How does the credit crunch affect the 1031 tenants in common investor? Hard to say at this point. If you break down the components of return on any real estate investment, you can break it down as follows:
1) buy vs. sell cap rate
2) cash flows
3) leverage level
The credit crunch negatively impacts #2 and #3. If the 1031 TIC sponsor can't raise cheap debt, debt service of its offerings will increase, decreasing cash flows. Likewise, lenders are becoming conservative, so LTV should also decrease. All this means, lower cash flow yields.
#1 is harder to understand. If you think that the credit crunch allows 1031 sponsors to buy at artificially high cap rates, then you should expect some appreciation over time. However, given the incredible real estate bubble of the past few years and cap rate compression, it's hard to count on any appreciation.
I think this all nets out to pressure on cashflows.
Because 1031 sponsors market their securities on cash flow yields, I think this makes it even more imperative that investors really do research on the sponsors and the underlying buildings. There are a ton of ways to game the proforma projected cash flows, and given the pressure from higher cost debt, many more dubious sponsors are going to play some dangerous games.
Again, make sure you spend time on www.1031reviews.com and really understand what you're getting into.
Excerpt from the Wall St. Journal 2/8/08
In January, no commercial mortgage-backed securities -- pools of commercial real-estate loans -- were issued. That's the first time that's happened since October 1990, says Commercial Mortgage Alert, a newsletter.
Since the start of the year, the cost of protection against default on a basket of CMBS originated in 2005 and early 2006 has more than tripled, according to Markit Group's CMBX index.
Goldman Sachs says the turning credit cycle could drive losses in commercial real-estate loans up to $183 billion, compared with $211 billion on subprime loans, and commercial real-estate prices could fall as much as 26%. While banks have recognized 91% of subprime losses, Goldman says they've come clean on only 17% of expected commercial real-estate losses.
This causes troubling feedback for the economy. Nonresidential building last year added a little less than half a percentage point to economic growth, and cushioned the decline in construction employment. If commercial construction stumbles, that cushion is gone.
