CRE, CMBS Disaster Imminent? Not So Fast

The general theory has been that commercial real estate [CRE] & commercial mortgage backed securities [CMBS] may be the next shoe to drop, as I speculated here in March. But some recent events force us to take a closer look.

Since March we have seen improvement in the AAA rated CMBS market, mostly due to the TALF being used there. Again, no comment on the "right or wrong" of this action, but it is undeniably helping this market.

Then we had none other than Sam Zell coming out and saying that all the talk of a REIT industry "meltdown" was overblown.

Most recently was the very important news that loan servicers were looking at extending maturities on debt from the customary 6-12 months to out as far as 5 years.

Now this from the WSJ:

With the commercial real-estate industry bracing itself for the onslaught of hundreds of billions of dollars in maturing loans, the Treasury is considering issuing rules that will make it easier for property developers and investors and their loan servicers to restructure debt, according to people familiar with the matter.

Tax rules make it difficult for borrowers who are current on their payments to hold restructuring talks with the servicers of commercial mortgages that were packaged and sold as bonds. This lack of flexibility was one of the reasons cited by the management of mall giant General Growth Properties Inc. for its Chapter 11 bankruptcy filing in April.

At present, developers and investors complain that only those who are delinquent can talk to servicers of these bonds, named commercial-mortgage-backed securities, or CMBS. But now the Treasury is considering issuing guidance that would allow servicers to start talking about ways to avoid defaults and foreclosures sooner, possibly at least two years ahead of the maturity date of a loan, these people said. The Treasury guidance, which could be released within weeks, would essentially enable loan-modification talks to take place without triggering tax consequences, these people say.

What does it mean? If we convert this to housing, you are having trouble with your loan. Under the current rules, the banks could not talk to you about altering your loan until you defaulted. Once you default on commercial loans, all sorts of cross defaults and debt covenants are triggers across other debt. This is bad.

When Treasury alters the current rules, loans can be altered BEFORE default. This is huge and in retrospect may have saved General Growth Properties (GGWPQ.PK) from Chapter 11, as it was not able to restructure loans until it defaulted which then drove into 11.

Back to the article:

... property owners and investors hoping to restructure troubled mortgages are hearing a tough message from CMBS servicers: We can't talk to you unless you first fall behind on payments. This is because when CMBS offerings are created, the underlying mortgages are legally held by tax-free trusts. The trusts can be forced to pay taxes if the underlying loans are modified before they become delinquent, according to current CMBS rules.

"It can be frustrating," says Monty Bennett, chief executive of Ashford Hospitality Trust Inc. The Dallas-based real-estate investment trust that owns 102 upscale hotels has tried to start negotiations with servicers for extensions of payment deadlines for CMBS loans coming due. They have had little success. "You're trying to be proactive and get a plan together to address [a loan maturity], but you can't get someone to talk to you

There are scores of operationally healthy REITs that will simply not be able to restructure debt as it comes due to stagnant credit markets and will suffer the same fate as GGWPQ.PK. By allowing refinancing (for lack of a better word) before default, many will be avoided.

Will there still be defaults and REIT collapses? Yes. But the key difference will be that those falling by the wayside will not be healthy organizations but the weak that deserve to fade away.

Yesterday I had an email exchange with reader Davidson on the subject and he said:

All the noise about Alt-A and Commercial Real Estate being the tsunami on the horizon tells me that this one will be solved as well. I can tell you that private equity funds of $billions have been established to capture value. Roth of Vornado (VNO), Simon of Simon Prop (SPG) have cash to buy up the best properties that may be thrown on the market. Some one may take a hit but these guys may be stumbling over themselves to buy this troubled stuff and in the end a solution will clear the inventory.

It would seem that the commercial real estate market has watched and learned something from what happened in housing. They are taking proactive steps to stave off a total meltdown. For instance REITs have already issued equity and cut dividends (issuing them in stock rather than cash) ahead of problems rather than well after as the banks did with housing. This means that going into any problem they are already capitalized to levels that will allow far more of them to remain healthy and actually expand operations as this develops.

Does it mean there is no more pain in store? There surely is. But, I think one has to revisit the "total collapse" meme and perhaps materially alter that. Now if the Treasury opts not to modify the current rule, (which does not make much sense by the way), then we may very well see considerable pain here. Based on recent actions though, I think it is safe to assume something is coming from them.

I am going to begin to look far closer at this sector and will report in as I find things..


Disclosure: Long GGWPQ.PK

Comments

[veronicabenn:]

Check out obamamortgage2009.blog... or obamamortgage2009.blog... There needs to be a program for the elderly but not quite to retirement age for mortgage modification when the have lost their job during this particular recession. I made a decent wage because I put my time into a company and now have no job. I am looking at $10 - to $12 hr jobs after working all my life. You can't make a mortgage payment on that kind of money. I will eventually lose my home.

Jun 15 07:14 AM

[CMBS Analyst:]

As far as CMBS spreads improving, that is like watching the DOW go up and saying the economy is getting stronger. Apples to oranges. The REIT industry is dwindling. Loan extensions will help for the CMBS industry, but no more than 40% of the maturing loans coming due this year will be extended due to the requirements of most servicers and their best judgement for the investor. In addition, negotiating new loan terms requires a special servicer, in which those costs get passed on directly to the investor. Plus, servicers don't have the capacity to restructure a large amount of loans, they're already swamped and expensive. Retail, office, warehouse, hotel, self storage, and industrial properties will surely suffer due to the slowing economy. No doubt about it. There will be a total collapse, it will just happen slower and with less impact than the residential market, as has always happened in the the past.

Jun 15 07:58 AM

[John Christy:]

Davidson is right on. People have been talking about commercial real estate as the "next shoe" for several years. It's already priced in. The next shoe is almost never telegraphed that far in advance...the thing that kills us will be something we're not talking about now and nobody sees coming. It's an "unknown unknown".

Jun 15 01:33 PM

[Deal Warrior:]

Commercial real estate will remain the next shoe. Almost all of the short-term, non-CMBS loans done in '06 and '07 are bleeding cash while they sit on the bank's books with no where to go. If the banks recognized the loses, they'd all be out of business. Either the government does an RTC Part 2, or the loans rot and fixes trickel out for the next 5 to 10 years. These are not easy choices, and I can't think of a group less suited to making good choices, than politicians.

Sam Zell. Isn't he the guy who was bailed out in the last cycle by Merrill Lynch, who put all his underwater real estate deals into REITs, and made him look like a genius? The limited partners in those deals, were Merrill private clients who were facing huge capital calls.

Sam Zell. Isn't he the guy who bought a newspaper that has done nothing but lose money and is on the way to going out of business?

Just wanted to make sure I knew who Sam Zell was and why I want to hear he thinks.

If a property doesn't have positive cash flow, it ain't going to worth much no matter how much money the government gives you to keep it on your books at full price.

We will not hit bottom until all the loses in commercial real estate are recognized, no matter how long that takes.

If you want to think about a next shoe, think about all the taxes the government is going to start sucking out of economy. The more they raise taxes, the slower the economy gets, the more they have to raise taxes again.

Or maybe just inflation in the low teens.

Jun 15 04:12 PM

[Rhino Realty:]

Well put Deal Warrior...Zell is not anyone's mentor. At best, one should invest in the opposite direction as he is pointing. Also, last time I checked with a CMBS servicer, they were not too forgiving when a major tenant went bankrupt. Circuit City, Goody's, etc.. Maybe the next shoe to drop will be Rite Aid ? Blockbuster ? What's Obama gonna do for Rite Aid ? Maybe his new health care reform will give everybody free drugs at Rite Aid....that would allow Rite Aid to get foot traffic which, in turn, provides Landlord's with rent checks, and in turn, keeps loans from going into default.....that seems brilliant doesn't it ??


On Jun 15 04:12 PM Deal Warrior wrote:

> Commercial real estate will remain the next shoe. Almost all of
> the short-term, non-CMBS loans done in '06 and '07 are bleeding cash
> while they sit on the bank's books with no where to go. If the banks
> recognized the loses, they'd all be out of business. Either the government
> does an RTC Part 2, or the loans rot and fixes trickel out for the
> next 5 to 10 years. These are not easy choices, and I can't think
> of a group less suited to making good choices, than politicians.
>
>
> Sam Zell. Isn't he the guy who was bailed out in the last cycle
> by Merrill Lynch, who put all his underwater real estate deals into
> REITs, and made him look like a genius? The limited partners in
> those deals, were Merrill private clients who were facing huge capital
> calls.
>
> Sam Zell. Isn't he the guy who bought a newspaper that has done
> nothing but lose money and is on the way to going out of business?
>
>
> Just wanted to make sure I knew who Sam Zell was and why I want to
> hear he thinks.
>
> If a property doesn't have positive cash flow, it ain't going to
> worth much no matter how much money the government gives you to keep
> it on your books at full price.
>
> We will not hit bottom until all the loses in commercial real estate
> are recognized, no matter how long that takes.
>
> If you want to think about a next shoe, think about all the taxes
> the government is going to start sucking out of economy. The more
> they raise taxes, the slower the economy gets, the more they have
> to raise taxes again.
>
> Or maybe just inflation in the low teens.

Jun 15 09:45 PM

[cmbsobserver:]

First we need to address the pink elephant in the room and bring the regional and even in some cases the community banks from denial to acceptance of their CRE current market values. This means no more footnotes in the smallest print possible of true balance sheet debt to equity ratios. Sorry these banks made bad decisions and made bad loans but they either need to clean up their mess and fast, or turn the keys over to their regulators. Stop hiding in the dark corner and do something more than the trendy business plan of 2009 which seems to be do nothing and hope for the best! The shoe will drop whether we like it or not and pain is going to come. That being said, we can do some things to make an improvement:

First, get banks to recognize that they need to restrucutre their existing portfolios and stop thinking they can sell loans at 95 cents to the dollar (that is a year too late guys)

Second get the Treasury to think a little more out of the box and provide alternative financing for originators to fund new CRE loans based upon new credit guidelines. CMBS new issue deals have not been done to date and even with its expansion until 2010 it is unlikely to have an impact on the capital market without a primary source of funding of commerical whole loans first. Banks are not lending has anyone noticed! (Insurance balance sheets don't count!).

Third, provide some emergency tax and accounting treatments for Banks to restrucutre their current balance sheets with a sunset date. Provide a reason for banks to do something now rather than sit, hold their breath and wait for everything to be wonderful again.

Aug 24 07:33 PM