction
It's the worst of times for real estate money managers.
Properties with purchase offers are not closing; transactions are down; and managers are going hat in hand to their investors for cash to prop up properties they do own.
“Some people are being wiped out,” said Claudia Faust, co-founder and managing partner at Hawkeye Partners LP, a real estate private equity firm in Austin, Texas. Hawkeye takes stakes in real estate money managers.
Deals are being broken at historically high rates.
Some buyers are reneging on deals struck just a month or two ago. Others have walked out on deals or “shamelessly” renegotiated deals after they have been struck, Mr. Barclay said.
For example, in October Tishman Speyer Properties reportedly backed out of a deal to buy the Mobil Building in midtown New York for $400 million. This was after the collapse of the New York-based firm's $1 billion deal to redevelop the New York Metropolitan Transportation Authority's 26-acre Hudson Rail Yards into a new commercial district and residential neighborhood.
In September alone, deals worth $20 billion were scheduled to close, but only about half actually were completed, said Neal Elkin, president of Real Estate Analytics LLC, the New York-based real estate global markets group of State Street Global Markets. The firm and Moody's Investors Service, New York, sponsor a series of real estate transaction-based indexes based on data from Real Capital Analytics Inc., a real estate research firm in New York.
Failed deals rising
Data from the last two months show that the rate of failed deals is starting to escalate nationwide. In October and November, real estate transactions worth $1.9 billion were canceled compared with a total of $793 million worth of deals in the prior quarter. Also, $6.4 billion worth of properties that had been put up for sale were pulled off the market in the past two months, approaching the sum of the $7.1 billion in pulled deals in the entire third quarter.
Four or five times more new properties are being offered than each deal completed, estimated Aaron Jodka, senior real estate economist at Property & Portfolio Research Inc., Boston.
“Property is available, but it is not getting sold.” Mr. Jodka said.
Across property types, the larger transactions (valued at more than $50 million) were down 56.72% in the third quarter from the prior quarter, according to PPR and Real Capital Analytics data. “Nothing is going on, just pain,” ING Clarion's Mr. Barclay said.
What's more, real estate managers are having trouble with the properties they do own. They are asking their investors for more money to pay banks because the properties they own have dropped in value, in some cases below the amount of debt they owe on them.
“Banks have changed their tunes,” said Ms. Faust from Hawkeye.
Banks are asking managers to fork over more cash to avoid default, even though the managers are current on their mortgages. Banks also are requiring more cash before they will entertain extending loans, Ms. Faust said.
Until recently, banks had worked with property owners, extending loan contracts and overlooking breaches of certain contract covenants such as leasing levels. Now, banks are demanding property owners pay down more principal before they will continue loans. Bank executives know that leverage on properties is so high that the owners have very little cash investment at stake in the financed properties. A serious drop in property value will wipe out the owners' equity.
“Given the banks' own financial situation, they are trying to get more capital from them (the debtors) before the prices start to plummet,” Ms. Faust said.
Banks are refusing to extend loans where leverage is too high, said Philip H. Sheumaker, managing director of Hawkeye Partners.
Managers are trying to sell properties to get the capital to complete other investments. Some money managers are so strapped for cash that they are talking about starting side funds in which the new investors will be in a preferred position over investors in the original funds.
A few players such as opportunity funds and mezzanine firms are coming to the rescue of real estate money managers and other property owners that need to come up with additional capital with so-called sliver equity or gap equity loans, Mr. Sheumaker explained.
The new loans, given in exchange for an interest in the property, might mean the difference between keeping the property and foreclosure. “It provides a lifeline to the guy who's being crushed,” he said.
It's no wonder institutional investors are not wild about the idea of their managers buying real estate now. Institutional investors have been asking their managers to hold off until next quarter on making deals, Mr. Barclay said.
But managers themselves are worried about buying too early as well, for fear of buying too high Ms. Faust said. A combination of less favorable loan terms and more equity required on deals is expected to cause prices and property values to decline, she said.
Investors interviewed by the Urban Land Institute, Washington, and PricewaterhouseCoopers expect all real estate sectors to hit bottom next year, said Susan Smith, director of real estate business advisory services at PricewaterhouseCoopers in New York. She is the author of the ULI/PricewaterhouseCoopers Emerging Trends survey released last month. Investors expect a 20% decline in pricing in 2009 from the 2007 peak, she said.