QIs as Mezz Lenders
I heard yesterday from an industry player that QIs are acting as mezzanine lenders for TIC deals. (QIs make loans with escrowed, exchange funds to a TIC sponsor so that the sponsor can close on a property. The TIC sponsor than repays the loan proceeds when it completes its equity raise.) There are so many bad outcomes and conflicts of interest in this scenario I don't know where to begin. QIs are not qualified to make mezz loans. There are reasons mezz lenders charge rates two to three times current mortgage rates - they are risky loans with variable repayment horizons! QIs are not banks, they are escrow companies. Banks run on the premise that when people make deposits they don't withdraw the entire amount and close the account in less than 180 days, which is the case with money at QIs. (This is why so many checking accounts pay no interest - it's short-term, transitory money.) If mezz lending by QIs is widespread then the TIC industry better address it fast. It may be time for TIC sponsors to start looking for more seasoned, reliable equity partners to supplement the equity from the vagrancies of broker/dealer raised capital.

QI Mess Threatens TIC Marketplace
The greed of Qualified Intermediaries is threatening to undo the TIC business as two QIs stole $250 million of investor exchange funds. I have blogged about this before. The QIs were using exchange funds for their own purposes rather than segregating the cash and holding it in trust for the short (up to 180 days) exchange period. Exchange monies are very short term and should only be invested in the best money market funds or other cash equivalents. The QIs were using the funds for other businesses or personal activities and could not meet payment obligations. One misappropriated $95 million and the other $151 million.

The Wall Street Journal has an article explaining the two cases. A top TIC lawyer, Richard Lipton of Baker & McKenzie, recommends only using QIs affiliated with top firms:

Many large financial institutions have QI services business. J.P. Morgan Property Exchange Inc. is a unit of J.P. Morgan Chase & Co.; Wachovia Exchange Services is a unit of Wachovia Corp. Mr. Lipton of Baker & McKenzie says that because of the lack of regulation, he refers clients to QIs that are affiliated with regulated entities.

This advice is so simple and smart it almost begs the question as to why everyone does not follow it. If you look into the relationship between QIs and registered reps, I bet you will find the answer. QIs are a top referral source for registered reps specializing in tenant in common transactions. The rep gets referred clients who need an exchange and will buy a product that pays a 7% commission to defer the taxes. The QI gets the use of the exchange assets for up to 180 days. This is a mutually beneficial relationship and the client likely has no idea. A rep's allegiance to a QI can be built in a short period. (I would be surprised if reps know of malfeasance on the part of the QI.) Broker/dealers need to stop these relationships immediately and require only QIs affiliated with large banks or title companies. This referral source is brining in clients the rep does not know from a source that may be suspect.

If You Aren't Cheating, You Aren't Trying
It's been the impression for sometime that cyclists use drugs to improve performance. This article adds more credibility to this impression. But if everyone is cheating, is it really cheating? If every top cyclist is using drugs than there is no benefit because the enhancements are canceled out.

Scuttle
Last week I heard the reason why Louis Rogers left NNN Realty Advisors. I didn't know until today that he was terminated for cause in early April. It looks like the fight between Rogers and NNN is going to get ugly. There is nothing like two rich guys (Tony Thompson of NNN and Louis Rogers) fighting over money. The story I heard relating to Louis Roger's departure/termination was second or third hand so I am not going to repeat it here, but from what I heard it warranted termination.

Merger Reason?
Maybe this is the reason for the NNN Realty Advisors and the Grubb & Ellis merger. Disclosure can be such a pain.

NNN Merger
NNN Realty Advisors is merging with Grubb & Ellis. Information on the merger is here. This is interesting merger, as NNN filed to go public earlier this month. At first glance, I am not sure what to make of this merger other than it's an easier way for NNN to go public. There is a conference call tomorrow (5/24) that I will have to listen to.

Putting Your Money Where It Counts
One way of getting around the CMBS market's tightened lending requirements is for sponsors to step up and close deals with their own equity. This eliminates the need for bridge financing and shows just how much a sponsor believes in a particular property. I know of one that did it and I applaud the principals for putting up their own cash to get the deal closed. It is a bullish sign for the property. I don't believe many sponsors would be willing to do this, whether they had the cash or not. It runs counter to the OPM (Other Peoples' Money) philosophy of the real estate syndication world.

Right-Wing French Style
New French President Nicolas Sarkozy was called right-wing in an article in the weekend edition of the Financial Times. The article went on to state that two of his main platforms are protecting environment and preventing human rights catastrophes like Darfur. If this is right-wing, I'd hate to see what would've happened if the Socialist candidate had won the Presidency.

Is this a Disease?
Several times in the past week I have heard 70s' songs and not turned the radio station. What the hell is afflicting me? I listened to more than twenty seconds of the Eagles' Hotel California, Fleetwood Mac's Rumors, and Don McLean's American Pie. American Pie?!?! For chrissake, if this continues I'm going to have to commit myself.

More Chinks in the Armor
I heard today that tighter lending standards in the Commercial Mortgage Backed Securities (CMBS) market are causing some TIC deals with mezzanine debt not to close. This could roil the TIC industry. Most TIC deals are financed with conduit financing - i.e. loans that are sold shortly after they are made to large firms that then package the loans into mortgage backed securities. The packagers are getting tougher on the loans on properties that were closed with mezzanine debt.

This affects TIC sponsors that use the mezzanine debt because they are having a hard time raising equity. TIC sponsors will start to look at portfolio lenders - i.e. insurance companies that do not sell the loans - despite the higher interest rates portfolio lenders charge if the conduit lenders prohibit mezzanine debt on properties. This is a development that may change the TIC landscape. TIC sponsors need to find good deals where they can raise equity, not marginal deals that are hard to sell but that fit a particular model. The mezz issue then goes away. I don't know the spreads between conduit and portfolio loans but a portfolio lender may be easier to work with for a TIC sponsor, especially if a property is going to be sold early or held longer than anticipated.

Looking in the Wrong Place
The TIC industry has been tacitly waiting for some rouge TIC sponsor to steal investor money. The wait was for the wrong part of the TIC transaction. Two Qualified Intermediaries - the companies that act as escrow companies so the an investor affecting an exchange does not handle the funds and therefore invalidate the exchange - have stolen investor funds through appropriation of investor funds for other uses. The 180-day exchange period was just too much for these douche bags. I am not sure who are the big QIs, but I am guessing there are a large number of mom-and-pop outfits. I don't see a reason not to use a bank or major escrow firm. The risks, now exposed, are too great.

Foreclosures in San Diego
This article in today's WSJ sounds scary and gives the impression that a 30% to 50% decline in San Diego home values is a possibility. I am skeptical of these bank auctions and would hesitate to draw definitive conclusions from them. The quote towards the end of the article that San Diego home "prices generally have been drifting lower over the past year" is closer, in my opinion, to reality. In my neighborhood homes are moving and some sales have been surprising, to me at least, for their high prices (thanks Zillow for recent sales information). Several homes sat for extended periods and sold for 20% or more less than their original list prices. Other listings have sold in a matter of days, not months, when priced near recent, comparable sale prices rather than at inflated list prices. It is hard to predict the future, but I am guessing a floor for prices has been reached.

What's A TIC Sponsor Worth?
At the Orchard Securities Conference two weeks ago, Darrel Steinhause (?), a reputable attorney who writes the memorandums for some TIC sponsors, said that some sponsor(s) are using bridge equity financing. Wow! It's hard to believe a sponsor is giving up part of its company to close a TIC transaction. That is expensive financing. This raises questions to me about the value of a TIC sponsor and whether the lack of sponsor equity in the deals they syndicate is the TIC industry's Achilles heel.

I don't think most sponsors are worth much, if anything, if their sole business is doing TIC transactions where TIC investors own the properties. The property management fees are minimal and many are paid to third parties. Real estate commissions are also shared with third parties. Combined, these do not generate substantial value. A sponsor's value is its ability to do deals and earn initial fees. But the initial fee, since it is earned when a deal closes, has no value going forward. In my opinion, a sponsor that relies on bridge equity has no value at all. I am not sure how this can be good for investors.

This was the problem fifteen or twenty years ago. Sponsors stopped raising money and then could not find investors to help with problem properties because they had little equity to offer as an inducement. The only enticement was their back-end participations and ongoing revenue sharing and management fees, which had no value when real estate prices declined.

The outlook for current TIC sponsors is no better. A TIC deal, to qualify as an exchange, cannot have partnership features like revenue sharing and back-end participations. The sponsors of TIC deals have no equity in their deals and by tax code, no participation features. If a sponsor has multiple deals get in trouble the options look bleak.

Not all is negative. The deals today are economic while the deals in the 80s were tax driven. This is an important difference. The financing for real estate today whether through private equity or REIT structures is also improved from fifteen years ago, and would make consolidations of TIC deals better for investors than the crude "roll-ups" of the early 90s.

Allusion Update
This post last week alluded to a sponsor. I found out that it is US Advisor, and as noted here, I heard it is selling seventeen of its apartment deals. Not much of a story, but it is good news. I bet that it is not a big enough portfolio to sell to a REIT or private equity firm and will have to be sold individually.

The American Way
If you can't beat them, sue them. I have been waiting for this article. We must be near a bottom in the real estate bust if home buyers are starting to sue developers. This happened in the late 1980s and early 1990s. Homeowners started to sue when the value of their new homes dropped. Buyers in the early phases of developments sued the builders when prices were lowered for later phases. This is called a market. Developers are not lowering prices due to altruism. What if the developer went back and demanded a higher price from the early phase buyers if it was able to obtain a higher price from later phase buyers. This would be unheard of. I love this section:

Other disputes are more heated. Red Bank, N.J.-based Hovnanian, one of the largest builders in the U.S., currently is embroiled in one such dispute with buyers in Florida.

One of those buyers, Daphne Sewell, received three construction loans, totaling about $750,000, to buy three houses in Cape Coral and Lehigh Acres, Fla., in May 2005.

An administrative assistant in Broward County government, Ms. Sewell said she and her husband, a carpenter, earned $90,000 a year at the time of the deal and never should have qualified for their mortgages. She also claims a real-estate firm involved in the deal promised that it would find them tenants to rent out the houses. But the renters never materialized, her houses are vacant, and two of her loans are in foreclosure.

"If I close on them I deplete my savings in two or three months," said Ms. Sewell. "It's worth the fight."

After she was served with foreclosure lawsuits by the lender, she filed a countersuit, which names the builder, First Home Builders of Florida, the lender and a real-estate firm that she alleges promoted the deal, claiming she was defrauded by an investment scheme that promised minimal risk. A lawyer for First Home Builders said his client denies any wrongdoing.

This lady thought she was Donald Trump. More like Donald's long lost cousin, Gary the Retard.

This quote from a principal of a developer sums up my feeling on the matter:

"These are not situations where a woman bought a unit and she's now a widow and can't pay," he said "These are people who don't want to close because they can't flip and make $100,000."

Conference Update
The Orchard Conference went well, I thought. Orchard sure seems to have its act together, and I think, has to be the top dealer manager. There were whispers and allusions at the conference about sponsors and properties in trouble. No specifics, though. One interesting point, US Advisors, which used other real estate companies to source its TIC deals, is apparently selling the seventeen properties it syndicated with Creekstone. I think these were mostly apartment deals.

Speaking Update
I sat on the panel, told my story and spouted my opinion. I thought it went well, people laughed at the appropriate places, which is important.