PIMCO Warns That U.S. Commercial Real Estate Is In Trouble

There may be a storm coming for the Real Estate Market, according to PIMCO.

They predict that prices will fall during the next year, opening up refinancing and buying opportunities for investors.

PIMCO, or Pacific Investment Management CO, warned Monday that Commercial Real Estate in the U.S. may see a drop in prices during the coming 12 months of up to 5%.

This may be a result of tightened regulations, which would essentially be debt maturities, as well as property sales, done by publicly traded landlords.

In a report involving U.S. Real Estate and the idea that a storm was brewing, two PIMCO portfolio managers named John Murray and Anthony Clarke said that a global surge in the demand for U.S. property investments that pressed real estate values up to record levels may wane for a few reasons.

Slowing growth in China, along with dislocated debt markets and decreased oil prices threaten to cause a halt in the steady six years of growing prices.

Clarke and Murray compared storms to the real estate market by saying that storms are formed when updrafts mix with unstable air and moisture and the commercial real estate market is seeing a similar situation.

They said that a mixture of similar factors were creating a great deal of volatility in the market itself.

Additionally, PIMCO reported that it was possible for opportunities to arise from a real estate shakeout that would allow a group of buyers to buy properties at a bargain price.

Another thing is that there is a mass of maturing debt from the last ten years that starts showing up this year.

This opens up a window, which will give some investors a way to fund borrowers that come up short.

Murray and Clarke argue that while it may be a storm, it could be a beneficial one.

They go as far as to say it may be welcome.

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The Fall of Prices

There have been signals that a cooling real estate market is emerging since the beginning of the year.

In larger U.S. cities, commercial property values saw the most significant increases during the latest boom.

However, these same cities are now seeing a decline of 3% in the last three months alone, according to a June 6th report from Moody’s Investors Service and Real Capital Analytics Inc.

New York is the biggest U.S. property market and real estate transactions there are predicted to decline up to 30% this year, says Cushman & Wakefield.

The graph below illustrates this principle:

PIMCO surmises that due to the turmoil in the market that deals with commercial mortgage-backed securities, there has been an increase in borrowing costs for landlords, which will diminish future price growth.

This will hold true particularly in the case of smaller city properties that rely more heavily on getting their funding from Wall Street banks.

Some attribute the tumult in commercial mortgage-backed securities to regulations that cause higher expenses for banks that intend to hold securities.

An example of these regulations is the Dodd-Frank.

One result from this is that Wall Street dealers could not provide liquidity when hedge funds had to sell CMBS holdings in February during a global market rout, a move that sent the debt prices in a downward spiral. 

The graph below shows that CMBS are possibly heading for a crisis.

Murray and Clarke said that the sellout highlighted a crucial headwind to the commercial real estate, but was more to do with the debt market than property fundamentals.

What This Has To Do With Selling

Another part of real estate that has been hit hard by volatile markets are real estate investment trusts.

Companies are trading their shares for prices that undervalue their holdings.

These holdings include shopping malls and hotels.

This is leading to REITs becoming net sellers.

For foreign investors that invested cash in the commercial U.S. real estate when the dollar increased in value, and overseas economies were wavering, the future is cloudy and unsure.

One example is China, who has hinted at increasing controls on capital outflows.

Another is decreased oil prices leading to a curtailing of investing in Canada and the Middle East.

The current presidential election in the United States has led to uncertainty about continued investments from other countries.

For PIMCO, real estate, as well as other alternative investment options, offer a potential area of growth since the company usually solely deals with fixed-income securities.