Commercial Real Estate: Why a Rising Tide Won’t Lift All Boats

Even as the economy struggles to regain its footing in the post-recessionary environment, the state of the commercial real estate industry remains questionable. Many experts estimate that a meaningful recovery isn’t likely to happen in the sector until 2011 at the earliest. Though the recession may have officially ended in the summer of 2009, improvement in the real estate market typically lags the general economy by 12 to 18 months.

Grant Thornton LLP’s Corporate Advisory & Restructuring Services professionals have analyzed the challenges facing the CRE industry in the wake of the credit crunch and economic downturn in a new white paper. Their study found that real estate companies would be ill-advised to depend solely on the economic recovery to be competitive in today’s market place.

With $1.4 trillion in commercial property loans coming due over the next four years, lenders are expected to face overwhelming demand to refinance existing borrowings. Higher loan-to-value ratios, tougher credit standards and an uncertain securitization market will put further constraints on liquidity. In short, the opportunities to refinance existing real estate loans may be limited. CRE market participants are expected to face an environment where capital may be tough to come by and competition stiff.

Furthermore, history shows that the companies with the strongest performance pre-recession are not necessarily the strongest performers post-recession. “Our findings suggest that benefits from a recovery are redistributed among industry players and are not necessarily correlated to pre-recession performance levels,” said Paul Melville, a partner in the Corporate Advisory & Restructuring Group at Grant Thornton.

Grant Thornton’s white paper analyzed the return-on-assets (“ROA”) of 100 real estate companies, primarily real estate investment trusts with publicly available data, in order to assess portfolio property performance from 1997 through 2009. Companies were divided into four quartiles based on their return-on-assets at the beginning of the period, with the first quartile comprised of the best performers and the fourth quartile comprising the worst. Moody’s Investors Service’s REAL Commercial Property Price Index was also applied from 2000 to 2009 in order to gauge pricing trends. The median annual ROA for each quartile was then tracked to assess performance.

Grant Thornton’s research revealed a number of interesting findings:

• The median ROA for each quartile trended downward, with the 2001 recession putting disproportionate pressure on companies in both the first and third quartiles.
• The best performing companies before the recession experienced little to no benefit in return-on-asset performance after the recession ended.
• The 2005 to 2007 asset price bubble and its subsequent deflation is apparent. Asset prices are expected to improve as industry ROA stabilizes, reflecting a more normalized relationship between returns and prices.

The white paper discusses how most companies tend to operate in survival mode during an economic downturn as they seek to conserve cash, but this thinking often leads to actions that deliver little or no value in the long-term, and may even erode value.

Grant Thornton proposes a framework by which companies can evaluate their ongoing projects and initiatives to ensure that the right balance is struck between short-term costs and long-term value. This framework is particularly valuable in a distressed setting, whereby this kind of strategic thinking tends to become eclipsed by the crisis du jour.

This white paper urges CRE companies to act quickly. By the time the CRE sector begins to recover, capital may already have become scarce. Companies have a limited window of opportunity to make changes which can impact their future performance and viability. The critical need today is to pursue forward-thinking initiatives that will drive future growth.

To obtain a copy of Commercial real estate: Looking Beyond the Recovery, please visit www.GrantThornton.com

The group’s professionals possess extensive experience with both bankruptcy and out-of-court restructuring, spanning many industries, including energy, automotive, gaming and hospitality, healthcare, manufacturing, real estate and retail. Our clients include debtors, lenders, individual creditors and creditor committees, in addition to officers and directors and the boards and committees involved with corporate governance.