Notes From the Credit Market's Front Lines

Fears vs. Fundamentals

Jack Foster is managing director of Franklin Templeton Real Estate Advisors, which has some $4.5 billion in assets roughly evenly divided between real estate investment trust, or REIT, securities and private equity . Foster, who has been on the job for two decades, is blunt in assessing the current capital-markets fog.

"There isn't going to be much clarity until September or October" at the earliest, he says. The situation is having an impact on anyone involved in a transaction. "Right now the costs of lending are increasing, and capital-markets players are going to have fewer stamps on their dance cards."

To assess the amount of what Foster calls a "spillover" into commercial lending from the residential world -- led, of course, by the subprime-mortgage morass -- he is surveying Franklin Templeton's fund managers "on how this is playing out. The initial take is that smaller managers are less impacted. But this is not going to clear itself for some time." Still, he says, echoing a now-familiar theme: "The commercial side is not as impacted as the residential side, because of" -- can you guess? -- "strong fundamentals."

While some observers express little concern for the time it will take markets to unwind, Foster sees an impact for lenders and syndicators "who can't move loans off their books." Those loans, he notes, "are depreciating in value." That is setting the stage for "opportunistic players that surface and clear the market -- at a substantial discount."

One wrinkle that Foster sees is that "lenders are spending a lot more effort marking to market, and that is going to cause balance-sheet deterioration" for investment banks and commercial banks alike. Longer term, he says, "this will be more of a problem with your overleveraged players who geared up and bought big chunks of this stuff." He says there won't be "the same level of damage on the equity side of property, although we could see cap [capitalization] rates expanding. The bottom line is that you're looking at an increased cost of debt for strong and secure borrowers. "

Foster expects perception on both sides of the fence -- the players and the played -- as being a major factor. "Players in real estate have always been willing to consider disastrous situations," he notes. "Everyone knows the drama of overextended property. And the sentiment issue is exacerbating the problem.

"It's going to feel ugly as we get through September and October, but given that the commercial markets are fairly healthy, the impact there will be substantially less" than in the residential market. In fact, he says, "I'm enjoying this, because I look to buy things cheap."

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