Just Say No to Commercial Real Estate Beggars

If you read this earlier and are just now scraping yourself off of the ceiling, I apologize making you go ballistic once more. The WSJ and others reported that the new beggar at the Treasury’s bailout window is the commercial real estate industry.

A recent letter sent to Treasury Secretary Henry Paulson, and signed by a dozen real-estate trade groups, painted a bleak scenario: “Right now, we believe there is insufficient systemic capacity to refinance expiring, performing commercial real-estate loans,” said the letter. “For many borrowers, [credit] simply is not available,” the letter noted.

To head off some of the impending pain, the industry is asking to be included in a new $200 billion loan program initially created by the government to salvage the market for car loans, student loans and credit-card debt. This money is intended to go directly to help investors finance purchases of securities backed by these assets. If commercial real estate is included, banks might have an incentive to make more loans to developers since they’d be able to repackage and sell them more easily to investors with the assurance of government backing.

As part of their lobbying efforts, some industry representatives have asked lawmakers to explore the idea of setting up a separate program aimed at boosting lending to commercial real estate only.

“We’ve been urging Washington to put this as one of the top priorities in dealing with the economy,” says Steven Spinola, president of the Real Estate Board of New York, underscoring the need for the government to help spur commercial property lending either directly or indirectly.

What we are really talking about here is bailing out a bunch of private money funds, developers and other assorted needy types that over paid for real estate during the boom, over borrowed on their purchases and now are being forced to face reality. The cry that there is no money to refinance their loans is bogus, what is true is that their is no money to refinance their loans at the inflated price they paid for the properties.

The article correctly points out that this year about $141 billion worth of commercial property loans came due. Most of those loans were refinanced by either new or existing lenders. Why were these loans rolled over? Quite simply because they were made some time ago at reasonable purchase prices. The debt on the properties is supported by the rent payments they generate, ergo it’s a money good loan.

The difference is that during the heady days the commercial types were buying properties at cap rates that didn’t make sense going out the door. Most were at best marginally cash flow positive from the outset and many required interest reserves to make them work at all. The only sense these loans ever made was on paper, in other words in the proforma projections that the promoters and lenders talked themselves into believing. In many respects these loans were the negative amortization and liar loans of the commercial sphere.

Yes, it’s true that the commercial mortgage backed securities market is moribund and the banks are reluctant to lend money, but the reality is that many of these loans are not bankable without a substantial equity infusion. Operating cash flow is simply insufficient to service the existing debt at an acceptable level. Properly structured these loans would find takers for refinancing, but that’s the rub. The owners are strapped for cash. What they are looking for is someone to carry the projects in their current form in the hope that economic conditions will improve to the point that these projects make some semblance of sense.

This is one class of beggars that the government would do well to turn away. The banks have already been recapitalized in order to allow them to take write-downs on this sort of loan. If they need more cushion then give them some more capital. We learned through the RTC the best way to handle these sorts of commercial loan problems. What you don’t do is refi them in hopes of a turn in the cycle that never comes. What you do is take back the property and sell it for what it’s worth on the market now.

Comments

[REITBull:]

I am long REITs but I do not want to see any bailout for commercial real estate. Government intervention will keep private money and pension funds on the sidelines and effectively prevent the market from correcting itself.

2008 Dec 23 02:44 PM

[Dabqs:]

This article is not thorough enough to be taken seriously.

In the article itself, the author indicates that the REIT/Commercial Real Estate industry is seeking help due to an inability for REITS/Commercial Real Estate industry participants to obtain financing EVEN WHEN THEIR PROPERTIES ARE PRODUCING FINE CASH FLOW.

Sure, in a recession, as in all recessions, there will be a reduction of operating cash flow, however, there is no doubt that banks are unwilling to lend in this credit crisis environment, and though some REITS are getting financing, they are finding it many times difficult and more expensive, and many are finding it very difficult to obtain financing at all--even though their operating cash flow would permit them financing without question in normal non-credit constrained economic environments. And this is the problem, as we are in a credit crisis environnment which is quite unusual and abnormal.

I don't think anyone doubts that bad businesses should not obtain financing, however, the author forgets the most important part of the current situation, and that is that due to the credit crisis, many creditworthy REITS which should get financed may not, or the terms may be prohibitive not for any fault of their own, but rather from the fault of the banks which have gotten themselves in such trouble that they do not want to lend--to almost anybody, even those that are deserving!

This is why the government needs to add REITS/Commercial Real Estate to the list of industries getting help-->> since a normal financing market is not available to them.

And what are the consequences if the government should not help? Should we then allow good businesses producing very good cash flow to go under just because the banks are unwilling to lend to these creditworthy borrowers???

Indeed not, this is why we need government or the Federal Reserve to step in--afterall, the Federal Reserve is empowered to be "The Lender of Last Resort " for a good reason, and that reason is becoming apparent to everyone now since banks are unwilling to lend.

dabqs

2008 Dec 23 05:08 PM

[Selbur:]

Author is spot on in his opinion. Just like the uninsured speeding motorist, most RE developers/borrowers generally are pinky-ringed slippery devils who overdose on risk at others' peril. For too long our system allowed them to make big levered bets with low-risk bank money, with all the spoils going only to the slimeball dice-roller. Or, if their deals go bust, neighbors, communities, banks etc all suffer. Hopefully those days are done.

2008 Dec 23 10:21 PM

[monday1929:]

You must be one of the beggers. The risk of tight credit, the risk of an econonomic slowdown, the risk of the largest credit bubble imploding-

RISK is what business people take. And when they bet wrong, and when I bet wrong, WE LOSE MONEY. Stop begging, take your losses, wear your flag pin, and preach the benefits of free markets. Shut up and take your medicine. Remember the "personal resonsibility" you are always telling the poor about? Well, it's your time now.


On Dec 23 05:08 PM dabqs wrote:

> This article is not thorough enough to be taken seriously.
>
> In the article itself, the author indicates that the REIT/Commercial
> Real Estate industry is seeking help due to an inability for REITS/Commercial
> Real Estate industry participants to obtain financing EVEN WHEN THEIR
> PROPERTIES ARE PRODUCING FINE CASH FLOW.
>
> Sure, in a recession, as in all recessions, there will be a reduction
> of operating cash flow, however, there is no doubt that banks are
> unwilling to lend in this credit crisis environment, and though some
> REITS are getting financing, they are finding it many times difficult
> and more expensive, and many are finding it very difficult to obtain
> financing at all--even though their operating cash flow would permit
> them financing without question in normal non-credit constrained
> economic environments. And this is the problem, as we are in a credit
> crisis environnment which is quite unusual and abnormal.
>
> I don't think anyone doubts that bad businesses should not obtain
> financing, however, the author forgets the most important part of
> the current situation, and that is that due to the credit crisis,
> many creditworthy REITS which should get financed may not, or the
> terms may be prohibitive not for any fault of their own, but rather
> from the fault of the banks which have gotten themselves in such
> trouble that they do not want to lend--to almost anybody, even those
> that are deserving!
>
> This is why the government needs to add REITS/Commercial Real Estate
> to the list of industries getting help-->> since a normal financing
> market is not available to them.
>
> And what are the consequences if the government should not help?
> Should we then allow good businesses producing very good cash flow
> to go under just because the banks are unwilling to lend to these
> creditworthy borrowers???
>
> Indeed not, this is why we need government or the Federal Reserve
> to step in--afterall, the Federal Reserve is empowered to be "The
> Lender of Last Resort " for a good reason, and that reason is becoming
> apparent to everyone now since banks are unwilling to lend.
>
> dabqs

2008 Dec 24 08:33 AM

[Dabqs:]

Monday1929,

No, I'm not one of the beggars, just a realist.

Unfortunately, just letting the chips fall as they may will cause more harm to everyday Americans such as myself than it will to those deserving the pain of letting "the chips fall where they may."

As your name suggests, you are likely aware of the risks of not supporting the economy in such a critical time. This is not a risk we should take, and, as we are witnessing, government is doing the right thing by stepping in so that we do not suffer another Monday1929 and subsequent economic malaise as we did in the 1930's.

You seem to be quite the hardliner. Unwilling to recognize the greater good that is at stake. May a thousand fire ants take up refuge under your armpits, and should we suffer the type of economic decline you seem to desire as "medicine", may all of your past and present mother-in-laws and other undesireable relatives take up residence in your house with the fire ants--perhaps this experience would encourage you to think a little more broadly.

Dabqs


On Dec 24 08:33 AM monday1929 wrote:

> You must be one of the beggers. The risk of tight credit, the risk
> of an econonomic slowdown, the risk of the largest credit bubble
> imploding-
>
> RISK is what business people take. And when they bet wrong, and when
> I bet wrong, WE LOSE MONEY. Stop begging, take your losses, wear
> your flag pin, and preach the benefits of free markets. Shut up and
> take your medicine. Remember the "personal resonsibility" you are
> always telling the poor about? Well, it's your time now.

2008 Dec 26 09:46 PM

[David Fischer:]

Bang on! I am glad some form of capitalism survives in this country. It's amazing how few understand the devistating consequences of the government owning more and more privately held assets. That is comunism or at least socialism. So when the government forcloses on these companies because they are well below debt value and cash flow cannot sustain the debt payments, what then? Folks will be screaming about the government intervention and bullying. This backing of assets leads to the government owning all assets which is comunism. Backing these assets in the hopes they don't go down in value is rediculous. I

The first step in backing loans is one thing, looks harmless. But the next obvious results that would come later when these companies owe billions and need to be taken back is the phase which would enlighten investors to what is really going on. The day the loans are called if things gets worse is a day of reveoution. When there is no clear line in the sand between what the government owns and can take from you and what you think is yours.

Capitalism has a downside which is recession/depression, this needs to be undertaken, but the government wants votes, so all those senators give in. But that only delays the recession for years to come, as savvy investors stay on the sidelines unwilling to buy unless values reflect reality in valuations.

Most of these reits should be gone as their models of payouts are rediculous. These company strategies only work when times are good and asset values continue to go up, but not during pullbacks in values.

And this crisis is a crisis because knowone has any money any more, so it is warranted. Such a rediculous notion that is somehow an anomoly due to some quasi event, and not real. It is real, all asset values are plummeting, so don't loan. That is the motto of banks, wait it out, stay afloat until this is over.

The government didn't save housing, and its' a good thing, look at the tsunami of refi's to come with no takers. The same is just beginning in reits. The model does not work, they need to be purged and values reset.

2008 Dec 27 10:50 AM