Commercial Real Estate Not Immune to Economic Woes
Back in June, I had a brief chat with an investment banker who specialized in commercial real estate financing. He focused on securitizations, where mortgages on hotels, office buildings, malls and other income-producing properties were sliced, diced and repackaged into instruments that were then sold to institutional investors such as insurance companies.
In his view, the commercial market was somewhat immune to the problems afflicting the residential property sector. Among other things, he believed his segment had witnessed less of the speculative excess that had undermined housing markets, the major players were more sophisticated and had deeper pockets, and the revenue streams that supported new and existing developments were solid and dependable.
I countered that while those differences might have meant something under normal circumstances, his sanguine view failed to take account of new realities. Like the fact that various aspects of the economy had become highly interdependent; or the degree to which leverage had permeated Wall Street and Main Street; or the now apparent reality that greed and short-termism had swamped prudence and patience when it came to how things were really being done in the financial sphere.
Needless to say, he remained unconvinced and told me so. Unfortunately for him, that means he probably did not make the kinds of adjustments in his lifestyle or operating environment that would have allowed him to prepare for the unfolding reality described in the following MSNBC report, "New Crisis in Commercial Real Estate Looms:"
Malls, hotels may foreclose and banks can’t renegotiate loan terms
The full scope of the housing meltdown isn’t clear and already there are ominous signs of a new crisis — one that could turn out the lights on malls, hotels and storefronts nationwide.
Even as the holiday shopping season begins in full swing, the same events poisoning the housing market are now at work on commercial properties, and the bad news is trickling in. Malls from Michigan to Georgia are entering foreclosure.
Hotels in Tucson, Ariz., and Hilton Head, S.C., also are about to default on their mortgages.
That pace is expected to quicken. The number of late payments and defaults will double, if not triple, by the end of next year, according to analysts from Fitch Ratings Ltd., which evaluates companies’ credit.
“We’re probably in the first inning of the commercial mortgage problem,” said Scott Tross, a real estate lawyer with Herrick Feinstein in New Jersey.
That’s bad news for more than just property owners. When businesses go dark, employees lose jobs. Towns lose tax revenue. School budgets and social services feel the pinch.
Companies have survived plenty of downturns, but economists see this one playing out like never before. In the past, when businesses hit rough patches, owners negotiated with banks or refinanced their loans.
But many banks no longer hold the loans they made. Over the past decade, banks have increasingly bundled mortgages and sold them to investors. Pension funds, insurance companies, and hedge funds bought the seemingly safe securities and are now bracing for losses that could ripple through the financial system.
“It’s a toxic drug and nobody knows how bad it’s going to be,” said Paul Miller, an analyst with Friedman, Billings, Ramsey, who was among the first to sound alarm bells in the residential market.
Unlike home mortgages, businesses don’t pay their loans over 30 years. Commercial mortgages are usually written for five, seven or 10 years with big payments due at the end. About $20 billion will be due next year, covering everything from office and condo complexes to hotels and malls.
The retail outlook is particularly bad: Circuit City (CCTYQ.PK) and Linens ’n Things (LIN) have sought bankruptcy protection. Home Depot (HD), Sears (SHLD), Ann Taylor (ANN) and Foot Locker (FL) are closing stores.
Those retailers typically were paying rent that was expected to cover mortgage payments. When those $20 billion in mortgages come due next year — 2010 and 2011 totals are projected to be even higher — many property owners won’t have the money.
Some will survive, but those property owners whose loans required little money up front will have less incentive to weather the storm.
Refinancing formerly was an option, but many properties are worth less than when they were purchased. And since investors no longer want to buy commercial mortgages, banks are reluctant to write new loans to refinance those facing foreclosure.
California, New York, Texas and Florida — states with a high concentration of mortgages in the securities market, according to Fitch — are particularly vulnerable. Texas and Florida are already seeing increased delinquencies and defaults, as are Michigan, Tennessee and Georgia.
The worst-case scenario goes something like this: With banks unwilling to refinance, a shopping center goes into foreclosure. Nobody can buy the mall because banks won’t write mortgages as long as investors won’t purchase them.
“Credit markets have seized up,” corporate securities lawyer Michael Gambro said. “People are not willing to take risks. They’re not buying anything.”
That drives down investments already on the books. Insurance companies are seeing their stock prices fall on fears they are too invested in commercial mortgages.
“The system has never been tested for a deep recession,” said Ken Rosen, a real estate hedge fund manager and University of California at Berkeley professor of real estate economics.
One hope was that the U.S. would use some of the $700 billion financial bailout to buy shaky investments from banks and insurance companies. That was the original plan. But Treasury Secretary Henry Paulson has issued a stunning turnabout, saying the U.S. no longer planned to buy troubled securities. For those watching the wave of commercial defaults about to crest, the announcement was poorly received.“He’s created havoc in the marketplace by changing the rules,” Rosen said. “It was the stupidest statement on Earth.”
The Securities and Exchange Commission is considering another option that might ease the crisis, one that would change accounting rules so banks don’t have to declare huge losses whenever the market declines.
But the only surefire remedy is for the economy to stabilize, for businesses to start expanding and for investors to trust the market again. Until then, Tross said, “There’s going to be a lot of pain going forward.”
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This article has 11 comments:
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investor88
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732 Comments
Nov 30 08:23 AM-
Jimmy Lathrop
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268 Comments
My Website
Nov 30 10:42 AM-
The hand
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763 Comments
My Website
Nov 30 09:30 PM-
billp37
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165 Comments
My Website
Dec 01 08:52 AMPRU, HIG, LNC ... apparently are invested in commerical real estate according to Cramer 11/13/08
www.cnbc.com/id/158402...
Sandia National Laboratories retirees are paid by PRU.
More New Mexico finanical news:
"Eclipse Aviation, had built up more than $1 billion in debt owed to more than 5,000 creditors and shareholders during its 10 years of existence, triggering this week's filing for Chapter 11 bankruptcy protection, according to court documents. ..."
www.prosefights.org/nm...
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carey_jim
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539 Comments
Dec 01 11:23 AMOnly the very old and those who have studied American history have any real feeling for the way things were in America before World War II and only those who have studied history know what America was like before World War I.
At various times in history, ruling elites have been swept away by historical events and sometimes have been replaced within a very short time by other elites either within their own country or from outside.
The power of the American landed aristocracy was replaced by that of the robber barons after the Civil War.
Hyperinflation destroyed the wealth of the upper classes in Germany after World War I (and paved the way for the Nazi take over.)
The Russian revolution destroyed the wealth and power of the Russian ruling families in 1917.
World War II destroyed the power of Europe and moved the center of world political and military power to the United States.
America has over 700 military bases all over the world and there is serious talk of closing them down because we can no longer afford to keep them.
American military imperialism is hated by people all over the earth and the war in Iraq is seen as a naked act of American military aggression to secure oil for American use.
The American plutocracy is not immune from the laws of history.
On Nov 30 10:42 AM Jimmy Lathrop wrote:
> The sophisticated investors behind REITS and commercial real estate
> entities aren't going to be selling pencils and apples. They will
> come out okay. Maybe their youngest daughter will have to wait a
> few months for her nosejob but it is not going to affect Main Street,
> unless you are a plastic surgeon. We are talking about entities which
> have loads of cash and other assets. There is always Chapter 11 to
> fall back on or other individual state debtor-creditor laws to ride
> out the credit crunch. There are many problems with the economic
> health of this nation but we don't need to worry about who is going
> to buy the mall. Five years from now, the New Yorker will print a
> breathless piece about some filthy rich guy picked up all of these
> properties on the cheap and he will be heralded as a savior and fifteen
> years later there will be another piece about how after the filthy
> rich guy his kids mismanaged the real estate empire and were forced
> to sell everything to protect their expensive drug habits. Meanwhile,
> the other 99.9 percent of the nation will have been going about their
> business as usual.
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CRED Buyer
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6 Comments
My Website
Dec 01 11:43 AM1. Very highend Hotel in California with $90MM in debt and only a $4.5 NOI, and is arguably stabilized.
In todays underwritting this entire hotle is worth probably only $60MM. not the $112 million the bank thinks. They are trying to sell the B piece at price that still values teh hotel at $95. This hotel is owned by a mjor REIT - and they have several of these loans, are they going to put up the additional capital by my estimate $45MM that will be needed to refinance these loans when they come due in 3 years. I am seeing this all over the place, and teh smart guys on Wall Street still seem to be smoking crack.
When it is time to refinance this debt assuming there are some lenders out there, they will want 1.2 - 1.4 DCR inplace, real cap rates, and a 60 - 75% LTV if you apply this metric to a lot of these deals out there - a lot of 06 and 07 loans are under water.
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Tedspick
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15 Comments
Dec 01 11:43 AM-
BerkeleyBob
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115 Comments
Dec 01 02:00 PM-
carey_jim
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539 Comments
Dec 01 03:23 PMYou are right about my sentence "secure oil for American use" I got carried away by my own rhetoric. What I meant was "secure oil for use by the West" and to serve American interests.
The Middle East was never of any concern before the discovery of oil. The British moved in during World War I and took it from moribund Turkey.
After World War II until it came under (mostly) the domination of America. The alliance with the Saudi Royal family (hardly a democratic regime) and the overthrow of the democratically elected Iranian president Mohamed Mosadek (a socialist with ties to Russia) in the early 50s marked the beginning of the American hegemony.
After all, Rommel didn't invade North Africa to secure the rights of women in Islamic countries but to secure the oil there for the use of the Nazi war machine. And don't forget that Saddam Hussein was a socialist and his government was closely allied with Russia.
This has nothing to do with liberalism.
On Dec 01 11:43 AM Tedspick wrote:
> We keep hearing about the belief that Iraq was "all about oil".
> If that is correct, where's the oil? How come we in America aren't
> awash in Iraqi oil? If you read the Bernstein books (an author who
> can hardly be considered an apologist for the administration) on
> the Iraq war you find the word "oil" barely mentioned. Whether rightly
> or wrongly, the Iraq invasion seemed to be about the assumed presence
> of "Weapons of Mass Destruction". Oil in Iraq belongs to the people
> of Iraq and still belongs to the people of Iraq. If we want that
> oil we must line up like everyone else and buy it on the open market.
> Its time to put to bed that old liberal fantasy about how the Iraq
> invasion was "all about oil".
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carey_jim
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539 Comments
Dec 01 09:39 PMI should have given you a few references. My bad.
Here is one :www.sodahead.com/blog/.../
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granger
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282 Comments
Dec 03 07:54 AM