Property Lenders to Shift From ‘Extend and Pretend’

Lenders will shift toward amending commercial mortgages next year instead of extending maturities, leading to increased sales of distressed real estate, according to a survey of almost 900 property professionals.

More than 63 percent of those surveyed said they expect maturing loans to be modified, while 7.1 percent said loans will continue without changes to defer losses, a practice known as “extend and pretend.” About 16 percent of respondents said real estate with maturing loans will be foreclosed on and put on the market, and almost 14 percent said properties will be sold by borrowers, PricewaterhouseCoopers LLP said in a report today.

“‘Extend and pretend’ was the sound bite from a year ago,” Mitch Roschelle, co-chairman of the annual “Emerging Trends in Real Estate” survey, said in a telephone interview. “Now it’s ‘extend and amend.’ There’s less pretending and more focusing on the reality.”

Commercial real estate executives have lowered their return expectations as they enter “an era of less,” according to the 74-page report. Stagnant wages and high unemployment have led landlords and their lenders to focus on current yield rather than expecting prices to rise, PricewaterhouseCoopers said.

“The metric that the real estate world is most sensitive to is job creation,” Roschelle said. Rising employment spurs demand for office space for workers, apartments and houses for them to live in, stores where they can shop and warehouses used by retailers, he said. “So one job creates all these different uses of real estate.”

‘Core’ Property Yields

Investors are seeking returns of 6 percent to 7 percent from well-leased “core” properties, meaning the highest-quality buildings in the best locations, according to the survey.

For higher-risk investments, they’re expecting returns within two or three percentage points of 15 percent. That’s down from the more than 20 percent returns they sought before lenders withdrew from the market after the 2008 credit crash caused more than $1.8 trillion of financial losses and asset writedowns worldwide.

Investor confidence is rising, with 56 percent expecting at least “modestly good” profits in 2011, according to the survey. That’s up from the 35 percent who are expecting modest or better profitability this year.

‘Raising the Bar’

“In the past, every transaction was bigger than the last transaction, and we were constantly raising the bar,” said Roschelle, who conducted about 10 percent of the survey’s 275 face-to-face interviews. “Now our survey respondents are telling us nothing’s going to be as big as it was in the past. We’re not going to see blockbuster transactions that grab the headlines.”

Washington and New York have pulled “away from the pack” in investor favor while such coastal cities as San Francisco, Boston and Seattle were near the top in almost all property categories, the survey found. Values in Washington, where the “government never downsizes,” stayed within 10 percent of their peaks through the economic slide, according to the report.

In New York, the Troubled Asset Relief Program and federal support for banks helped limit job cuts, the researchers wrote.

“Who says TARP hasn’t helped real estate and markets?” Jonathan D. Miller, the study’s chief writer, said during a webcast today. “It certainly helped here in undergirding the financial industry, which is so important to that market. There’s a lot of confidence that New York will be strengthening.”

‘Most Livable’ City

Pittsburgh was cited in the survey as a model for Midwestern cities struggling to recover from manufacturing losses. Pittsburgh, named Forbes Magazine’s “most livable” U.S. city for 2010, shifted its focus to health care and education, offering “decent, steady returns” to investors even with stagnant rent and property values, according to the report.

“In the Era of Less, modest, boring income returns should become more expected, accepted and necessarily embraced in more markets,” the study’s authors wrote.

The survey is a joint venture with the Urban Land Institute, a Washington-based organization of real estate investors and developers, architects, engineers and academics. The report is being released today at an institute conference in Washington.

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