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.

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The Battle of the Tranches

There is a very interesting story in today's WSJ that explains the incredible complexity of huge, multi-site deals, foreclosures and various investors in CMBS.

This story is about the John Hancock Tower (in Boston, not the iconic Chicago building). The tower was part of a seven site deal of a fund of Broadway Real Estate Partners two years ago. The deal's now in default, according to the story.

Back in the old days, when a deal went south, you had one lender, or maybe a syndicate of lenders with interests that were usually somewhat aligned. And you sat at a table, did conference calls or ever wrote letters back and forth working out the loan, or you proceeded to foreclosure.

Not so anymore, thanks to the complexity of CMBS. If you are a regular reader or know the business, then you are aware that CMBS has various tranches of debt, with senior tranches having the least risk (and lower return) and junior tranches having more risk but higher interest rates. The same is true in this deal, where you have multiple tranches of mezzanine debt, which was supposed to be a bridge loan pending sales or refis that went south with the credit market.

The interests of these lenders are not aligned. If a deal goes south, the senior lenders might be OK but the junior and B-piece folks are probably SOL (and I don't mean "statute of limitations" when I use that term). And that's what is going on here:

"Tranche warfare is starting," said John Zizzo, a real-estate lawyer at Cadwalader, Wickersham & Taft LLP, referring to the loan "tranches," or slices, that investors own. "It has never been tested before this current market meltdown."

The disputed $700 million of debt in the Hancock battle is mezzanine debt that was divided up among nine investors. With real-estate values declining, not all of the investors would be paid off in a liquidation.

As a result, investors who believe they would be in the money are pressing for an immediate foreclosure, according to people familiar with the matter.

Such investors include Five Mile Capital Partners, led by former real-estate financier Steven Baum, and Normandy Real Estate Partners, founded by property investor Finn Wentworth. Mr. Wentworth also is a founder of the New York Yankees' YES Network.

Investors likely to lose out in foreclosure want to give Broadway more time to repay the loan. Among those investors is a BlackRock Inc. fund run for outside investors. That fund owns the riskiest slice of the loan.

Also involved in the scrum are Chicago developer John Buck, who owns the most senior portion of the debt; the RBS Greenwich Capital unit of Royal Bank of Scotland Group PLC; Lehman Brothers Holdings Inc.'s bankruptcy estate; and hedge fund Petra Capital Management LLC, run by Andy Stone, a pioneer of commercial real-estate securities.

Complicating things further, State Street Corp. inherited stakes in two tranches from Lehman Brothers, according to a person familiar with the situation. The failed investment bank had pledged the loans to State Street as collateral for a short-term "repo" loan. State Street seized the collateral after Lehman filed for bankruptcy.

Ouch. What's more? This might be just the start. If there are more foreclosures like this -- and people expect there will be -- the fighting, pain and possibly litigation will only further complicate getting properties back out into the market and into the hands of people who can turn things around. One solution is to negotiate between the tranches and settle with a buyout, giving control to one or another group. There's some very sophisticated players in that list of lenders, and I would think they will all realize their interests are better suited through compromise.

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Trmup's Lawsuit: Developer See, Developer Do

Tom Corfman's Crain's piece today predicts:

Donald Trump’s lawsuit against the menagerie of construction lenders for his riverfront tower is likely to be followed by more pre-emptive strikes by other developers.

Amid the prolonged credit crisis, such lawsuits could become common.

We've heard all the stories, so I won't bore you with lenders turning the screws on their borrowers. (Hey, the borrowers did it to them a few years ago, let's not forget.)

There were two opinions given about the lawsuit:

“We’re in an economic crisis, yes, but does that constitute force majeure?” said real estate attorney James Fox, a partner in the Chicago office of law firm Quarles & Brady LLP. “Only crazies would do that.”

The force majeure claim is “a stretch in this case, but it gave him a toehold,” said Mr. [Marv] Romanek, managing director with Northbrook-based Romanek Properties Ltd.

I wrote about this here on the 8th. The gut reaction was similar to Mr. Fox: economic problems aren't events of force majeure. But I don't know what the language is in the loan agreement. If drafted (im)properly, you might -- just might -- have a case. Look at the clauses here, for example. Others that I have looked at are too tight to beat Trump here in my opinion.

Moreover, assuming the allegations are true, would you want to have to defend banks in this climate that "no longer have the cash to fund the completion of the project" and that apparently refused to let Trump take steps to mitigate such as lowering prices? Again, I'm no Trump apologist and I think this is a negotiation tactic. While I still think he's got an uphill (mountainous, perhaps) battle to win this one, I'm no longer 100% convinced that the theory is utterly crazy or sanctionable.

The moral of the story? This is just another example of why, as a lawyer, you have to sweat the details, including the boilerplate. My favorite example of boilerplate coming back to get a party is here. (Free sub. required.)

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From overbought to oversold?

A couple of years ago, we were all riding a crazy, insane wave of deals that no rational person thought could go on forever. Confidence was at an all-time high.

Just as we had the highest of highs, now we see the lowest of lows. Record optimism has turned into record pessimism, or so says the latest DLA Piper State of the Market survey.

But let's think about this: is this any less insane than where we were a few years ago? Some say yes. Take this Business Week post comparing what is going on to a run at the bank. Just as we may have overvalued some properties and mortgage pools, are we now over-discounting them? It is a thought-provoking comment, at least to me.

I'm still torn about the bailout being proposed. Very smart people tell us that without it we could be back in the 1930s, but, at the risk of being political here, I've always been of the mindset that government involvement generally makes things more costly and less efficient. Here's a rational post that I found interesting. And the average Joe is apparently wary about this, too.

One thing I know is that the lawyers should, at the end of the day, make out all right. I keep hearing about some tightening of the belt, but the smarter law firms are keeping the bench ready for when this all hashes out. Of course, I thought that would be how long ago?

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Ready to roll the dice?

Because Las Vegas has apparently rolled snake eyes. The story will tell you all about the woes of CRE in Lost Wages.

You might be able to make a killing if you buy at the right price from a lender and can hold out long enough for things to turn, flip the deal or sell and lease at lower prices because you are all in for less money than the first guy. LV is not the Rust Belt, after all.

Legal stuff? Think about mechanics' liens, title insurance and survey issues, zoning, liquor license and related issues. I won't even venture to think about gaming.

Oh, one last thing that may sound silly. Water rights. They keep saying there's not enough water to go around, and how would you like to be in after the camel's back is broken?

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Ever wonder about foreclosure auctions?

Here's a video on Business Week's website showing an actual auction on the steps of the San Diego County Courthouse, a place I once knew well.

Yes, there are auctions once in a while for commercial property. The last one I worked on was a few years ago, for a prominent local investment company that purchased two apartment complexes in the Southeast. The total purchase price, as I recall, was in the mid eight figures. And yes, the client flew down to the courthouse and literally bought the property on the steps. It was very exciting.

The key to these deals is doing as much due diligence as you possibly can, since you are expected to buy the property on an absolute as-is basis, and with a closing occurring almost immediately. So you'd best order minutes of foreclosure from your title company, get your hands on a survey and dig into whatever information you can find. You'd better also cash, a good line of credit or have a lender or money partner on board to do this deal. This is all a part of good opportunistic investing.

It's down and dirty work sometimes, even at those price points, and, as you can see from the video, it can be dull and sometimes no one buys anything. The key (duh) is to pay the right price, which isn't always easy to figure out. I didn't work on the sale of the property I mentioned, but I understand the client made a nice profit on the deal.

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