New strategies for post-recessionary environment

CRE Firms Lay Out Modes for Operating in a Post-Recessionary Environment
Investments Expected To Focus on Distressed Opportunities While Firms Shore Up Debt, Liquidity Positions

By Mark Heschmeyer

March 31, 2010

It's the annual report season for the majority of public companies and those from REITs and real estate operating companies not only lay bare the damage from the economic declines of the last year, but also the strategies they intend to adopt this year in the post-recessionary environment, and their outlooks for when market conditions will improve.

As one might expect, these reports tend to be very specific in detailing what has happened in the past, but become less so in projecting when conditions will improve. In an analysis of reports filed thus far, CoStar Group has identified at least a dozen strategies that companies reported that they have adopted or will adopt for the period in between.

In several cases, companies reported that the steep recession had wide-ranging but subtle consequences that went beyond the most obvious effects of rising vacancies, lower rental rates and negative absorption.

KBS Real Estate Investment Trust II reported that the commercial real estate industry has been experiencing more difficulty in collecting rents, more tenant defaults and more tenant demands for rent adjustments. "This has created a highly competitive leasing environment which impacts our investments in real estate properties as well as the collateral securing a majority of our real estate-related investments."

Kimco Realty Corp. reported that it, "has noticed a trend that the approval process from mortgage lenders has slowed, while pricing and loan-to-value ratios remain dependent on specific deal terms, in general, spreads are higher and loan-to-values are lower."

The most common other effects reported were that declining asset values had resulted in sharply lower loan originations, reduced access to capital, and increased cost of financing. At the same time, uncertainty has impaired both the ability to buy and sell properties and that has kept many firms on the sidelines waiting for clearer signals from the marketplace.

Strategies outlined to deal with current conditions were also wide-ranging. None of the strategies were universally embraced across all companies, but there were common threads among a number of them. We've broken down the strategies into four categories: acquisitions, dispositions, financing and retention of capital.

On the investment front, a number of companies reported that they expect to see sharply decreased investment activity. While not the preferred strategy, the expectation was that this is the reality of the situation resulting from lack of access to capital or to the increased cost of capital. Where many were willing to buck that trend was in their efforts to capitalize on current distressed market conditions.

For example, Starwood Property Trust reported that: "We believe that there will be a significant supply of distressed investment opportunities from sellers and equity sponsors of real estate, including national and regional banks, investment banks, insurance companies, finance companies, fund managers, other institutions and individuals. The specific investment opportunities within this real estate investing environment may change over time and therefore, our investment strategy may also adapt to take advantage of the changing opportunities."

Other firms also reported that would consider diversifying their portfolios in terms of property type, locations, sizes and markets as a way of spreading out their risks from a high concentration in one of those categories.

On the disposition side, companies reported that would also pursue selective sale of properties. For the most part, these would be done as a way of paying down debt or building liquidity.

For example, Pennsylvania Real Estate Investment Trust reported that were considering steps that might involve "joint ventures or other partnerships or arrangements involving our contribution of assets with institutional investors, private equity investors or other REITs, through sales of properties with values in excess of their mortgage loans or allocable debt and application of the excess proceeds to debt reduction."

Paying down short-term debt as a way of improving their balance sheets was also a key element in companies financing strategies this year. Besides selective property sales, the companies also said they would consider pursuing new public debt and equity offerings for as long as those markets are favorable to public companies.

Many public REITs and real estate operating companies also said they would seek alternative sources of financings. For example, Kite Realty Group Trust reported that: "We are conducting negotiations with our existing and potential replacement lenders to refinance or obtain extensions on our term loan and unsecured revolving credit facility. We believe we have good relationships with a number of banks and other financial institutions that will allow us to continue our strategy of refinancing our borrowings with the existing lenders or replacement lenders. However, in this current challenging environment, it is imperative that we identify alternative sources of financing and other capital in the event we are not able to refinance these loans on satisfactory terms."

In most of the cases, the public companies reported that their negotiations with lenders focused primarily on extending or refinancing maturing mortgage loans. And if there were a consensus on anything involving strategies, almost all of the companies said they expected some difficulties in these negotiations but expected to be successful but at less favorable terms than they what they enjoyed in the past.

In addition to finding new sources of capital, almost all of the firms reported that would also be taking efforts to maintain or build on their liquidity. For example, many reported that they would curtail substantive development activity on existing and/or new projects, in part also because of the sheer difficulty in obtaining funding for their development commitments.

In addition, many companies reported that would continue to restrict or consider restricting dividend payments and would continue to reduce expenses at both the corporate and property levels.

While many of these firms identified these strategies as their means for dealing in the current unfavorable markets, very few, if any, would give any indication of how long they would be in place. For the most part, though, most firms said that a recovery was not in the foreseeable future. Although, the time frames outlined did range from later this year to "beyond the foreseeable future."

The closest the firms came to a consensus was that any improvement would take place at different points during the cycle for different property types and for different markets. In addition, many said a recovery would take longer to occur as long as the current conservative lending standards continue.