My random thoughts on regulatory reform and the market

The one thing we know is this: markets hate uncertainty.  And after reading this CoStar piece about Dodd-Frank I can see why there is a lot of angst and uneasiness among some investors in the commercial real estate market.  It is going to take time -- and a lot of manpower and legal analysis -- to sort through yet another behemoth set of laws, rules and regulations.  While I am not a deal guy, here's what I am thinking, and I encourage you to critique me or even tell me I am dead wrong.

Pricing and cap rates will have to be lower than they were to sustain any good returns on deals.  If the days of what I liked to call "cowboy lending" are over, that is fine.  I was never a big fan of it anyway as a lawyer.  But we need to adjust to the fact that with lower LTVs on loans and stricter underwriting (including the requirement that lenders keep at least 5% of all their loans on the books as so-called "skin in the game") and more documentation (yay, lawyers!), this will be a change from the go-go days.  Yes, we will all have to work a little harder and be a little more careful.  Once again, fine with me.  If you have real money at stake you are going to be more careful.  But at the same time that means the "home runs" of a few years ago are going to be harder and harder to find, unless we go the the old days of, "Buy at a 10 cap, sell at an 8."

What I think is a dual concern and an opportunity is that some people will just stay out of real estate or exit the investment market.  Why?  Better places to make returns right now, even with prices deflated by as much as 50%.  There is already evidence of banks dumping their RE investment arms and advisory groups to boot.  So why is this an opportunity? Plenty of good pros will be out there needing something to do, and there will be a lot of property on the market.  Hopefully one or two of them will be calling me.  And what does this do to the hopefully slightly reviving CMBS market?  Again, uncertainty.

Another concern is development.  It might be a lot harder to build new projects with reforms and tighter standards in place, like we have had the last few years.  Again, this is not necessarily bad, but without construction moving then how is the economy ever going to really recover?

This is not meant to be gloom and doom for real estate.   I see and hear and know about opportunities in the market all the time.  But I do think some certainty and then some major league creativity is going to be what it takes to really get the market moving again.  That's going to be a fun cycle once it comes, be it next month, next year or down the road.  We will all have to put on our thinking caps for each deal.


Lastly, I also wonder aloud to what extent this will make mezz financing even more popular as a means to improve return rates to the levels that some of the players really want.  But we'll save that discussion for another time.

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Where's the private equity money?

According to this nicely-done New York Times post, not in real estate:

Private equity real estate fund-raising fell in the second quarter to its lowest level since 2004, suggesting that a recovery has yet to take root in the investment property market.

For years you kept hearing about everyone having "dry powder" but not using it.  Is that like the Mutual Assured Destruction theory of the Cold War?  I think the story correctly states that many lenders are wary to lend money to PE-backed concerns.  But it could also be --as the piece correctly mentioned -- that these entities raised a lot of money in past years, are looking for the right deals carefully and slowly; so looking for more cash right now when you are not deploying what you have is not necessarily a good thing. The deals I know about are often all-cash ones, perhaps or perhaps not levered after closing.  That just makes a take-down of the dirt so much easier when you can do that.

The piece also talks about an expectation of continued choppy prices -- you can expect that when volume is still low.  For all the talk in the market of recovery I'm still unconvinced it is robust and sustainable.  Of course I want to be wrong. 

As the story says, right now it is all about the lending.  The PE folks make their money when they can deliver big IRRs, and high interest rates and low LTVs don't help on the big returns unless the purchase price is THAT good.  (And that is not common.)  Yes, there is a little life in CMBS and the life guys are kicking in and reeling in some deals, but without liquidity of a type we saw, say, perhaps 9 or 10 years ago, we may not have a very robust recovery in our part of the market, at least not for the PE guys.

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Some thoughts on broker/lawyer relationships

Why are so many brokers and lawyers mortal enemies?  I cannot being to tell you the stories I've heard about broker x and lawyer y fighting with one another to the detriment of a deal.  I think there are two main reasons for this: (1) lack of communication and (2) interference.

I had a great conversation with broker and fellow blogger Duke Long yesterday that made me want to write about this.

In many deals if not most, brokers are at the table before the lawyers, negotiating the business terms and working the deal.  That said, smarter client in my humble opinion get legal counsel involved earlier, such as at the LOI stage.  They often take ownership of the deal, guiding it through for the client and to collect that commission.  Sometimes we lawyers laugh at the brokers, thinking that they do nothing to earn their money -- which, by the way is way too much anyway since it is so much more than the legal fees.  That happens sometimes, but not as often as lawyers think in my opinion. (And heck, sometimes lawyers don't earn their fees too.)

Conversely, some brokers unjustifiably see lawyers as deal killers. But our function is to point out flaws in deals, possible problems and raise issues so a deal can be properly underwritten.  OK, once in a blue moon I will find a deal that "needs killin'."  But that is few and far between -- a very rare occurrence.  And even then, my advice is simply there to accept or ignore, to point out good and bad things about a transaction.

A lack of communication is often a problem here.  Brokers, please realize that we are just out to protect our client's interest.  That is what we are paid to do, and if we don't, we are in major league trouble not to mention incompetent.  Lawyers need to realize that brokers have a vested interest in getting a deal done and should work with them toward that end.  Getting to the closing table ought to be the goal.  That is why I like to talk to my client's broker in the deal, so he or she knows where I am coming from and that I am simply not some annoying impediment to a commission.

That leads me to interference.  We each need to respect the other's boundaries.  Brokers should try to lawyer the deal; when a legal issue comes up, refer it to counsel.  It is not only the right thing to do but usually the legal thing to do, unauthorized practice of law and all that. (Note: Here in Illinois, a lawyer that has a broker's license cannot act as both the lawyer and the broker on a deal.)  And lawyers should, unless there is a compelling reason or unless you are asked, stay out of the business side of the deal.  A lot of us are frustrated business people or (in my case) business owners ourselves.  But by and large that is not our function, substituting our client's judgment with our own.  And they hired a professional to help with that.  (There are exceptions to every rule, of course, but I see this all the time.)  And often our business advice as lawyers is not quite as stellar as we might think it to be.


As a general rule, I have had terrific relationships with brokers.  We respect each other.  Have I run across some for which I have had little respect?  Sure, but not as many as you might think.

In short, there's room at the table for everyone.  We each have our function, advising our clients and getting deals done.  I think brokers and lawyers would get along a lot better if they just realized that instead of trying to bash the other as a waste of money or time or a detriment to the deal process.

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