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!

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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.

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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.

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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.

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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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Uncertainty

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!

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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.

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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.

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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.

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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.)

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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.

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$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.

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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. :)

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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?

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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 scenario...wow! 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.

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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.

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TALF and Ratings - Get Out Your Cash!

Here's the latest gloom and doom piece -- perhaps warranted, too -- this time in the Journal. The point? It is great that the government finally got on the darn bandwagon by including CMBS and commercial properties in TALF, but that's just not enough.

Now, if we are going to have all this bailout money in the first place (we will not get into the philosophical or practical arguments of how to repay all this debt) including the commercial sector is important in my opinion. But, as the story points out, only top-rated debt is eligible. And S&P is telling us that it may downgrade a boatload of properties, thus rendering them ineligible for TALF money.

A lot of people blame the ratings agencies for getting us into this mess in the first place by rating deals AAA that had no business being so. And now when they want to clean up the mess by downgrading these deals, it could create another, even larger, problem. Jeez.

The moral? Owners are going to either have to pony up equity to stay in their deals, bring in mezz lenders who could make a killing with liquidity, have a fire sale, do a deal with the special servicer, walk away or...well, you get the picture. Not a pretty one. With LTVs on loans going down and property values declining, this could be the era of the capital call.

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Landlords or Carnies?

You may recall reading my post the other day about landlord's coming up with creative uses for vacant space, including indoor surfing. Well, the Llenrock Blog has taken this one step further with an informative and humorous post on creative use, to wit:

This concept seems all to familiar to retail landlords of regional malls, power and lifestyle centers. The only thing worse than a rainy day to a carnie is a dark store to a landlord. And landlords aren't being all that shy about it either. A recent article in the New York Times showed that a burgeoning trend to fill up the mounting oceans of vacant space is, well, water.

I'm not really into indoor surfing, but if a landlord let a tenant put in a temporary indoor pool (how you do that is beyond me, though, because of the dehumidification costs), I'd be all over it. But I am dreaming because of the damage to the space, the objections of tenants, the cost, the insurance and a million other legal issues. I can tell you this, however: I have been to the local mall exactly once this year, and I was there a grand total of twice last year.

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Tuesday Tidbits - April 7, 2009

There's a lot going on both in dirt and in my profession. Here's a quick summary of what I have been thinking about and reading:

In the "It's about time" department: many law firms are cutting way back on summer associates, retooling the programs from cocktail parties to work and even reevaluating the necessity of them altogether. I actually worked hard as a summer associate, but I wonder aloud whether we should to to an articling/apprenticeship system (a la medical residency) where law grads are low-paid interns at firms for a year before taking the bar -- and if they cannot find an articling position then they cannot take the bar. I always felt the second year law student thing was not a great way of evaluating talent.

WTF is going on with GGP stock? Up big yesterday, up again so far today...and the company is acting like Sergeant Schultz.

Some harsh but perhaps accurate advice for laid off associates who are not networking and developing business: get out of the profession. You don't belong.

I mean, lets be real here. Most of you never wanted to be lawyers. You wanted the trappings of what L.A. Law made you believe the practice was all about.

So get out.

Don't go into foreclosure defense, that'll be dead in two years. If you have no established practice in an essential area of law, get out. It's not going to get better in the next 5-10 years. If your goal is money, go make money. Buy a franchise, open a business. You went into law to make money, the money is not there, get out.

What is so wrong with realizing that you never really wanted to be a "lawyer?

What are the world's safest banks? Mostly not here. And "Bank of America is notably absent from the list."

No shock, but nontheless shocking: S&P is about to downgrade a boatload of CMBS. This is a very ugly quote: “We concluded that the ratings on a significant portion of our CMBS portfolio may no longer be appropriate, given our view of the increase in credit risk.”

That's enough for one morning. Enjoy!

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Surfing at the mall? Yup. And I don't even mean web surfing or channel surfing.

Desperate time require desperate measures. And with mall owners facing vacancies, you'll see just about anything. Community colleges, multi-level anchors with two users, temp stores, medical offices....but surfing?

Yes. That is not a typo. Read here. It makes lot of sense, especially here, and also because it appeals to the young demos that retailers covet.

Leave it to the dirt industry to find ways to use space creatively.

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