Commercial Real Estate Mortgage Woes Worsen
Data centers are IT assets, but they’re also real estate. Analysts have been closely tracking IT spending indicators for signs of slackening demand for data center space and services. But the supply of data centers is linked to the health of the commercial real estate market, which took a turn for the worse this week.
Here’s a summary from Wednesday’s Wall Street Journal: “The market for debt used to finance hotels, offices and shopping malls tumbled Tuesday on worries that the long-feared rise in defaults for commercial mortgage-backed securities had begun, possibly ushering in the next phase of the financial crisis,” the Journal wrote.
The growing difficulties are reflected in a sudden spike this week in the CMBX, a gauge of default risk in commercial mortgage-backed securities (CMBS).
How does this affect the data center sector?
- It makes it even more unlikely that new data center projects will get financing, which restricts new supply to projects that are already planned and funded.
- The reduction in supply is likely to offset any slippage in data center demand, meaning the shortages of quality data center space in popular markets may get worse, not better. This could affect pricing in high-demand markets.
- Opportunistic buyers with cash will go shopping for distressed data center projects, further tilting the competitive balance towards players with capital.
The problems in the CMBS market have been driven by two developments: the likely default of two projects held in many CMBS portfolios, and the changing focus of the federal bailout package.
On Tuesday news emerged that two commercial mortgage borrowers with $334 million of loans bundled into bonds are about to default on their debt. The commercial real estate market has been healthier than the residential market, where the subprime lending crisis has led to huge losses for financial institutions and triggered a wave of home foreclosures.
But that’s changing as the economy worsens. Delinquencies on commercial real estate debt rose to 0.78 percent in October, from 0.66 percent in September, according to RBS Greenwich data.
The New York Times also notes the impact of the federal bailout, which originally envisioned the government purchasing troubled mortgage loans. Treasure Secretary Hank Paulson now says the TARP program will invest directly in financial instutitions, rather than buying mortgages – effectively removing a large potential buyer for these assets.
“Investors bearish about the commercial real estate sector didn’t want to bet against C.M.B.S. for fear the government might swoop in and buy the securities at inflated prices,” the Times writes. ” But when that possibility dimmed, it increased expectations that value of C.M.B.S.’s would decline.”
Right now the turbulence in the Capital markets is severely affecting data center construction and will seriously constrain supply as we head into 2009 (possibly 2010). Even the largest wholesale/colocation providers (one announced this week) are failing to arrange additional financing and as a result have halted expansion projects which were already “under construction” in key markets all across the country. Many enterprise companies who originally planned to build data centers are now seeking to lease finished data center product (fully conditioned space) as way to preserve capital. If strong demand continues to outpace supply, in theory lease rates are expected to increase. (we’ll see) Rising building costs over the past couple of years (2006 and 2007) already made it difficult to attract capital (especially from banks) to build data centers. With the dearth of transaction activity, it’s going to be even more difficult to attract financing (especially a data center).