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    dcrocker
    Changing Tides in Due Diligence
    Entry posted February 18, 2008 by dcrockerElite Contributor, last edited January 19, 2012 
    807 Views, 7 Comments
    Title:
    Changing Tides in Due Diligence
    Entry:

    As I write my inaugural post, signs of a recession are mounting and the headlines in the business pages get bleaker by the day. Economists surveyed by The Wall Street Journal have become increasingly pessimistic about the economy. Testifying before the Senate Banking Committee just a few days ago, Fed Chairman Ben Bernanke voiced a gloomier forecast than his previous statements, emphasizing that “downside risks to economic growth remain.” Credit is more expensive and less available. Nervous real estate buyers have retreated from the playing field and investors have withdrawn from the CMBS market until the dust settles. The bad news of course is that commercial real estate transactions are down—and with them, Phase I ESA activity, which just took a downturn for the first time since 2002.

    Commercial real estate prices have declined, forcing lenders to sell securities backed by commercial real estate or take write downs. Risky mortgages have already cost banks and investors more than $100 billion in losses and pushed the U.S. economy that much closer to a recession. Financial institutions are trying to get a handle on how bad their losses will be, and that uncertainty makes them less willing to lend capital to borrowers. Lenders and the investment community are understandably jittery—as are the environmental consultants who support real estate transactions. The banks that are lending are exercising tighter lending standards across the board—putting all types of risk, including environmental risk, in the spotlight. This is a significant change in our market, and arguably, the only bit of good news about what’s been happening lately. As recently as a year ago, lenders were issuing loans—sometimes with little or no due diligence conducted—in order to compete with other lenders and meet the frenetic pace of deals with multiple bidders at the buying table. Those days are over. At least for now.

    The events of the past two quarters have been a double-edged sword for environmental consultants. On the one hand, transactions are down. On the other hand, the general mantra now is more conservative underwriting. Deals that may have sailed through a year ago with little or no due diligence are now being scrutinized for any risk, including that associated with environmental contamination. So where does that leave us? The hardest thing about any market downturn is that no one ever knows if the worst is over or just how long things will last. One thing to watch is the CMBS market. The first impacts from the subprime mortgage turmoil were felt on the commercial real estate side in the CMBS sector, where activity fell a staggering 69% from the third to fourth quarter of 2007. A return to robust CMBS activity will be critical for the investment sector since banks have come to rely on the ability to securitize loans in order to lend at the high levels of the recent past. Until CMBS recovers, lending activity of the largest banks will continue to be more restrained than the levels the market enjoyed in 2006 and early 2007.

    For now, the return of balance sheet lenders appears to be fueling transactions. Foreign investors, and other cash-heavy investors, are also quite active. Whenever market activity is down, it becomes much more critical to watch market barometers, stay abreast of shifting tides, stay close to existing clients and get where the action is. CommonGround provides an avenue for the industry to interact with each other, share ideas and hopefully weather the storm.

    Comment

     

    • Jay Gaines
      Hi Dianne, Welcome to the wonderful world of blogging! Great first post. I look forward to reading more from you. Jay
    • AmyH
      Great topic! I've been following this closely, and I know EBJ is about to publish a story on the credit crunch. Look forward to frequent updates, especially how to attract and retain clients in a downmarket.
    • Jwalker
      Nice Blog Dianne. I am curious to learn if consultants that are feeling the effects of the downturn in the CMBS market are finding or creating business opportunities elsewhere. If so, please share.
    • dcrocker
      Thanks Jon. Some consultants have shifted efforts into other types of transactions. For ex, some are doing Ph Is being done to qualify for Fannie Mae or Freddie Mac, loans that would've gone to Wall Street in the past. Others are tied in with institutional investors, foreign buyers and new opportunistic funds looking for deals as prices fall. Small balance lenders are also picking up some of the slack while the big lenders asssess their losses, but all indications are that this is not strong enough to make up for the shortfall in CMBS. CMBS will be an important barometer to watch as the first sign of recovery in CRE. Without that, it'll be hard for the big banks to resume lending to the levels they were at in early 07.
    • T. Wight
      Great blog! I like your ending with an upswing of encouragement that suggests there are shifts in focus possible based on industry barometers. Are there other specific movements you can suggest for people losing business that might help them refocus and find these alternative markets?
    • dcrocker
      Twight, Our data show that the downturn is affecting firms very differently depending on the mix of clients they serve. Any time there's a dip in CRE markets, opportunistic buyers step in to get properties at a discount. For those who are experiencing declining volume in Phase I work, the financial pages, particularly in local markets, can be extremely valuable sources of information on who the active investors are. The WSJ just had an article recently specifically identifying lenders who are ramping up their CRE lending--in contrast to the big guns who are still tallying up their subprime losses.
    • seand
      Great blog Dianne. We're seeing the takeaway message is two fold. First, diversify your client base. Include a mix of private and public, a mix of equity and debt, a mix of insurance and workouts - and stir! Someone, somewhere, is always doing a transaction and the best you can do as a firm (and as an individual) is to learn about the deal from all vantage points and be positioned to take advantage of each when the opportunities present themselves. Second, the relationship is everything. If some sectors of your business have been dormant for sometime, don't forget to kick yourself if you ignored them for years and now they are busy again.