Carried interest is done? Pretty please?

According to this story, the proposed tax hike on carried interest appears to be dead for the time being:
Senator Debbie Stabenow, a Democratic member of the finance committee, told Crain’s Detroit Business on Tuesday a hike in the rate of taxation for carried interest would “not be part of any bill we pass”.
Boy, let's hope so. I understand the desire to go after the hedgies and Wall Streeters and the banking industry in general. Really, I do. But, as I have said before for, oh the last year and a half or so, this would be a disaster in the making for commercial real estate. And I am by no means alone. As the ICSC puts it:

Unlike private equity firms, the carried interest for the general partner in a real estate partnership is not guaranteed income. Most real estate partnerships must exceed numerous hurdles,
which result in the limited partner realizing a return on investment before the general partner sees the first dollar of gain. Moreover, the general partner often experiences a significant “hold” time before seeing that gain.
 So, if you really want to depress the market even more, pass this bill.  If you want activity to improve at least a little, as more and more are predicting will happen in 2010, leave well alone.  And I believe President Obama mentioned something about some capital gains relief for small business too. That wouldn't hurt either.

In a word, Illinois is...basically bankrupt. What do we do?

For all intents and purposes, that is what this excellent story in Crain's, captioned "Illinois enters a state of insolvency," is telling us.  I think most of us already know it and just do not want to say it. California is in worse shape in terms of numbers but on a per capita basis I think Illinois takes the cake.  And we have the worst negative net worth too.  We are about $1,000 per person in the hole -- or $12.8 billion.

Hoo boy. "According to Jim Nowlan, senior fellow at the University of Illinois' Institute of Government and Public Affairs[,] 'We're close to de facto bankruptcy, if not de jure bankruptcy.'" (Full disclosure: Jim was teaching at my undergrad during part of my tenure there, but I was not his student as I recall. I do remember Jim being a good, smart guy with a tennis game to boot.)  The problem? Chapter 9 probably does not apply to states, so how does a state go bankrupt?

Some very hard choices are going to have to be made. And I have a feeling this is going to be painful. Where do we start? Here is my manifesto, even though I am not running for office. (N.B.: I am, however, an elected, non-partisan and unpaid library board member.)

Caps on pensions and cuts to high-earning multiple pension dippers. Period. We and other states have let pensions get completely out of control. Unfortunately, the 1970 Constitution guarantees pension benefits for government employees and politicians. And you wonder why I was part of the 20% who said we needed to call a constitutional convention in 2008?

Salary cuts, starting at the constitutional officer and legislator level. How did we get to the place where the average government employee (at least at the federal level) makes more than a counterpart in the private sector? The tradeoff is job security for money and the added benefit of government service.

So let's eliminate job security. That hurts but we're going to have to cut to the bone. Man, that hurts.

I also don't know how we cut entitlements without causing a lot of pain. Take Medicaid, for instance. Doctors already do not want to see patients on Medicaid. Imagine if the state stops paying altogether! One way to cut expenses is to get rid of fraud and teach people when and how to use primary care doctors. But that only goes so far.

I feel like Chicken Little today. And I am sure I will get over it. But when you look at the numbers and the stark reality you have to wonder how sometimes.

The beginning of the end or the end of the beginning?

And I say that with apologies to devotees of Winston Churchill.

Most people will say that Tishman and BlackRock walking away from Peter Cooper Village and Stuyvesant Town is the end of the beginning, and that the [insert cliche - shoe drop, train wreck, yadda yadda -- here] is now going to go into full force. This should be a major league equity write off on the equity side-- say a cool billion?  And, given the huge drop in value of the complex, the lenders are in deep too. This happened, by the way, after some weeks of negotiation between the parties.  But then let's also not forget this deal has been is trouble almost from the get-go; what, two years or so now?

Others are going to say, there's blood in the streets, so buy. I hope so and that they can find the money to do so. It has been suggested that we need some FDIC type shared loss agreements to get the debt markets moving again. Not a bad idea.

What I found interesting from the legal side is that this deal will be a deed in lieu, three ugly words that are nonetheless usually better than foreclosure.  Rather than go through the expense of foreclosure proceedings, the borrowers are simply deeding the property back to the lenders through the special servicer. With the property that under water it makes sense, and the lenders seem willing not to go through the exercise of foreclosure, meaning they have negotiated a deed in lieu agreement or you have a largely non-recourse deal, or both.  Remember, most commercial deals that go this way will have a deed in lieu agreement talking about the rights and responsibilities of the parties, and a default this size...well, you get the picture. This is where good dirt lawyers earn their pay, and try to make the best out of a tough situation.

Relationships or money?

What is more important these days? At one point I would have said the former but now I think I may have forgotten the Golden Rule: those who have the gold make the rules.  That is the case with lenders and borrowers. After having had the upper hand for so long, borrowers are now on the shorter side. And that is why we are seeing what we are in the business on loans, whatever cliche you decide to use. Lenders insist that to extend or to enter into new deals, more money, more guarantees, more collateral, more interest -- more everything, really -- be on the table so the lender is in a better position. Oh how times change. About the only thing that is lower these days is LTV.

This isn't necessarily to blame lenders either. Some property is worth less.Banks are afraid to write down deals even if they should or the FDIC urges them to.  And this is all as some people think prices are finally stabilizing. Now the money has to flow.

As a lawyer, what do you do? Negotiate the best terms possible. Find ways to make the hammer a little softer. Client X + Lender Y = Deal Z.  Remember that you are a legal guy first and that the business analysis is left to those experts unless you have something really compelling to add or you are asked. (And boy that is hard sometimes. Luckily my clients usually ask for my gut feelings on a deal.) One piece of advice I give myself every day: slow down. Look at the picture. Don't overlook and sweat little details. That is why you make the big bucks. Finally, and perhaps most importantly, add value. Bring something to the table or push away from it. Be able to look at yourself in the mirror every morning and say you are more than a cog or a paper pusher. Make sure you provide value in everything you do.

Why loan money?

Much as I rail on the bankers sometimes for not loaning money for commercial real estate projects, perhaps I cannot blame them. Why?

One reason is certainty. Loans were packaged as safe and rated investments by the rating agencies. But now we see that insane numbers of deals are under water, meaning more pain is on the way. We are talking 36% of loans maturing this year, according to reports. There is utterly no certainty in that type of investment, thus making it very risky. And properties going back to special servicers can be ugly, as the linked post suggests. This will present challenges to us on the legal side and require major league due diligence on these properties, since I don't think you can expect no reps and warranties from the servicer in a distressed sale.

Meanwhile, "Banks are making money because they're borrowing at ridiculously low rates from the public and central banks and then investing in higher-yielding government securities." Borrow our money at 0.5% and invest it in government bonds "yielding anywhere from 3.75 percent to 4.75 percent in the U.S. and Europe." So, unless the bond market crashes, you have a very safe investment with a good return, and, oh gee, huge bonuses.

Because of LTVs and market conditions, too-high rates on CRE mean deals cannot get done. But why lend money at even 6% on a spec when you can borrow our money for next to zero and invest it at many times that cost of return? You see where I am going.

So...the next thing the market has to figure out is how to deal with this problem. Raise rates? Stop the arb plays? Make CRE investing more attractive through JVs? Start all over again or find a new product? It'll be interesting to see how the market sorts itself all out.

Extend and Pretend, Train Wreck...what next? Armageddon?

Oh, wait...Armageddon's been used as well to describe real estate. I've also been guilty of using hackneyed phrases to describe what the market has been like. Last year's fave was "extend and pretend." So far in 2010, "train wreck" is in the lead.  You've got Jamie Dimon, the New York Times, plenty of other news outlets, Time of goes on and on and on, sort of like The Song That Goes Like This from Spamalot. (I love Sara Ramirez...she basically stole the show in Chicago.)

Here's another piece of good analysis from Kenneth Leonard.  And here is a contrarian view posted recently.

My pledge? I will try to stay away from using cliches to describe the market. But I will probably fail. After all, it is practically a tradition.

Why do commercial real estate blogs die? And why the heck am I still here?

When I go through my list of blogs I like to read, I often come across a casualty: a blog that has ceased to exist or has stopped actively posting stories.  I'm always sad to see that because I like reading what my fellow bloggers have to say.  And there have been some very smart people doing this.

Maybe these factors are the same in all types of blogging -- I'm not about to do the research -- but I have some ideas as to why and would like to hear from others about why this trend goes on.  And let's talk about why I am still here, too -- what the heck.
  • Most -- but not all -- of the bloggers who have quit are not professional writers, or part of an organization or a company.  As my profile in Real Property Alpha points out, I am not one of those folks.  I am just an individual.    
  • Time.  Yeah, blogging can take up a lot of time.  So many people quit because of the time factor.  I am not a professional blogger so I do not parse every word.  Most of what you read is a first draft, stream of consciousness thing.  Some say I have been blessed with the ability to crank out a few hundred words on most subjects pretty quickly -- I think a good liberal arts education helped here as well as some speaking and writing practice when I was a kid.  So I can perhaps crank out a blog post without having to spend all day on it, which is an advantage. My clients take priority over writing, but I'm usually able to balance that.
  • Money.  I really think some people write because they think they will make money blogging, or attract more clients.  Maybe you will, but my humble opinion is that you have to have a passion for the topic about which you are writing.  If not, it will show and the blog posts will be boring.  I write to educate myself: having to read and think about the business makes me a better lawyer in my opinion. As almost all my clients tell me regularly, I add value or at least try to in every deal.
  • Client development.  Maybe. But some people, when they do not immediately see a huge increase in clients calling, drop the blog. I don't get that. As I said, if I get new clients out of the blog, great. If not, that's okay too. This is about learning and self-improvement for me, believe it or not.
  • Fame.  Not happening, at least not in commercial real estate.  And I don't understand why you'd care.  I get picked up in the media from time to time and enjoy doing interviews, but don't expect any notoriety out of this.  (Heavens, I think I'd quit if that actually happened.)
  • Ennui.  I think this should have been at the top of the list, but hey, stream of consciousness and all that.  It can get tedious to think of new things to write about. Finding topics can also be hard sometimes. You want something new to say, without repeating yourself or others. It has to be fun or you may as well hang it up.
You may ask: why am I writing this? Because I gave very serious thought to ending the blog at the end of 2009. As you can see my posting frequency dropped off significantly. Let's see if I can do better in 2010 and write compelling material that you want to read. (This post may not be among them since it really isn't about CRE.) At the end of the day I realized that I like what I am writing and what I do here, and that I need to try a little harder for more content that will not bore you to death.

Of my readers -- and I know there are regulars thanks to analytic tools -- I ask three things. First, if you have ideas or topic you want me to write about, by all means let me know. It is much easier for me to write when there's a set topic. Second, tell your friends about the DLB. Third, if you have constructive suggestions for the blog, please also let me know.  Should I move to WordPress? Hire professional designers? Look for co-bloggers? Make this "amateur" blog more professional?  Let me know.  And thanks for reading.

The slo-mo train wreck and mainstream media

A lot of people have been writing about Time's characterization of the commercial real estate market as a "slow motion train wreck."  And I agree with those who think it may well be an apt analogy.

There is still going to be hurt going on as loans mature, lenders do not lend, and equity requirements go through the roof. And I wonder aloud if we'll still need some kind of RTC situation to eventually handle it, although the slow-mo nature of it all may obviate that need.  I do know this: when some smart folks were talking about how awful the market was, the mainstream media was gaga over how great it was.  So...can you say vice versa?  I'm just saying....

Mortgages and the Due-On Sale Clause

I am guest blogging at Jeff Brown's excellent website today; if you like to read my perspectives on mortgages and the due-on sale clause, then read here.  And have a great day!

The 7% Solu....errr....Problem?

That was my immediate reaction when I came across this piece over the weekend. Previously I was pooh-poohing talk of 2 and even 3% delinquencies on the grounds that they were still crazy low. But once you get over 5% then you start a-thinking a little more.

The numbers by sector were about what I expected with one exception:
The multifamily sector accounted for 26% of the $37.9 billion delinquent unpaid balance for CMBS in November, followed closely by retail (25%), office (16%), and hotel (15%). Conversely, the industrial market accounted for less than 2% of the delinquent unpaid balance for CMBS during the same period. Health care properties represented less than 1%.
Hotel at 15%? Does that include the ESA loan? If not, I agree with the story that you are going to see more trouble there before it is all said and done. But are we going to hit 7 or even 8% in 2010? The hotel sector alone might be able to push that number, but we'll all just have to see. (Boy, do I wish I owned a working crystal ball sometimes.)

From the legal perspective: this means more and more working out. And I don't mean the treadmill, although I am going to take a spin in that as soon as I finish this post. We lawyers will have to spend some long hours negotiating and documenting deals. And that has to be done carefully -- no more of this "cowboy law" stuff we saw going on. I am starting to see litigation ramping up over some deals where you have to wonder, if you know what I mean. This is a time to dot i's and cross t's like you never have before.