Are we in a cycle or a reset?

Here's a thought provocative enough to get me to post on a Sunday. RevPAR and occupancy are down so much at hotels that at least one industry mogul says this isn't cyclical:

What the U.S. hotel industry is experiencing today isn’t simply the downside of a highly cyclical business, emphasizes Thomas Magnuson, but rather a massive fundamental shift. “It’s a reset,” declares the CEO and principal of Magnuson Hotels, ranked by Inc. Magazine as the world’s largest independent hotel group.

So combine occupancy drops with supply increases and you have a whole new paradigm. Now for consumers that may be a good thing, even for the long term from a pricing perspective. You also have the possibility of some shutdowns, a ton of foreclosures and an even larger expansion on mom and pop owners buying properties on the cheap and managing them close to the bone to eke out a profit.

But let's look at this from a more macro perspective: could this thesis be expanded to the sector as a whole? We did not think office buildings were generally overbuilt. But with a jobless recovery it could be a while before demand picks up, and you may indeed see a trend toward minimizing office expenses. Ditto the retail sector. Without jobs, people reduce shopping. And if I am any example, people are buying more and more online. I would argue the industrial sector is less of a potential reset candidate because of fundamentals and different expectations, the numbers of vacant buildings I see notwithstanding.

I'm not prepared to say that the entire real estate market is in a reset mode. I still think we are at the bottom of a cycle, But the hotel theory extrapolated to the entire market is, in my humble opinion, an interesting thought, especially as we see the market look for and hit bottom. Perhaps then we'll know -- with 20/20 hindsight -- whether it was.

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More on restructuring guidance - a good start but not a panacea

As I mentioned in my last post, I thought it was about darn time the government came out with some guidance on restructuring CMBS to allow modifications to individual loans in the pool without having to throw everything into default and the special servicer.

That doesn't make this move, however, good, a cure-all for the market. As an excellent story in Retail Traffic points out, this just might be a delay to solving the fundamental problem rather than a solution. Think of it as, perhaps, a more complex and less personal extend and pretend? But the hope is not completely illusory -- but modifying the loans the thought is that they could be extended into the next cycle, although I suppose you could also argue that the extensions could delay a new cycle too. I tend not to think that way.

One potential difference between CMBS pool loan extensions and bank extensions, in my opinion, has to do with the future. In some cases, banks that extend have another factor to consider: the customer relationship. I can think of some lenders with foresight who are trying to give the client the benefit of the doubt because they want to maintain a good relationship into the next cycle. Well, that and they probably do not want some of these assets on the rolls and the losses that come with them. Call it a symbiotic relationship if you will.

And as we all know, what goes around comes around. It isn't a matter of if but when in the market. There are just a lot of different opinions as to when "when" will happen.

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Treasury issues CMBS restructuring guidance -- about time

Here are relevant stories: here and here . The gist? "The guidance would ease requirements for collateral and other guarantees in many cases. Borrowers in investor pools known as Real Estate Mortgage Investment Conduits would be allowed to refinance some loans without paying tax penalties."

Why should this have happened sooner? Pain, that's why. As the WSJ notes,

"Until now, tax rules have made it difficult for borrowers who are current on their payments to hold restructuring talks with the servicers of these bonds. Developers and investors complain that only those who are delinquent can talk to the servicers. Indeed, many property owners -- notably mall giant General Growth Properties Inc., now in bankruptcy protection -- have cited this lack of flexibility as one of the reasons for having to default on debt and give up properties."

Not much time to post more today except to say this should have been done a long time ago. Apparently more guidance is to come. Hopefully that will happen soon.

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I guess it's not impossible - judge rules against earnest money refund

I've written here before about buyers and borrowers raising defenses of impossibility or impracticability of performance or even force majeure under contracts because of the global economic situation. One of those deals was at 180 North LaSalle, where Younan Properties put down $6 million in hard earnest money to buy the building from Prime Group Realty Trust. Younan could not close and sued to get back the deposit.

Judge Maki in the Cook County Circuit Court has told Younan that it loses.

“The purchase and sales agreement is a promise to purchase this property for a set price on a set date with no provision for any financing contingency,” Judge Maki said. “That cannot be overlooked or given less importance because of other circumstances that. . . .possibly developed here.”....“That was the deal,” says Robert Hermes, a partner at Chicago-based law firm Butler Rubin Saltarelli & Boyd LLP, which represented Prime Group. Mr. Younan “assumed the risk if he didn’t have the cash to close.”

Younan is appealing. Meanwhile, Donald Trump, who used the force majeure argument with Deutsche Bank, is in a holding mode with the lender, whose counsel says courts are generally not buying the force majeure defense.

I haven't read the actual ruling, but impossibility of performance is a pretty steep hurdle to clear, even with fouled up credit markets. The precedent of a impossibility defense in these circumstances might also not be all that great from a public policy standpoint. But a few years ago we were doing hard money deals with no free looks in order to get the deal landed; and this is what happens. Perhaps it comes down to this: you pay your money, you take your chances. Who knows -- maybe the appellate court will disagree, so we'll stay tuned.

Have a good weekend!

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Surviving the market - take plenty of water!

Forbes has a good article out on the state of the market captioned Commercial Real Estate: Big Troubles, Small Bailout. The gist is that there is a lot of potential trouble facing the market and government will not be the solution.

My favorite quote from the story is this one:

California billionaire and Colony Capital Chief Executive Tom Barrack talked with Forbes in July about the struggle for survival in a downturn. "The object of the drill for everyone in commercial real estate--and this is everyone in the world--is just get to the other side of Death Valley. If you can make it to the other side of Death Valley, there's hope."

So how do you get to the other side of Death Valley? Plenty of water. Water in this real estate market means a different type of liquidity: cash or access to it. And that is easier said than done. There are people who levered a ton and may pay the price. There are companies that supposedly have the liquid and are sipping very very slowing from the canteen, reserving that cash for the right time. The hard part of the equation is lenders. TALF has not been the answer. If I were the guy in charge I would have jump started the commercial market by backstopping losses after a certain point, but I guess people smarter than me had other ideas or other ways to spend the money. (See here and here for opposing viewpoints.) I guess that's why I am not in DC.

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A shameless double plug

John Reeder was kind enough to profile me as one of his top 100 real estate tweeters at his fine blog, Real Property Alpha. I had a lot of fun answering the questions. By the way, if you are not reading John's blog, why not? He does an excellent job with it and I commend him to you.

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