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.