Global real estate markets are only half way through repricing with unlevered property values expected to decline peak-to-trough by roughly half – and possibly up to 60 percent.
Cohen & Steers’ funds of funds chief investment officer Stephen Coyle warned unlevered values were set to fall by between 40 percent and 50 percent, and in some places up to 60 percent. He said in a publicly released investor letter that a 19 percent decline in unleveraged values would translate into a price fall of 35 percent for an asset leveraged at just 50 percent.
“If a current owner has leverage at the 65 percent level or higher and purchased the asset after 2003, then he is probably in serious trouble. In fact, not only is the leveraged equity owner in serious trouble; the mezzanine debt holder and the B-note holder are also likely under water,” he said.
Coyle led Citi Property Investors’ funds of funds unit before he and his team were hired by Cohen & Steers last April. He is CIO of Cohen & Steers' Global Realty Partners group.
In his letter released today, Coyle said rising real estate yields, declining net operating income and over-leveraged properties were leading to an unprecedented decline in valuations.
However, he said expectations the UK was leading the repricing wave, including the belief its economy was already starting to recover, were wrong. “We believe this is a head fake,” he said. “Instead, we expect home prices to begin falling again, which will undermine consumer confidence and economic growth.”
But he noted the UK would start to recover in “earnest” late this year, early 2010. Overall, unlevered values in the UK would fall between 50 percent and 55 percent peak-to-trough.
Coyle said real estate debt would be one of the best opportunities, particularly in the US and UK, partly because many investors, including private managers, “still appear to be in denial” over the need to deal with their leverage. Capital markets were not expected to ease much over the next few years, he said, with the volume of debt maturities set to vastly exceed new debt supply.
“We believe that it is just a matter of time before we see a huge wave of distressed sales and mortgage defaults. Today, most equity owners and their lenders are in the ‘extend and pretend’ camp.”
Coyle continued. “We suggest that they ready themselves for the day of reckoning that will soon arrive. Investors will either have to mend their balance sheets or send the keys back to the senior lenders. Extend and pretend will transition to ‘mend or send.'”