Good-Bye, 2009 - and Good Riddance

I hope you will excuse the recharging I have had the last few weeks. Sometimes bloggers need that, you know, especially when you put out a solo effort without co-writers or guests writing with you.

Let's face it: 2009 wasn't a great year for the legal profession or for real estate. The predictions of the bottom keep coming, but there is one problem: notwithstanding all the talk, try to get a loan for any decent size project, especially in development. Good luck.

The big story for lawyers was cutting, cutting and more cutting. Rates, associates, partners -- you name it, and it got cut. I have to chuckle at the fact that BigLaw is finally realizing that you have to "add value" to the clients to make the big bucks and keep the clients. Having been in that world, I know firms that do and firms that do not. (I know I add value, as it is why clients hire me in the first place.) Let's see if that lasts into the next boom cycle.

The problem with all this "value" stuff I am reading about is that I'm still not sure how much clients really get sometimes. Example: I charge about what some firms bill out second and perhaps even first year associates, and I have a sneaking suspicion I know a little more about dirt law. Also, much of what is being called "value billing" consists of discounted and blended rates. Blended rates rarely add value, in my opinion. And I am not alone in that opinion either; Jay Shepherd makes a great case against it in my view. With blended rates, all it does is lower the partner's rate and raises the associate rates. Given that, ideally, associates are doing the lion's share of the work with the partner supervising, what is "valuable" about that? Not much, except for the law firm that just managed to raise realizations for the associates.

Flat rates, on the other hand, might be a different story, and I have had some mutually beneficial success stories with them since I have a good idea on how to price a deal. Call it experience.

And for those I know and do not know who are in the legal profession and unemployed or underemployed: good luck. Hopefully that will change. The big problem is that we keep churning out lawyers without sufficient demand.

Now, the real estate market: we've seen retail woes, office vacancies, deterioration in the multi-family market as some people use bailout tax credits to buy homes (One client has seen its modest multi-family units vacancy rate triple this year) -- you name it, we've seen it. But one fundamental problem remains: lending. I know this may not make any friends in the banking community but you see senior execs getting tons of money for making "profits" off the backs of layoffs and other products, and touting all they are doing, but I'm really seeing no lending uptick in the markets in which I work. Foreclosures, yes. Cramdowns and even litigation over lenders making allegedly unreasonable decisions? Oh, yes. And that may just be beginning.

So what does 2010 bring? Beats the heck out of me. What do I want it to bring? A meeting of the minds in the middle, without which we cannot have a real recovery. (Okay, jobs would help too.)

I think pricing is getting where it needs to be. The dry powder stories are true, as this deal will show you (yes, that is not a typo in the story - $116/sf). So why aren't more investors buying in droves? Leverage and IRR. The cash is there, but unless you want to do an all-cash deal or a 50% LTV loan, it isn't happening by and large. And with deals so poorly levered, it is hard to get the IRRs that some investors demand.

I'm not saying we have to go back to the crazy days of 90 and 100% financing. I said then and say again that was insane. But we need to find some ability to do, say, 70% or maybe even 75% LTV deals, especially at these prices. That can give the buyers a reasonable chance at a good IRR, lenders a chance to make money with reasonable risk and create a win-win situation. Without that the sidelines stay crowded.

Some borrowers need to realize it is time to give up. Some lenders need to play ball. Find the middle, already.

Property owners have to make money but must also be good corporate citizens. If they were able to get concessions from landlords, great. I have seen some owners of fully leased or single-tenant properties (including national retailers) ask for 60 and 70% property tax reductions, and this is after they already got a TIF! Asking for reasonable tax reductions is one thing, but trying to use the recession to hose the public is entirely another.

Finally, we all need to find ways to get along. I think borrowers should try to be as transparent as they can with lenders. Lenders need to find more ways to work with their customers rather than play games (more on this soon, I think) and take unreasonable positions, if for no other reason than because the borrower will have a long memory when the cycle turns. (Lenders, of course, may say the same thing on their side about clients messing with them, and I can respect that.) Tenants and landlords also need to find the middle ground. And all of this can be done with or without us dirt lawyers being involved.

With that, I bid 2009 a thankful farewell, and wish you all a happy, healthy and successful 2010!

Still more on GGP - up for sale?

According to Adam Metz per this article, GGP is exploring options with "multiple parties." We've been talking about that for a while.

The good news is for those who bought low when it was uncertain whether shareholders would be wiped out. Take a look at its share price today. (We're talking less than $.50 at the low up to $10.67 Friday. Wow.)

The suitors? According to James Sullivan at Green Street Advisors, count on Simon (the Prime acquisition notwithstanding), Brookfield and Westfield. I would still not be surprised if a "dark horse" emerged from the hedge fund, private equity or other sectors. But the obvious players have to be the front runners, if for no other reason than they now have debt stakes.

Simon buys Prime. Is that all there is?

John Reeder has a good blog post on the Simon acquisition of Prime Outlets. I agree with his thoughts on market timing. I think buying before market bottom is fine as long as the numbers work. And Simon obviously believes that.

If I recall, Simon had billions of dry powder. This is an 80% cash deal, so there is money left for other acquisitions. While valued at $2.33 billion, Simon is only paying ~$560MM cash and assuming debt and preferred stock obligations.

Todd Sullivan says that antitrust problems may have played a role with multiple bidders and that Simon is out, with Brookfield the main player now. His story also says Brookfield would go the JV route with GGP, which is much more palatable to management. Makes some sense. And Brookfield has also apparently become a "meaningful creditor" of GGP. (I believe Simon also owns some GGP debt.)

Simon may or may not be out, Brookfield may or may not be in the lead, and I would still not be stunned if someone else in the business -- or outside it -- wasn't sniffing around a little, too, under the radar screen. (I will open my prediction envelope once a deal is announced.)

Thursday Tidbits - December 3, 2009 Edition

Sorry for the lack of posting lately -- a lot going on at work and otherwise and I haven't been inspired to write much. But there is much going on.

Yet another (small) CMBS deal for Inland Western properties? That's the word.

The NYT weighs in on the Block 37 situation.

The Chicago real estate and zoning boutique firm Schain Burney Ross & Citron, Ltd. is apparently losing roughly half its lawyers to Thompson Coburn LLP after merger talks break down, including Messrs. Ross and Citron. I have always liked and respected the Schain Burney firm for their work, although I'm not sure why I never looked into working with them. I guess it was because I was satisfied with my job.

GGP has filed the restructuring plan and completed what must have been the Mother of All Negotiations with the lenders, resulting in a restructuring of $9.7 billion in debt. Is that enough? Will GGP remain on its own? My spider senses tell me there may be another party looking at the company besides Simon (and Westfield?), but I have utterly no concrete information to back that up. So call it instinct. My personal hope is still that they stay independent or are bought by someone that runs the company as a sub with its team largely intact.

I finally got around to reading ULI's 2010 outlook and got depressed. But if you thought that was bad, what about this assessment?

November retail sales weren't very peachy according to Traffic Court. And the holiday may not be much better. My evidence is anecdotal, but where I live by mid-afternoon on Black Friday stores were relatively empty and some bargains left over from the early birds were still to be had. New unemployment data comes out tomorrow. Remember to look at the critical U-6 data, which also gives you the number of underemployed, people who have given up looking, etc. That number, if I recall correctly, around 17.5%.

The French Market is open down the street from my Chicago office. I am looking forward to trying some of that food out.

Enough. I'll try to post again soon. Until then....

Real Estate and The Sopranos...

Sometimes real estate lingo sounds like an episode of The Sopranos. For instance:

We gotta take a haircut on this deal, Paulie.

Oh, just whack the tenant.

Is (Broker X) a friend of mine or a friend of ours?

We're gonna take out the bank. It's what we hafta do.

Okay, maybe I am exaggerating. But taking out the bank is Joseph Freed's goal and its best alternative to a negotiated agreement since any such agreement at this point seems impossible. Freed is looking for equity and debt, according to Crain's today. You can read all about what is going on, including a hearing next Friday. While the receivership order was entered, I think based on the story that the order was stayed until the next hearing, by which time the receiver can take over upon presentation of a bond and insurance.

Now, is Freed going up for interim appellate relief in the meantime? I haven't read the order in the case so I don't know whether the so-called magic words regarding such an appeal are in there; Freed vowed to appeal but in the meantime is doing what it should -- looking for that BATNA. Because, you see, its the bottom of the eighth inning and the lender just took a big lead in the game.

Shortsighted, indeed?

In yet another chapter in the black hole otherwise known as Block 37, that's what some people are saying about Bank of America, who got its wish today in the appointment of CB Richard Ellis as receiver over the retail portion of the property from Joseph Freed & Associates, LLC.

As Eddie Baeb and Tom Corfman point out, and rightly in my opinion based on what little I know, "While the bank is within its rights to demand a receiver, the move may prove shortsighted, costing the bank more money over the long run and hurting the project's chances of success." Mike Reschke and David Stone, who both know their way around dirt, agree. The project is (does that means was?) about to open, so it'll be interesting to see how seamless the transition should be.

On the legal side, this was largely a slam dunk for B of A, the successor to LaSalle Bank, which underwrote the original deal. Some would say this is what happens when an out of town bank comes in and takes over from a trusted local player (most of whose senior management has moved on, with a huge number of them at The PrivateBank). Others would say that this is simply a sign of the times. The architects, contractors and others should have no problem passing on to the bank and CBRE; after all, that is why the construction plans and contracts are all collaterally assigned to the lender as part of the construction loan. But legal does not always mean practical, so whether or not there will be further delays is a question as yet unanswered. All I know is this: there will be some really, REALLY angry tenants if next Friday rolls along and we're not welcoming holiday shoppers.

And all that said, let me play devil's advocate, especially since I respect a lot of people at B of A and their lawyers (see below). It could be that things got so bad in the relationship between the parties that the bank had to do something drastic. (And I say all this with the greatest possible respect to my friends and former colleagues who represented the bank, by the way.) So, now we have a new game in town -- let's see where CBRE takes this baby.

And have a good weekend, everyone!

UPDATE: according to this Tribune story, some stores and the Pedway are set to open this weekend. And Freed retains control over the weekend, with the order for the receiver issuing Monday. Doesn't this remind you of a book or a movie?

Now that's good work!

Kudos to Adam Metz and Company at GGP. Here's another 70 loan extensions at ya. I said some time ago that these guys know what they are doing. By the way, something I want to repeat but that I didn't say yesterday is this: Even though I have no connection to the company I really want it to succeed and stay on its own. I think there is still a first-rate team of folks there who know the mall business.

The question of course still remains as to whether someone tries to swoop up the company as mentioned here yesterday. But they are hoping to get 170 of the SPEs out of Chapter 11 by year's end, and that alone is, in my humble opinion, an accomplishment.

Simon, GGP and predictions

A year ago, I said I would put a prediction in an envelope about Simon and GGP and see if I was right. Let's open it.

"Simon will end up owning part of GGP. But a team up with Westfield makes the most sense, especially if they do try to take in the whole company. This was done before so it is familiar territory for them."

My grade? Incomplete. Simon now is exploring ways to use its dry powder to buy some or all of GGP. My bet is still on some, with some interesting lender negotiations perhaps to occur. I noticed Westfield, which also has plenty of cash, was also mentioned in the WSJ story but apparently hasn't hired advisers. (By the way, that means bubkes, in my humble opinion.) So don't be shocked if we see another Rodamco-style deal.

Tidbits - November 16, 2009 edition

Haven't done any tidbits in a while, so here goes!

Block 37 - everyone is talking. Gee, you think the judge and Mayor Daley might have told Freed and B of A to lock themselves away in a conference room and not come out without a solution and an opening of the center before Thanksgiving?

Seventh Circuit reverses en banc on the FHA mezuzah case between residents and their the condo association. Read here for the opinion, in which the two judges who originally sided with the association changed their minds. (Thank goodness, thanks to changes in the law, we won't be seeing any more cases like this.)

Finally, a CMBS sells courtesy of Developers Diversified. Alas, it is only $400 million.

AMB says industrial demand and activity will pick up. What did you think they would say: "The market sucks and will continue to do so until 2017 -- we'll see you then?"

David Bodamer has a great post captioned, "Tracing the Commercial Real Estate Boom and Bust." And Deal Junkie has Bernanke's hopefully positive comments on opening up CMBS and a good CNBC video featuring Meredith Whitney. Let's face it -- unless we get money flowing into deals, things are going to get (Cue Arte Johnson).

Ho-hum department: InkStop files Chapter 7. Back in October they said they were temporarily closing their stores to restructure and concentrate on cash flow. Was that a howler.

These two stories about the hits lenders are taking is probably why they are skittish or unable to jump back into real estate, even if pricing does makes sense now.

It's a PIP! How many new flags will we see at what are now Holiday Inns?

Okay, I'll admit it. I cannot remember the last time I stayed at a Holiday Inn. It isn't because I don't like the flag -- I do -- I think it is just a coincidence. (Full disclosure: I represent clients who have numerous franchise agreements with InterContinental Hotels Group, but I have not spoken to any of them about this post, nor do I know what their plans are respecting their properties.)

In today's Journal there is a story about IHG's plan to force its Holiday properties to upgrade their hotels by February 1 or risk being in default under the franchise agreement, which means the lender also gets a notice of non-compliance. I understand the reasoning behind the PIP program. Right now differentiation is important in the business, and as I noted about my vacation, hotels are doing everything they can to attract customers and preserve RevPAR. They have to, because right now at least there are too many rooms and not enough customers.

The story says the average PIP will cost $150,000 - $250,000 per property. That is a lot of coin when occupancy rates are not where most owners want to see them. I wonder how many of these owners will just look to deflag and move to another brand? This of course has transaction costs associated with deflagging and reflagging to another brand. Some may but many will just have to suck it up and try to keep their position, waiting for a brighter day in the hotel industry. IHG's position? It has lost 125,000 rooms but gained 160,000 more and there are another 120,000 rooms under development. Great, more competition.

Have a great weekend.

Bank of America making more local friends - The Spire spirals through court

First it was Block 37. Now it is the Spire. According to this Tribune story, Shelbourne Development and Garrett Kelleher are counter-suing the bank for fraud, saying that the bank was deceptive in the terms of arranging its portion of the financing for the now-dormant project. B of A went after Kelleher on a $4.9 million guarantee previously, and this is the response.

As with past cases, I haven't read the papers and am not planning to do so unless someone sends them to me and/or pays me. According to the story, the counterclaim says that Shelbourne should not be deemed in default because of the economy, in which B of A has taken billions of bailout money. That smacks of the Trump Tower force majeure defense and I think that will be a tough battle.

In addition, and again according to the story, one of the allegations of fraud is based on this: "the bank took the proceeds of a certificate of deposit owned by Shelbourne for more than $3.5 million and applied it to the amount due, an amount that was overstated because Bank of America “intentionally and deceptively” calculated the interest rate based on a 360-day year."


Since when isn't interest on a commercial loan calculated based on a 360 day year? Maybe that overstates it, but it is not uncommon to see this provision at all in loan documents. Was it not here? Even if it was not supposed to be a 360 day year, I'm not sure that rises to the level of fraud, which is pretty hard to prove and win in Illinois. Maybe I am missing something since I haven't had a cup of coffee this morning....

Personal Notes on the Hospitality Industry

I'm back from vacation -- and an old fashioned driving one at that! We had a chance to motor our way to Virginia and back, visiting several hotels in different categories ranging from reasonable to five-star. Here are some random thoughts I had last week that I would like to share with you.

Some properties are really stepping up the food service, perhaps in an attempt to attract customers and if not, then locals. We had excellent meals at two hotels -- as good as top places in Chicago -- and on prix fixe menus that were really attractive pricewise. I can especially recommend 1863, the restaurant at the Wyndham in Gettysburg, Pennsylvania.

While we are on the topic of food, hoteliers HAVE to train their employees to be sensitive to food allergies. Why? Because THIS could happen. Here's how.

While at a hotel in Virginia Beach, my wife (who, as you may know, is a physician) mentioned to a hotel staffer who was feeding us that I was terribly allergic to shellfish and that we were being very careful about out eating while in an area known for that food. That person unknowing served us some complimentary spinach dip, which I might add was delicious. We went down to the beach for a sunset walk, and I started having shortness of breath. We went back up to our room, where I started sneezing and itching uncontrollably and breathing heavily. We called the server, only to find out the dip apparently had crabmeat in it. We went downstairs, a manager called 911 and I was off to the hospital, where after some IV meds and observation, I was able to go back to the hotel. (Many kudos to the Virginia Beach volunteer EMR staff and VB General Hospital.) The staffer in question was not, imho, to blame -- she was a wonderful person who even stayed late at work to pick us up from the hospital. But management needs to be wary of these potential problems. What if my wife had not been with me? I might have died alone in my room hoping that Benadryl would stop the reaction.

A number of properties we saw needed PIPs. One five-star hotel we visited badly needed it, BUT they made up for it with exemplary service. I'll tolerate an old TV and some threadbare walls if the service is first rate. People can really make a property special. Given a choice between good amenities and good people, the latter wins every time in my book. Staff was exceptionally friendly at every hotel we visited -- that is much appreciated by weary travelers.

Indoor pools are a great thing. Can hotel owners consider perhaps one late hour an evening for adult use only? And perhaps consider later hours at a pool when they are placed in areas that will not disturb guests? Cleanliness is a good thing, too. The 24-hour workout rooms are a BIG plus these days, even a big guy like me likes getting on the treadmill, you know.

Usually we have at least one clunker meal and one clunker hotel each trip. Not this time. We stayed at five different properties and went five-for-five in satisfaction. The recession notwithstanding, I was impressed. Corners are presumably being cut in back of the house and other areas where customers are not seeing it as much and that is to be commended. Times are not easy in the industry and it is good to see such impressive efforts from hotels.

One non-hotel item aside: we rented a Chrysler 300 rather than use one of our personal cars. What a piece of junk. It was a reminder of why we will not be buying another American car in the foreseeable future.

Anyway, vacation is fun, but there's no place like home. I'm looking forward to catching up with readers this week and writing as much as I can.

The song remains the same....

Here's a nice little story comparing the downturn in real estate in the 1990s to the one today. And there are many: cheap and easy credit, big price drops in every sector (I remember a friend in California who parents could not sell their house for 40% of its appraised value), cap rate compression and the like.

And there are differences, too. This cycle has even bigger job losses, while the last cycle had overbuilding in many markets. We had an RTC then, and I'm not sure we are going in that direction at all. CMBS is a major player (and problem?) instead of the lifes and all. Blah, blah, blah.

Having the historical context is good. But the important thing to remember about all this can be summed up in one word: opportunity. The biggest complaint that most of us are hearing is about these days is a continued lack of credit. At some point someone is going to make that happen. Bank on it, if you'll pardon the pun. And if you are not "shovel ready," so to speak, with possible deals for your pipeline, you might miss out on some once in a generation chances to make money. Ask the guys who did in the 1990s; they ought to know.

Block 37 redux - "show" me the tenant!

So, more details are out on Block 37. Work from the awesome team at Crain's is that apparently Muvico walked from its anchor lease at the property but offered to come back at better (read: cheaper) terms.

In other words, it looks to me like the old tenant cramdown.

Freed, not wanting to lose the deal and presumably sensing it could still make money, takes the deal to Bank of America. Why? Because the lender as a rule in deals like this has the right to approve major leases or material modifications to existing leases. Sometimes there will also be specific criteria under which the borrower can enter into leases without lender approval. And Freed is telling us the lender said no, and did so "improperly." You can read the story to get the gory detail being alleged in Freed's motion to dismiss, the gravamen of which is that it thinks the banks wants to capitalize on Freed's work to lease up the property and profit from it.

Now, the lender can argue that it did nothing improper, negotiated for two years to modify the old Mills deal without coming to satisfactory terms and the fact of the matter is the project is millions over budget and Larry Freed has violated his net worth covenant (by pumping money into the deal?). The bank's lawyer is an old colleague (and an excellent lawyer) to whom I (indirectly) referred a case a year or two ago, so you know I think he's good too. It'll be interesting to see how this plays out next week in front of Judge Brennan. I may even have to show up for this one.

Block 37: foreclosure, receivership and all that

Is this a classic case of no good deed going unpunished? Or is it just a lender enforcing its rights, albeit at an awkward time.

Bank of America, as the lead lender, is foreclosing on the retail portion of the long-awaited and oh so troubled Block 37 in downtown Chicago and will be in court this afternoon to have CBRE appointed as a receiver to keep the project going, including finishing construction. Unless there are some defenses sitting out there that we'll hear about, legally they presumably have that right, and even though Freed says construction could grind to a halt, surely the loan documents contain assignments of the construction contracts, architectural drawings and all that so the lender could in fact take over the project. (Hopefully none of the retail deals will allow the tenants to pull out in the event of a foreclosure or bankruptcy or something, or the project gets done in time to prevent triggering the right to walk for failing to finish landlord construction.)

Why now? No confidence that Freed could finish the lease-up, so bring in CBRE? Is there a potential here for more gain by jumping in? Interestingly, according to one Crain's story, "As an additional ground for default, Freed President and CEO Laurence Freed’s “unencumbered, unrestricted liquid assets” have fallen below $5 million, in violation of a key condition of the loan, which was issued in 2007, according to the complaint." Or is it just the fact that there have been millions in major league cost overruns has the lenders frightened?

Okay. Lots of people have taken a hit in this market. I'll take an educated guess here and say Freed may well have been pumping his own money into Block 37 to get it done, probably to the extent that his net worth has gone below the threshold for the default. So, let's nail the developer for -- gosh -- trying to do the right thing instead of walking or handing over the keys? If that is the case then I really do not know what to say. I do know that Mayor Daley wants this property opened -- or else! Since I represent developers more than lenders my sympathies lie in that direction, and I wonder if this could have been handled better, of differently. And would the old LaSalle Bank folks have done the same?

Kiosks -- for all you microretailer wannabes out there....

Here's a neat little piece about renting kiosks in the LA Times. I don't really remember seeing them in malls as a little kid, but installing them made so much sense. By putting them in what was once common area of the center you essentially create found money. (There are also common area carts, which is a slightly different beast; contact me if you want to know more.)

It can also be a win-win for both parties. As the article says, kiosks can be a cheaper way for beginning retailers to get into the business, perhaps with a cheap(er) and short(er) term lease. And for landlords, while the rent may be cheap, on a per square foot basis the kiosk can be great.

But if you are thinking about opening a bead shop for the holidays, remember a few things. The break-even costs are not low, the hours can be brutal (you have to be open whenever the mall is, which can be 70+ hours a week), and there's plenty of competition even in a recession. But if you have an itch to do retail, are not on a huge budget, but also do not want to say to yourself, "If only I'd opened my own business..." then this is an entry-level way to do it. Just be cautious in signing anything as a tenant, and get a good lawyer to look over the mall's almost certainly one-sided lease form so you are at least aware of your obligations.

Statistics on lender recovery by sector

Here is an interesting story citing a study by Real Capital Analytics showing that lenders might expect to recover about 60% of their investments on defaulted commercial loans that have been liquidated, with varying numbers by sector. Is that an incentive to renegotiate deals, extend and maybe pretend, or to look to sell the notes, take the 60% and run?

The 60% is before costs and fees, by the way. I think it might be a sign that everyone is going to have to take a hit in this market. But we knew that already. My one quibble with the study has nothing to do with the methodology of RCA but rather of the study sample. I think, for instance, it is hard to say that a lender on a land deal is only going to get 32% of its money back when the sample size is so small. I also do not know the statistical significance of 145 properties in the grand scheme of the market. There's also the issue of asset location.

What I really found interesting is that the "underwriting" of the newer loans being liquidated is holding up pretty well compared to older loans under supposedly tighter standards. Now, as the story says, there are many factors that could come into play here but I think it does remind us that property, as we learned in law school, is inherently unique. Nonetheless, some data is always better than none, because there is nothing worse then negotiating in a vacuum.

CRE "failures:" A ripple, a wave or a tsunami?

Ask around. I have. Today's Journal has a story stating that Peter Cooper Village and Stuyvesant Town is in imminent danger of default (well, meaning two to four months), and that will be "signaling the beginning of what is expected to be a wave of commercial-property failures."

It could be. We keep reading and hearing about the coming crash. But then you have Harvey Green telling us that the shoe hasn't dropped and will stay on the foot, albeit unlaced. (H/T to Jeff Vinzani for pointing this out to me via Twitter.) Green's take is that lenders needs to get a little more to the center. (I agree that banks are still unwilling to lend in some cases.) That does not mean there will not be a disaster, but it does not have to be. I like his views on the state of the market.

My take? If there is no panic and people look at this smartly, then we'll have a market upset somewhere between a ripple and a wave. Many deals that "work" still need to be extended; there are plenty of good, cash-flowing assets out there (unlike sub-prime mortgages) that just need time. It isn't an extend and pretend scenario much of the time, believe it or not. And the deals that do not "work" need to be worked out sooner rather than later, one way or another. Why? Because that gets all the cash from the dry powder funds sitting on the sideline working. Everyone and his mother seems to have a vulture fund set up but nothing to buy. And I know I keep saying it, but: Lenders need to lend, with government back up on losses after a stop point if absolutely necessary. And borrowers? Let's just say everyone has to play ball.

Anecdotally, an informal poll of readers tells me that people are very busy. Now, that is admittedly self-serving. And people who are not busy are not likely to admit it to me. But I know not everyone is twiddling thumbs out there.

Yeah, there will be some pain. Of that there is no doubt. Will we have another crash a la the housing market? I doubt it and I certainly hope not. But who knows, there could be a tsunami in the commercial real estate market. Hopefully we've learned enough in the last eighteen months to keep that from happening.

What a difference a year or two makes - random thoughts

Just a few quick observations and thoughts on the real estate market on a rainy Thursday:

  • My nephew works at a bank and he tells me anecdotally that only 25% of mortgage loan applications are being approved. Is that tight underwriting, a lack of desire to loan, lack of capital, or something else?
  • On a related note, lenders are really taking underwriting seriously. While it can be a pain, I think that is a good thing so long as the lender is actually doing deals.
  • I'm looking at the October issue of ICSC's monthly magazine, Shopping Centers Today. At a mere 54 pages, it is a tiny fraction of the size it was even a year ago. Presumably chalk that up to a lack of advertising.
  • That same issue cited a headhunter who said he hadn't seen an opportunity in development, construction, tenant coordination or acquisitions. There was also a profile of a former GGP exec, David Grossman, who is working as the Chicago master franchiser of a fresh food restaurant concept. I haven't been to Freshii, but it looks interesting and I wish him well.
  • All this makes me wonder if I should do something else sometimes. Even Justice Scalia said too many smart people are lawyers, and I can't say I disagree. But I do really like being The Dirt Lawyer. :)
  • Totally off topic, but this high-speed rail stuff is a complete boondoggle in its present form. The proposed speeds of up to 150 mph -- and in many cases slower -- will never get me out of my car. I totally support high-speed rail, but if we are going to do this let's think like Eisenhower. 200 mph (see here, e.g.) is more like it -- but even that should only be as a start! For instance, a French TGV train has been tested at just over 350 mph. Imagine having that regionally and then nationally in 20 years, like the interstates. Much air travel, a big carbon burner, would be rendered largely obsolete. Put rental cars and ZIPcars, etc. at the stations and you can revolutionize travel. I don't mind spending money on good, sane green projects but let's do it right. Better yet, provide tax incentives to companies that spend the capital to make this happen.
  • Speaking of green, if we want clean burning fuel, why are we not investing more in nuclear energy? Even the French (OMG, I complimented France twice in one post - a new record!) have this one figured out. That could be an interesting dirt play, too.
  • ICSC Chicago is coming in a couple of weeks. A couple readers have already expressed in getting together. Anyone else so inclined should shoot me an email. I plan to be in Chicago on that Thursday.
That's all that is on my mind and fit to print. Enjoy your day!

What has me worried

Yesterday we saw some optimism about cap rates and interest spreads that made me feel good. But what still has me worried?

1. The dollar. We keep printing money and are running obscene deficits in the hopes that it will bring back the economy. Is the the 1970s (or even the New Deal) all over again, albeit on steroids? Remember, we are not out of the woods yet. And this story about the allegedly planned demise of the dollar as a reserve currency really spooked me. Maybe a weak dollar might encourage foreign investment in CRE in the US -- I understand that -- but that does not necessarily make it good for the future of the United States as a nation.

2. A jobless recovery. Unless you have jobs you have little need for additional office space. People can't or won't start new companies and existing employers don't want any new space. Bob Herbert at the New York Times has an excellent piece on this today. We need to find incentives for job creation. More government, regulation and taxes is not, in my humble opinion.

3. Technology. It is a great thing. But it could also mean a need for less office space and more efficient industrial space.

I am still optimistic about recovery and cycles and all that. Believe me. But that does not mean I do not have a healthy does of reality checking to do.

Lamentable or not -- we lost. What next?

Losing the 2016 Olympics seems like a big bust for some people, including in the CRE industry. Yes, we lost a lot of potential public and quasi-public projects because the IOC decided to send the 2016 Olympics to Rio. By the way, does anyone seriously believe the 80,000 seat Olympic Stadium could have been built for $397.6 million? We all know on-budget Soldier Toile....err....Field and Millennium Park were.

But this post is not about second guessing. Instead, where do we go from here? Infrastructure improvements, to me, seem to be the most important thing to concentrate on. Let's assume we find the money. Public transit needs to be improved. Chicago once had a public transportation system that was the envy of all. Today? Not so much. We keep talking about high-speed rail. If we are going to do that to make it really work then rail lines within the city need to be upgraded to accommodate decent speeds. Maybe commuter train speeds could be improved, too. Try taking the old IC line north of 115th Street...zzzz.....

Then there is the old Michael Reese Hospital. Man, can a creative developer, perhaps in a public-private partnership, do something with that campus! How about a mixed-use development that compliments or expands even more on McCormick Place? I see tremendous potential there. Saving some of the Gropius buildings would be a big plus.

These are just two examples. I am sure others smarter than I can think of other examples.

We lost. Big deal. I really think Chicago, with some visionary planning, can take that loss and turn it into a win for everyone.

Cap rate spreads - making sense?

I really like this analysis by David Lynn posted at NREI. Why? Because it makes sense to me.

At one point, the numbers were insane. People buying deals at a 4 cap with the unfounded expectation that the bubble would go on and on and on smelled of tulips in Rotterdam. And yes, the frost came.

But look at the charts now, if you happen to be a chart person. Add in your risk premium and real estate is slowly starting to make sense again. Buy at a 10, sell at a 8 is the maxim I have mentioned here before. And as the caps reach reasonable levels, real estate's making sense again. That is the beauty of cycles. The thing is - it could still get better. But I agree with the analysis that smart money will start jumping in again with relatively "safe" deals - reasonable interest rates, LTVs and expectations.

Get a life? Insurance that is, for a CRE loan....

What do you think of these thoughts from Chris Vittetoe, now of HFF? (I have done deals with HFF in the past and like the way they work, by the way.)

He tells us 80% of life insurers -- an old, traditional way of getting good size deals done before the CMBS boom -- are in the market. Of course, your LTVs are at 65% but decent rates, and then some aren't really back if you read this sentence: "We just met with one lender that has allocated $30 million for LA County for the rest of the year. That is $30 million for all real estate assets including office, retail and so on." That is one decent sized deal, even in this market.

I'm also not sure that I agree with this conclusion. "A lot of people think we are still in a liquidity crisis but that was never true. There has always been plenty of money available just not at the pricing and leverage that some borrowers want."

At least in my world, I knew a bunch of lenders who were not able to lend money at any price. I suppose if you wanted to do a juice deal with insane, unsupportable rates and terms money was to be had. But almost no one was able to do those deals, of course. And given other things Chris said I think he might agree.

All that said, I think Chris has some really good things to say, especially when he talks about the pride of some developers who do not want to admit their properties have declined in value. And I would agree that the life lenders are really back in the market now in that they are lending at terms where deals work. And that is always good a good thing to hear.

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.

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.

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.

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!

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.

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.

Bad underwriting + inability to refinance =?

According to this Journal piece, the next potential mortgage crisis. We, of course, have been hearing about this for a long, long time now. Extending loans (sometimes called "extend and pretend") has been working well, especially, when the property is performing; i.e., cash flowing. But there is less flexibility in the CMBS market, where investors are expecting to clip coupons.

I am going to go out on a limb and do a little crystal balling here, so please realize that these are just my own personal views. There will not be a collapse. Special servicers will be working long and hard and borrowers to find ways to stop a complete collapse. Lenders, as the story notes, have no incentive to realize losses. And there are supposedly buyers with dry powder waiting to pounce on properties at heavy discounts. The hedge to that is that I am not sure government programs will help that much on these deals. The other hedge is that the commercial market traditionally lags the residential market by what -- eighteen months, is it? -- so we could see pain before we move back into a market uptrend.

If you have your own thoughts or predictions, please feel free to share them.

Isolated occurences or great strategy?

Some real estate lawyers -- who probably know a lot more about the topic than I -- think the GGP bankruptcy ruling is "an anomaly rather than a glimpse of things to come." The theory, I think, is that this is a unique case mainly because of the brinksmanship: the whole company was thrown into BK rather than individual assets.

I still think this is a great strategy. Sometimes to save what you have you have to go to the brink. GGP did. It was the first in this cycke and may not be the last.

The gurus at Wachtell are saying, "[T]he GGP ruling may herald a trend towards bankruptcy filings by highly structured real estate enterprises which today find themselves vastly over-levered." They go out on talk about independent directors and separateness covenants and agree the issues are novel and have not played themselves out. Go click on the link above read it. It's worth a few minutes of your time if you care about these issues.

I believe most everyone agrees with the court that the real goal is to get this company out of 11. It is time for that real work to begin. Stay tuned.

GGP about to start some heavy lifting -- what a workout!

Sorry, I could not resist that head to my post. This article sums it up pretty well. Lenders want their money back from GGP, in full, and now. GGP wants a seven year extension and favorable rates.

The judge has been siding with GGP so far, from what I can tell, and the bankruptcy guru of gurus said it best when commenting on the judge's refusal to take some of the properties out of the BK:
"The judge encouraged all parties to commence negotiations as soon as practicable in light of the decision," said James Sprayregen, partner with Kirkland & Ellis LLP, General Growth's co-counsel.
Some think GGP's best outcome is an acquisition by Simon and/or Westfield, both of which companies I understand have dry powder. This has been done before, especially in combo, as you may recall when Urban Retail/Rodamco's assets were split up by a troika. Now you could have more antitrust problems with consolidation and all that.

Others want to see the company survive, meaning there may be some very heavy lifting and long nights ahead for bankers and GGP execs on the business side if they want to make this work. And as I have said before that spectre of substantive consolidation hanging over the lenders almost like a Sword of Damocles.

The signs of the bottom are....

Take a look here, as Michael Houge does an excellent job of describing them, in my humble opinion.

My favorite, to follow up on my last post, is #2 - The Bad News is At a Crescendo Level.

I'll stop right there, which may make this my shortest post ever. Just remember, only a lawyer can write a 10,000 word document and call it a "brief."

Remember about optimism and pessimism....

If you are too optimistic, you are probably wrong. I've been there.

If you are too pessimistic, you are also probably wrong. I've been there too.

And yet I have little to dispute with the facts presented on this Fox Business video featuring dirt lawyer Stephen Meister about mezz debt, loan write downs, equity problems, extend and pretend and TARP. You can see the video at Real Property Alpha and Traffic Court. Mr. Meister thinks the tsunami is coming and points out a lot of good evidence supporting his case.

It reminds me of a borrower-lender game of chicken. The process is being delayed, just as it was in the house market, by not writing down these loans.

Saying almost every loan written between 2005 and 2008 will not be able to be refinanced is a bold prediction. And it could happen. But while I do not have the empirical evidence to back it up, I think about the two axioms above and say to myself, let's hope for just a storm surge and that lenders and borrowers can find ways to meet in the middle. Otherwise no amount of government bailout will help. And that fact alone may be enough to prevent a disaster.

GGP: winning in BK, but at what price?

I'm not at all surprised by the ruling yesterday that rejected lender's motions to remove the automatic bankruptcy stay off a number of General Growth Properties' performing malls. As you may recall, several lenders tried to pull their malls out of the BK case on the grounds that the borrowers were special purpose entities. This may put GGP and its team in the catbird seat regarding loan negotiations and exiting bankruptcy next year.

As the Reuters story tells us:

In an opinion closely watched in the credit markets, Judge Allan Gropper ruled that those seeking to have the cases dismissed because they claimed they were filed in "bad faith" were simply inconvenienced by the Chapter 11 filings and that "inconvenience to a secured creditor is not a reason to dismiss a Chapter 11 case."

Moreover, the Wall Street Journal is saying:
[T]he ruling has no bearing on the question of substantive consolidation, which entails combining separate entities of the same corporate parent in a bankruptcy case. The case is being closely monitored by real-estate investors and borrowers, since many securitized mortgages are packaged as special purpose entities.
That is where we get to the interesting part (correctly, in my opinion): the Reuters story is saying that the judge's "decision could pave the way for General Growth to seek 'consolidation' of its subsidiaries, and treat some of its units as a single debtor, overriding their status as separate companies."

Why is that interesting? I don't think it is great news for the credit market -- how do you do these deals now? I'm sure some smart people are trying to figure that out if they haven't already. All along the CMBS market has been relying on non-consolidation as a vehicle to make these deals more creditworthy. That is conceivably off the table, especially if this works and other companies copycat GGP's legal strategy. I remember working on these reasoned legal opinions years ago and wondered about the worth and value of them. Maybe now I know.

Death watch or evolutionary cycle?

There's a lot of talk today about Maguire Properties handing back seven buildings to the lenders (one of which is another real estate company that bought the debt at a discount). The "imminent default" magic words language might also mean Maguire is trying to get into the hands of the special servicer, which leads to a workout or to a deed in lieu of foreclosure or something. Maguire bought these buildings at the top of the market.

Some bloggers are calling this a "commercial real estate death watch." After all, "Lending hasn’t come back, prices are plummeting and those that poured funds into the sector during real estate boom are getting killed by high vacancy rates and falling rents."

While I agree we are waiting for some properties to "die," in a sense, I take a more phoenix-like perspective to the whole thing. After all, the property is reborn by its transfer to a new owner. So I like to think of this as the bottom of an evolutionary cycle, after which a lender dumps the property to a new buyer on the cheap or holds it for a while. As I keep saying, however, the problem, at least for many prospective buyers, will be finding money, because traditional lenders are not lending much and the CMBS market -- well, we'll see when or if that phoenix arises.

Is it time to buy?

That's what CBRE Investors is saying, at least in this story. And the analysis is sound, in my humble opinion.
"At this point, we don't know if we're at the bottom, but it appears we're pretty close, from the pricing perspective,” Lee Menifee, Global Strategy senior director with CBRE Investors, told CPN. "Over the last two or three months, there's been a firming of prices on income-producing assets with secure tenants, especially smaller deals."
Waiting for the absolute bottom, as the story points out, could mean lost opportunity costs.

There's one bugaboo, however: money. Money, that is, at LTVs that allow the deal to work, at reasonable interest rates and on legal terms that borrowers can stomach. So, let's see if these guys are right. (The customary full disclosure: I worked with CBRE Investors in its capacity as an advisor on many deals some years ago, and perhaps even represented them once on a small transaction, but I have never worked with Lee Menifee.)

Have a good weekend! And thanks to Doug Lytle for pointing out this story to me on Twitter.

The latest on Strategic Hotels - a missed target

Since I know some of you follow locally-based Strategic Hotels & Resorts, here is the latest from Crain's:

Chicago-based Strategic Hotels, a real estate investment trust, said Wednesday that its comparable funds from operations were a loss of $2.5 million, or 3 cents a share, in the second quarter, compared with FFO of $36.4 million, or 48 cents a share, in the second quarter last year.

Analysts on average had estimated a 1-cent loss in FFO, according to Bloomberg L.P.

I'll let people who know more about the company comment. Regular readers know I have a soft spot for any company run by a admirer of Winston Churchill.

Shhhh...check out AAA spreads

Just a quick post to mention this story:
Spreads on AAA-rated CMBS have narrowed by 100 to 150 basis points as a rally in these securities continues for the second straight month, particularly in five-year triple-A paper, according to a new report from Trepp. Predictably, the spreads have narrowed more on loans backed by stronger collateral, Trepp says. The narrowing has occurred even amid what the CMBS information provider calls "continued negative headlines."
Combine TALF, underwriting and dealmaking and what do you get? This. Let's see where it goes.

GGP - people didn't see this coming?

You can't be serious. The way this case is going, and now with a plan delayed for quite some time, we see this:
[GGP] at a hearing said it was considering ways to treat some of its subsidiaries as a single debtor and override their status as separate companies, according to a transcript of the hearing.
Perhaps even more stunning is this howler:
"This was a surprising development that was probably saber-rattling on General Growth's part," said Daniel Rubock, a senior vice-president at Moody's, who attended the hearing.
Saber-rattling, yes? But surprising? Not in my humble opinion, as I think I alluded to some months ago. From a tactical legal standpoint it makes a lot of sense to me, and I know I am not alone in saying that you could see this being at least a thought in the back of someone's head. I readily admit to happily not being an expert in substantive consolidation, but the mere fear of it in the eyes of the lenders -- even if it is an uphill battle for GGP to get it -- might make some kind of global settlement more likely, as the story quite correctly points out.

Speaking of fear, if you've read this far I think you know this goes way beyond GGP. If the company were to go to that nuclear option and then even succeed, then every other distressed borrower will copycat on to that theory and create what could be a complete disaster at the end of the day. It almost goes without saying that this would mean "pop" goes the loan market, such that it is these days anyway.

Never bet against Goldman Sachs

That isn't a bad credo to have. Here's an interesting post on a Reuters blog about Goldman shedding assets, writing down real estate investments and apparently hedging on their loans. Also not surprisingly, they appear to be using "'cash instruments as well as derivatives' to reduce some of the firm’s commercial mortgage exposure."

Yes, they are taking the bet on CRE just like the residential market, figuring that the commercial market will follow suit with high amounts of default. And if it is wrong, having written down value, it can write the value back up. Not a bad business if you can have it and get government funds to bail you out to boot.

P.S.: Real Capital Analytics says $2.2 trillion of CRE is at risk of default because those properties are worth less than they were up to five years ago. Thats...uhhh....a big number if correct. (H/T @RetailTraffic on Twitter.)

Not over til its over

I'm glad to see people saying the recession is ending or slowing. That does not mean it is over for commercial real estate. Consider the following:
  1. Lenders are not lending what borrowers need, and loan activity is declining. I'm not sure whether that is a function of less demand or just futility. I've heard some real horror stories from clients, regardless of credit.
  2. If this is truly a jobless recovery, then it will be hard for the office sector to rebound. Add the sublease market to the equation and you see what I mean. And delinquencies appear to be on the rise.
  3. Ditto the hotel sector. With less business and leisure travel RevPAR isn't going to rebound just yet.
  4. And retail? Well, there it is a matter of location. The best ones will still be ok and go forward. But tenants are smelling blood. And retrades like that makes it hard to price deals and loans going forward.
Now, that does not mean things will not somehow turn on a dime and we'll all be yelling "winner, winner, chicken dinner" at Christmas time. Just remember, when people are too optimistic or too pessimistic, they are probably wrong.

Experts Talk Hotel Woes

If you read the comments you'll see some discussions about single properties such as the St. Regis in California. But hotel troubles have been a macro issue, what with no money to lend, RevPAR down and business and leisure travel decreasing.

Just like the original version of the Game of Life, the experts, according to this story, anticipate a "day of reckoning." Some may end up at the Poor Farm while others go to Millionaire Acres. According to Morris Lasky, the CEO of Lodging Unlimited here in Chicago:
“Lenders have been holding off, hoping that industry conditions would get better. They haven’t,” Lasky said. “We could see close to half the hotels in California go back to lenders. When the market gets that bad, then you can say that we’re at the bottom. This foreclosure phenomenon is not a matter of if, only when. And the moment is getting closer.”
Others think pain will not until for at least a year, and will last so long as we have a jobless recovery, which could be the way we go. 2011 is what people there said as far as hotel deal flow goes. I think it could be a little sooner but I am no expert.

All this makes you think everyone will spin the wrong number, meaning Poor Farm. Who doesn't? The eventual buyers who get good deals with reasonable loans. But that could take a while. But even if this cycle is the worst the experts have seen, it all turns around eventually. Just as with every other cycle, the people who buy low will be the ones at Millionaire Acres. (On a personal note, I hope to take advantage and do some traveling at cut rates!)


It is a bad thing. So is a lack of confidence. One reason why the market tanked before was the lack of knowledge. And that is what we have here. We know prices on real estate continue to decline. Fear is in the street...maybe not blood, which is why more are not taking that time-old Rothschild advice to buy when there's blood in the streets, even if the blood is your own. The uncertainty extends to lending, because the market is nowhere near where it needs to be for CRE. People are scared on so many levels. Even the time honored tradition of eating out is taking a major beating.

I don't know how to create certainty or confidence. Yes, there are some encouraging signs recently; banks making profits, consumer news, and so on. But when faced with uncertainty the gut reaction is to sit tight. And that may not be bad. Just remember that downturns are often when the most money can be made. Ask a Rothschild if you don't believe me. The only certainty is that the cycle will again turn, be it next week, next month, next year or in ten years. Just as a boom cannot last forever, neither can a bust.

By the way, I think the best news I saw on the economy over the weekend is that people in LA are starting to get plastic surgery again!

Voluntary defaults and alternatives

That's right, we're starting to see an interesting strategy being put into play: borrowers are intentionally allowing properties to go into default in order to renegotiate a deal with the lender.

In the case cited here, "Millennium Partners this week acknowledged purposely defaulting on its two-year-old, $90-million CMBS loan for the 277-room Four Seasons San Francisco with hope of renegotiating the debt with the special servicer, LNR Property Corp., because the hotel, once valued at $135 million, is now worth less than is owed. The strategic move appears to be working for Millennium and others in California, which has industry experts expecting a lot more of it."

Why? Because on these CMBS loans the master servicers are mute, and typically powerless to really do anything outside a very narrow box. The special servicer has to get involved in order to get any attention on a possible workout. So the borrower purposely throws the deal into default by not paying or by otherwise defaulting on some covenant.

This strategy, of course, has risks, especially depending on what state you are in and the foreclosure laws there. I think Maura O'Connor of Seyfarth Shaw (where, in the interest of full disclosure, I worked for a couple of years in the 1990s) takes a better approach:
So, in order to trigger a file transfer from the master to the special servicer, a borrower or its counsel should request such a transfer in writing (to the master servicer), and should spell out that a default is “reasonably foreseeable” and imminent, and explain why. (However, I do not think it is a good idea to default in order to trigger a servicing transfer!)
This quote is taken from the comments, and I think this and other concepts in Maura's series on workouts are the best approach. Intentionally defaulting should be a last resort.

And here's the MBA's take

$8.9 billion in property sales in the first quarter. We knew from local results the number would be down. Its opinion? "While the pace of the economic slowdown appears to be easing, different aspects of commercial real estate and commercial real estate finance are feeling different levels and types of pressure."

Originations are down (no shock there), amd the CMBS market is dead (gee, imagine that!) but what I found interesting was that cap rates were, yes, up from 2007, but at 7.4% they are not as high as I might have thought. These are only reported deals, but it is an interesting sign that we may have a way to go or the prices might not drop as low as the vultures expect. Or, we could just be waiting for the shoe to drop on CRE foreclosures. Heck, I will leave it for the experts to figure it out. I'm just interested in the news.

Is the buy-sell disconnect connecting?

That's what this article claims is happening, at least in Orange County. On top of loan money often not being there, the disconnect between buyers wanting to buy low and sellers wanting to sell high might be narrowing. Until that happens in many more markets, and money is there to lend instead of being spent on raising banker salaries then you'll see slow activity. Oh, and it goes without saying that a soft leasing market does not help either, and that won't improve for so long as unemployment keeps rising. I am starting to sound like Chicken Little again and I don't like that, so I'd better stop writing.

We won't be fooled again...or will we?

I think Jonathan Miller at Trend Czar may have largely hit the nail on the head with this post last week, captioned "Don't be fooled." The gist, in my opinion? The financial system has stabilized for now but it is in recovery mode yet. Some provocative points he makes are:

1. Banks are building huge reserves with government encouragement while not lending much, hoping the economy will turn enough so it can write down some of its bad loans to reasonable levels. Then lending can get back to reasonable levels.

2. The people closest to the toxic asset problem don't want us to know how bad things really are.

3. Government is skirting around the issue of why it is not forcing more lending, all the while printing more money.

I don't want to get overly gloomy either (2017?), but I have had some of these questions in my mind for a while now too, and I also got a new thought or two from this post.

Thinking small ball...

In baseball some managers play small ball: a game strategy emphasizing single run production through bunts, hit-and-runs and base stealing. You see that more in the NL, where there is no DH. (And yes, I hate the DH rule.)

The same is true in commercial real estate. While the big deals you read about in the papers are at a near-standstill, the smaller deals -- bloop singles, reaching on an error, etc. -- are getting done. There's money for those small deals out there, and that's all because of less risk. That and the fact that you do not have to depend on CMBS to do a deal.

These deals aren't sexy, nor are the returns so great sometimes, but the deals are at least there. Face it, if you cannot do a Wal-Mart bond lease deal, a GSA building or medical offices, you may as well hang it up. I like seeing clients go after singles and doubles and then swing for the fences once in a while too.

Full disclosure: I have a vested financial interest in saying something like this because these types of smaller deals are in my wheelhouse, so I stand to make money from those deals. I am not equipped (or even interested, for that matter, other than as a spectator) in the mega-deals we saw a few years ago. But it also happens to be my humble opinion.

All that said, we need to start seeing activity on the larger deals and construction to effectuate a CRE recovery. Banks are afraid, and perhaps this is why. But, much as I enjoy small ball personally, the market also has to swing for the fences in order to thrive.

Welcome to the property boom of....2017?

That is what the head analyst at Deutsche Bank Securities is saying according to this Reuters story.

The question in my mind is this: How can the rest of the economy come back without a viable CRE market? Does this analysis take into account improvement in other sectors which could lead to more deals, or is this just an analysis based on current falling rents and a prediction that we will not get back to past levels for eight more years?

My personal opinion is that these predictions are a little too dire. Just as we were too optimistic at one point, one can get too pessimistic. Compare, for instance, this thought. That said, the 1990s were not exactly great years for some, were they? Nor am I an analyst, which could be a good or a bad thing depending on who you are and what you do.

(H/T to Jeff Vinzani for pointing this story out on Twitter.)

Are you a vulture?

I keep hearing the word "vulture" in stories like this. There are so many vultures out there you have to wonder what kind of real estate carrion they are actually eating.

Most any sophisticated investor will tell you they are looking for value in deals, value that will allow them to make money. But right now we have two problems in the market. The first you know about: getting cash to do a deal and make it work. Here I speak mainly of loans, although you can also factor in finding equity to do deals or to refinance properties that have declined in value combined with increased LTV requirements.

The other is the buyer-seller disconnect. Sellers are not willing to part with properties at what "vultures" consider to be cheap enough. And buyers are not willing or able to come up to the numbers the sellers want. And there is very little middle ground. Only when that middle ground is reached along with reasonably available loans are we going to see this ice jam break.

Wednesday Tidbits - 6-17-09 Edition

Busy day today...but here are a few items on my radar screen this morning:

A Chicago panel says the worst is yet to come. They've obviously seen a bid-ask spread. That and lenders have to start lending again. Don't believe what you are reading about that topic, in my opinion.

Mark Walsh is back. You heard that right. "[T]he lead executive who loaded Lehman Brothers Holdings Inc. with toxic property investments, is part of a group chosen by Lehman to take over the bankrupt firm's real-estate private-equity arm." Read the comments in this story if you want some entertainment.

Motions to dismiss a number of the SPE bankruptcy filings of GGP by some of the lenders are being held today. Read about the lenders' positions here.

When is the last time you saw a headline like this: "Commentary: Extended Stay Bankruptcy Is An Exercise In Stupidity." Don't hold back now, folks. Tell us how you really feel.

Finally, without mentioning names or blogs, why are so many blogs about business, especially those written by lawyers, written so dryly, without any flair whatsoever? Is it a personality thing? Are they afraid of upsetting current or future clients? As for me, I'd rather not write if there was not at least a modicum of what I think is interesting. This blog's for fun, not profit.

$100 a square foot in Manhattan? Is that true, and, if so, is that the new market?

A couple of years ago, while trying to explain that my little local market was cheap, I told a friend that a large office building, 100% leased to a single credit tenant, and on a very good corner if redevelopment was necessary, sold for $100 a square foot. By contrast, I was just involved in a deal with a local medical office building costing and worth twice that.

CPN is reporting:
With rumors circulating of a sale price around $100 per square foot, the sale of the 66-story American International Group headquarters in Lower Manhattan likely set the bar for the biggest sale in the area market thus far in 2009.

Youngwoo & Associates (YWA), a New York-based investment and development firm, together with Kumho Investment Bank (Kumho), entered into an agreement to acquire the AIG building, 70 Pine Street (pictured), and an adjacent office building, 72 Wall Street. The two buildings will total 1.4 million rentable square feet in the heart of Manhattan's Financial District.
Okay. Let's assume the rumors are true. Now, this asset will require significant, if not complete re-leasing, which depresses the value since your income is, well, zero. I do not know the lower Manhattan market well anymore. But $100/sf? That's fire sale pricing in my humble opinion. Does it make a market? Beats me.

Another claim in the story is actually more interesting to me; namely, that there is a little thawing in the credit markets, especially in deals involving less than $100 million of $50 million. (I have always called these deals my sweet spot. I never liked big portfolio transactions and avoided them like the plague back in the day.) You mortgage guys out there would have to tell me about that and whether it is true.

UPDATE: Let's go to the other coast, where the WSJ is reporting the sale of a new office building in Irvine, California owned by Maguire Properties at a 40% discount to construction costs.

Want to know more about lender issues with recapitalization?

I think this post and accompanying charts from the Llenrock Blog pretty much say it all. So much so, in fact, that except for the quote below I have nothing more to say about it. They managed to make a lawyer speechless, and that's saying something. The quote?
After working through this example however, I’m beginning to ask myself whether I’d rather just see the bank go out of business as opposed to putting an equity band-aid on its bleeding balance sheet.

It might be, it could be....CMBS relief?

That is what today's WSJ is reporting. In short, Treasury is looking at giving some guidance that would allow borrowers and servicers to actually talk about some meaningful restructuring rather than having to wait to get to the special servicers, defaults, 1066 and All That. (The reason? Tax consequences.)

Being proactive in this crazy market is, in my humble opinion, a very good thing. The most annoying thing, according to people I know, is knowing you have a deal that needs to be reworked, only to be told, for all intent and purposes, "We can't do anything until you stop paying on the loan." Sad but true, and necessary until something changes.

But, given the scary market out there, is this move enough? I guess time will tell, sports fans.

P.S. My wife thinks my use of pseudo-Dennis Millerisms (i.e., references to books, movies, etc.) is too obscure. I'll stop if you readers tell me to. :)

Commercial real estate sales decline up to 99% in Chicago

That's right. You read here and at Crain's. Many properties cannot sell because (a) there is basically no lending going on, regardless of what you may hear, and (b) buyers are afraid the worst is yet to come.

Here are the Q1 2009 sector numbers for Chicagoland, per the story and Real Capital Analytics:

Industrial: down 81%.

Office: down 85%.

Apartments: down 94%.

Retail: down 99%. (Yup. Two properties, $12.5 million.)

I guess the good news is that it can't get worse. Or can it?

Is CRE okay, a ticking time bomb or a lifetime opportunity?

That is what some people seem to be saying to Congress, even as the major banks are repaying TARP money to get the Feds off their backs.

I am not making any predictions. But we know this: tons of loans are coming due. Special servicers are just trying to hold on, often by granting short-term extensions. Refi money isn't there for many deals, and when it is the LTVs aren't great, meaning capital calls or mezz debt. (Can you say Barry Sternlicht?)

The question is whether the bleeding will remain stanched until things turn around or whether the stiches will burst and we will have Banking Crisis #2 for the Obama administration. Optimists say we're good and that current measures will work; pessimists say the worst is yet to come, especially since printing more money is going to be a problem. Vultures are supposed to be waiting to pounce, but there's a disconnect on some asset pricing that still hasn't settled yet. (I think Mr. Sternlicht even talked about 20 caps in a worst case! Check out Deal Junkie to see the interview)

Sorry if you wanted a prediction. The crystal ball just isn't working. The only thing that is certain is that we're in for some very interesting times.

Why is BigLaw Shrinking?

This has been one of the top stories at the New York Times website for a few days now. I can give you my opinions, which you can also call a condensed version of the story.

Not enough transactional work to keep people busy.

Ebb and flow. This happened in the 90s, too, people. Granted these layoffs are bigger, but that's because BigLaw is bigger.

Salaries got out of control. I was a beneficiary of this, admittedly. Firms are rolling back these increases a bit and I htink that is a good thing for them. (Don't even get me started about how I think we should close about 2/3 of our law schools.)

To pay for everything, billable rates have become insane. Work that is not "bet the company" work going to people like me. Would you rather pay BigLaw rates for a routine deal or pay me a fraction of that for the same work? (I am busy enough to tell you what I think clients are saying.)

In some cases, greed. Per partner profits have become -- for better or worse -- the measurement of success. Just as pro athletes move from team to team, so do lawyers with books of business.

Unlike some, I do not think BigLaw is done and history. There will always, in my opinion, be a place for that kind of model. If you need the best of the best on a deal, then get it - and many times that means going to the biggest players in the biz. Also, if you are a GC at a company, boards are not likely to fire you because you hired BigLaw in the major deal or major litigation. But I think there is a trend toward finding guys like me to handle other matters in a cost-effective and efficient manner while getting first-rate service. So there's room for all.

It's Friday already?

Work, etc., has been slamming me too much to write, but here are a few things crossing my desk:

The sad story of the partially-built Waterview Tower: foreclosure and mechanic's liens from here to eternity. Expect this in bankruptcy court.

I"m happy to see that my former colleague Carrie Risatti was named a principal at the Much Shelist law firm. Good for you, Carrie!

Do we really need to change TALF again? Read David Bodamer's take.

Is there retail optimism from franchisees and other smaller entrepreneurs? Will they help fill the void caused by some national tenants?

Have a good weekend, everyone.

GGP phrase of the day: "Relief from the Automatic Stay"

That's what lenders want. They want out of the quagmire so they can foreclose or do whatever they have to in order to protect their secured interests. Here's a great summary of what the lenders think:
Attorneys for Metropolitan Life Insurance Co. and KBC Bank N.V., a unit of KBC Groep N.V., wrote in their motion to dismiss entities related to White Marsh Mall in Maryland: "It is clear that the petitions of the White Marsh debtors were not filed with any reorganizational purpose; they were filed solely to obtain leverage and a tactical advantage in any future efforts to extend the maturity of the loan."

General Growth legally created its malls as special purpose entities (SPEs), separate from the parent company. This prevented it from being on the hook for any of the SPEs' obligations.

"In determining to underwrite the loan, MetLife and KBC relied on the separateness and credit worthiness of the borrower and the underlying property, especially because no parent company repayment guaranty was required," attorneys for White Marsh wrote.

It gets better...wait for it....
The SPEs are governed by independent directors. But some of them, including SPEs related to Fox River Shopping Center in Wisconsin, say General Growth fired the independent directors minutes before the bankruptcy filing.
"Governed" really isn't the precise term. Usually the independent person(s) only step in to approve a bankruptcy or similar filing. But that's besides the point. Creditor-friendly judge or no, the firing of (possibly recalcitrant?) managers on that timeframe is very interesting, at say the least. Assuming that was permitted by the loan documents (and I have seen deals that would have allowed this so long as the new directors met the independence test), then there was some very good lawyering on GGP's behalf when the loans were documented.

Recovery in CRE - two and a half years away?

That is the prediction you will find here. The lag of the commercial sector behind housing will be a factor, and certainly vacancies will also have to be absorbed on top of any new construction. Chicago has plenty of that right now. I guess once you see a flattening of new unemployment claims that will help. The step I always think is critical is an increase of temp hiring. I think companies hedge in initial hiring needs and a pickup there might be an initial sign of movement. Now if we can only see that! My hope of course is that we rebound faster, but I do know people that are planning projects with 2011 openings in mind.

Ackman and GGP - somebody help me out here

Maybe I am just getting old and confused. I thought Bill Ackman was saying before that bankruptcy was the solution to GGP's woes. Now he is saying that the answer lies in a seven year debt extension. As we know, management was already trying to get extensions before the filing. Or was his real game plan a BK and then a forced extension to the creditors? You tell me, because otherwise I will never know.

I do know this: I hope Ackman's right about the bankruptcy judge for his sake and for others, including the human beings who still work there. I'm not sure a liquidation would be pretty right now. Actually, I am sure it would not. And if he is right, Ackman says that even at a 9.4 cap (compared to what - a 5.3 on the EOP portfolio?) he stands to make a 1300% cash on cash return. Nice money if you can get it.