Last month I attended and spoke on the real estate panel at the Western Regional Conference for the Turnaround Management Association at the La Costa Resort in San Diego, CA. The main themes of the conference regarding CRE were as follows:
1. CRE pricing will probably bottom later this year or early next year.
2. There is approximately $150 billion of REO in the system at banks, insurance companies, FDIC and special servicers.
3. There is approximately another $250 billion of distressed assets in the same system.
4. New and non GSA financing on commercial deals is starting to occur, albeit at about 70% of the existing or prior loan.
5. There are high search costs to find deals in this environment.
6. The CMBS market is seeing a lot of activity in loan restructurings.
7. Bankruptcy attorneys are very busy and will continue to be for the next two years.
8. Most of the distressed buying activity is in acquiring loans as opposed to REO.
9. The FDIC is the defacto RTC of the 1990’s and is operating like a real estate private equity firm by entering into joint ventures with other real estate private equity firms in acquiring distressed assets from closed banks.
10. Distressed real estate assets are not being recycled quickly enough and this is prolonging the downturn in the industry.
11. There is a better and less competitive opportunity to provide debt/equity capital to real estate companies at the corporate level as opposed to acquiring individual properties.
12. The Bid/Ask spread is still as wide at the Grand Canyon.
There is an interesting bill in Congress that has been pushed by the International Council of Shopping Centers (ICSC) and sponsored by a couple congressional representatives, titled, “The Community Recovery and Enhancement Act of 2010”. The bill seeks to encourage third parties to inject equity into situations where a borrower is under water on a commercial mortgage. The bill will provide a tax benefit in the form of 50% bonus depreciation on the amount invested in a distressed asset situation. The new investor would obtain a minority stake in the property and a preferred cash flow position in future income.
The lender would agree to take a haircut and restructure the mortgage while getting a chunk of the mortgage repaid immediately and the distressed borrower would use the new funds to make the mortgage pay down. The borrower would agree to reduce his interest in the property and if required use a portion of the new funds to make capital improvements. Additionally, the new investor would receive immediate bonus depreciation of 50% on the investment and the lender would take a small write-down and with the pay down, the loan would become current and performing.
An example is as follows; $30,000,000 property acquired in 2007 with a $24,000,000 mortgage at 5.5%. Today, the property is worth $22,500,000 and the LTV is now 107%. The new investor invests $7,000,000 for a 30% interest in the deal and a 4.5% preferred return. The lender will get the $7,000,000 loan pay down and the new loan will be $17,000,000 or a 75% LTV.
The motivation for the bill and what we have been harping on here at VOM for that last year or so is that too few distressed situations are currently being resolved as banks are loathe to take write-downs on existing CRE and encourage cash sitting on the sidelines to enter the market with tax benefits. We are not sure if this bill has any chance of becoming law but at least some members of Congress are concerned enough about the slow recycling of distressed assets to attach their name to it. Many readers may recall our proposal in the November 15th issue of VOM at Nov Issue for Congress to suspend the Passive Loss Rules as a quick way to jump start the CRE industry. For more information on the proposed bill, see the ICSC’s web site at ICSC.
The largest bond investment firm in the world is PIMCO based in Newport Beach, CA. They manage hundreds of billions in bond funds and are known as the best bond house in the business. They are not known to be CRE investors but have published a very good analysis of the state of the CRE industry which can be found at CREP.
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