Sunday, May 31, 2009

GM Bankruptcy
I don't really care about the GM bankruptcy. Yes, it's sad that an American icon is declaring Chapter 11, but GM is not going away. It is going to restructure its debt and start anew. Maybe it will finally make cars people want to buy. The Europeans and Japanese kicked GM's (and Chrysler's) ass in the 80s, and GM has been limping along since. What needs to be said is how the housing boom helped GM avoid the inevitable and then eventually forced it into bankruptcy.

GM derived a large amount of revenue from its GMAC financing unit and the housing boom spurred this growth. GMAC made a variety of home loans in addition to its car loans. Many people took out home equity loans (from GMAC and other finance companies) to buy Escalades and Suburbans. This credit-driven, artificial growth (artificial because a finance arm should be ancillary to a car maker's main business of selling cars, and because people taking out equity to buy more car than they can afford is not sustainable) led GM down a path it was unable to change when the housing bust and high energy prices and the recession caused people to stop buying cars. I'd like to think GM will be smarter this time around.

Saturday, May 16, 2009

Behringer Harvard REIT I Cuts Dividend
Here is an excerpt from Behringer Harvard REIT I's 8-K that was filed Friday, May 15:
In light of the historically weak economic environment, our board has set the distribution rate for each of the months of April, May and June 2009 at $0.0271 per share, which is a 3.25% annualized rate based on a purchase price of $10.00 per share. As reported earlier to our shareholders, our board determined to maintain a monthly distribution schedule. These distributions will be payable to shareholders of record as of each of April 30, May 31, and June 30, 2009. We understand this decision directly affects your monthly income and assure you it was undertaken with careful consideration.
To offset the distribution cut, the REIT's advisor is waiving its asset management fee for the second and third quarters. I read through the REIT's quarterly report and funds from operation was $28.5 million compared to distributions of $46.6 million. Over the same period a year ago, the REIT had FFO of $26.8 million and paid distributions of $32.5 million. Cash flow from operations was a negative $4.8 million in the first quarter of 2009, and it was negative $10.1 million in the first quarter of 2008. The distribution cut should not come as a big shock. This distribution should have been cut sooner, but distribution cuts are bad for marketing.

Of the $46.6 million in distributions, only $21.4 million was paid in cash, the remaining dividends were paid in REIT shares through the REITs dividend reinvestment program.

This REIT is highly leveraged. Its debt is approximately 75% of the value of properties listed on the balance sheet. The notes explain how the properties are accounted for, but the explanation is confusing and I am not sure if the properties' values reflect current valuations or are carried at cost. With leverage so high, this is an important question.
More On CMBS
The Wall Street Journal had an article this week on General Growth's bankruptcy filing and how it took 168 of its mall properties with in into bankruptcy. All these properties have loans that are in CMBS. This is no small issue because the article states General Growth is the largest CMBS borrower in the United States. Here are a few excerpts:
General Growth's action has rattled investors throughout the $700 billion market for securities backed by commercial mortgages, or CMBS. Investors in other deals had also figured their investment was insulated from a parent company's bankruptcy. Now they're worried that General Growth's move will set a precedent that could affect them.
For tenant in common investors this is interesting:
In past years, to get the malls' mortgages, General Growth had set up 166 "special purpose entities" whose sole purpose was to borrow money. SPEs are attractive to lenders because, according to legal experts, they are "bankruptcy remote," meaning their cash flows are dedicated to paying debt service. The lenders issued securities backed by the SPEs. Holders of securities expect the structure would ensure they'd be paid even if the parent company went bust.
This should give tenant in common investors pause:
A major issue in the bankruptcy case is General Growth's request to draw cash flow from its malls and use it at the corporate level or in other areas of the company. Such transfers of money within the corporate structure used to be routine at General Growth, as they are at other similarly structured real-estate companies. But, now that General Growth is in Chapter 11, its CMBS lenders want to enforce the malls' status as separate entities and keep the malls' extra cash flow from being siphoned away to pay other creditors, namely unsecured lenders.
I think DBSI, the failed tenant in common syndicator, tried this same maneuver. I don't think that General Growth is going to get away with this move, and I think it would be even harder for a TIC sponsor to try and take investor money. The Special Purpose Entities (SPEs) that the CMBS lenders required to protect them from a single investor bankruptcy (TICs had up to thirty-five investors, each that was required to form a SPE) may eventually help the TIC investors. General Growth's bankruptcy will give a good indication of what's ahead for investors in TIC deals with poorly capitalized sponsors.

Wednesday, May 13, 2009

Fun in the Sun
Last week I described a multifamily development limited partnership where the general partner decided to build high rise condos rather than garden-style apartments. Here is a a follow-up article from today's Wall Street Journal on struggling condo financier Corus Bank. This bank is in trouble:
While many lenders are being hurt by the condo crash, Corus is particularly vulnerable. Condo-construction loans accounted for nearly 75% of the lender's commercial real-estate loans. Some 41 of the bank's 85 condo-construction loans were in default at the end of 2008, and an additional 23 condo loans were considered "potential problem loans" at risk of default. In Florida, all but three of 20 condo loans were in nonaccrual, the company said last month.
Ouch. The vultures are circling and here is why:

Analysts say that Corus's loans could be attractive because they weren't syndicated or sliced up into securities. As a result, foreclosures on the properties wouldn't be subject to lawsuits from other lenders. In addition, many developments financed by Corus are high-quality properties in major metropolitan markets.

"Corus made loans on many of the most important properties in Florida, and control of those assets could translate into a very significant windfall" over the long term, said Robert Kaplan, chief executive of Olympian Capital Group, a real-estate investment firm.

Most of Corus's loans are in Florida, Southern California, Las Vegas and Atlanta. Many of these markets are at the epicenter of the housing collapse.

Saturday, May 09, 2009

Seemed Like a Good Idea at the Time
The use of conduit financing in tenant in common transactions will be a major obstacle for the TIC industry. Conduit financing allowed for high leverage and low interest rates. Conduit debt were loans that were originated by large commercial or investment banks and then sold into Commercial Mortgage Backed Securities (CMBS). This process, repeated hundreds of times on all types of commercial properites, accelerated the commercial real estate boom of the 2000s. While it was easy to get a commercial loan and easy for banks to get these loans into a CMBS, but once a is in a CMBS it is difficult to modify or refinance the loan. This inflexibility will hinder the TIC industry.

CMBS are dictated by the terms of the security and CMBSs' trustees and special trustees' obligation is to security holders of the various tranches, not property owners. If a property owner can not make debt service payments, the special trustees have limited negotiating authority and are tasked with maximizing the return for CMBS holders. The best decision, in view of the special trustee, may be to foreclose on a property. Extensions are possible, but usually only for short periods. Third parties, like private equity firms or other entities that acquire distressed debt at discounts, cannot buy loans that are in CMBS. Each CMBS was divided into various tranches, each with their own credit rating and investors, but all backed by the same pool of mortgages. This is why it is virtually impossible to "break up" a CMBS, there are just too many investors with differing priorities involved.

Conduit loans were pushed by commercial mortgage brokers and were commonplace financing until the credit crisis started. A conduit loan typically saved a borrower 15 basis points to 25 basis points over loans that banks or insurance companies originated and kept as "portfolio" loans. Before the credit crisis started, many commercial banks were not even making portfolio loans, opting instead for origination and sale into CMBS. Loans sold into CMBS typically had interest-only components that lowered mortgage payments for one to five years, or longer, which borrowers found attracitve because it allowed them to boost yields to investors.

The TIC industry and the CMBS market are going to mirror each other for the near future. The heartaches caused by a savings of 15 to 25 basis points show how yield hungry investors were and competition in the TIC and banking industries.

Thursday, May 07, 2009

More on Cap Rates
The previous post touched on cap rates. If the building discussed in the article, One California Plaza, sells for a 7.5% cap rate, to me, that would be a good sign for the commercial real estate. The building has vacancy, leasing and finance issues, all that would lead to a higher cap rate compared to a similar property without the issues. From what I have been able to read, cap rates are more of an estimate now due to the lack of transactions. One thing everyone is saying though is that cap rates are higher than their record lows in 2007, how much higher is not known. I was at a meeting Tuesday where it was stated that Class-A institutional quality apartments are trading at 8% cap rates. This seems high, but we'll see. If One California Plaza sells at a 7.5% cap rate, it makes sense that the cap rates for more stable office buildings in Los Angeles would be closer to 6.5% to 7.0%. The Wall Street Journal reported yesterday that cap rates for office space in central business districts was at 6.86% in March, down from February's 7.53%, a surprising trend reversal.
Cap Rate Indicator?
There was a good article in yesterday's Wall Street Journal about a building for sale in Los Angeles and how its cap rate may be a market indicator. The building is:

Viewed as one of the city's premier office buildings, the 992,000-square-foot glass-clad One California Plaza in the tony Bunker Hill neighborhood was put on the block in January by Macquarie Office Trust, a battered Australia-based real estate investment trust.

The property was acquired in 2006 for $325 million. Real estate experts expect it to attract bids or $200 to $240 million. This is based on the property's current net operating income and a $240 million sales price would translate to a cap rate in the 7.5% to 8.0% range. The article details that the building is 78% leased, has "a number of leases are set to expire over the next few years," which include a bank that occupies nearly 8% of the building's space. The property's debt matures next year. The low occupancy, expiring leases and maturing debt add uncertainty for any buyer that would reflect in a higher cap rate than if the property was stabilized. This property has value-added characteristics, despite its tony location and high profile. Based on this data, I am not sure whether the cap rate would indicate a new benchmark.

To me, the big questions are what lease rates the vacant space is attracting, what concessions and tenant improvements are potential lessees demanding, and who is going to pay for these in a deleveraging economy. By the last point I mean that if the the current debt matures next year, and the property was acquired in 2006, there is a chance that there is little equity left for the seller. The loan was probably interest-only so no principal has been paid down, and if the leverage rate was 75% or more, at a prices lower than $240 million there is no equity for the seller. It would be difficult, if not impossible for the seller to give a credit for leasing expenses. A buyer and a new lender would have to determine appropriate reserves for leasing contingencies. This deal will likely turn on the assumptions for that vacant space. The lease rates for the vacant space may be more of an indicator than the building's final cap rate.

Tuesday, May 05, 2009

A Funny Thing Happened on the Way to the Fourm
I recently read a quarterly update from a real estate syndicator. This sponsor was supposed to develop, build and lease garden style apartment complexes, and then sell the stabilized complex to institutional buyers. Well, this is not exactly what happened. The limited partnership, sold as a blind pool, has made four investments, three that were condo developments, of which two were side-by-side condo towers. Only one of the three investments was the garden style apartment (and this development has yet to secure construction financing) described in the memorandum. The sponsor had not previously developed condos. The quarterly summary had no financial data and did not specify the amount invested in each property. The building of condos rather than apartments is a huge change to the investment objectives and exposes investors to much more risk, in an already risky investment.

The first tower, which has been put in to bankruptcy, has sold a little over a quarter of its units in nearly two years of effort. The second tower is nearing completion and is being marketed as apartment rentals rather than as condos, and according to the investor letter, will likely be put into bankruptcy, too. The lender for the two condo towers is about to go into receivership, which will add another layer of complexity to this investment. (Why would anyone buy a condo in a building were the adjoining tower is offering rentals? How much will sale prices have to drop to offset the rental stigma? Will the new sales prices make any economic sense? There are multiple questions.)

The third condo development is now in the leasing stage as its condo sales failed. It can be argued that this investment has been hit by the unforeseen events of the credit crisis, housing bust and recession. It can also be argued that the original investment objective of building, leasing and selling of apartments was willfully disregarded in favor of the condo developments. Selling an apartment complex is only one sale and can be operated for income if a sale takes longer than anticipated. A condo is much different investment. Selling condos are multiple, individual sales that extend the investment time horizon. Condos are also governed by the condo association and require association dues. It is hard to end these associations. This is one investment that needs watching.

Sunday, May 03, 2009

Lehman's Real Estate Adventure
This New York Times article on the former head of Lehman Brothers' global real estate group provides a recent history of commercial real estate's rise and fall, all driven by financial wizards. It shows the power of securitizaton and how it fueled real estate transactions by allowing banks to get risky loans off their balance sheets, freeing up capital for more loans. And all decisions predicated on the assumption that real estate values would continue to increase.

The US attorney's office is looking into Lehman's real estate activities for any wrong doing, which I find troubling. You can debate the merits of Lehman's excessive leverage, decision to move into bridge financing, or a host of other business moves that look bad in retrospect, but nothing I read in the article was a crime. Lehman was a Wall Street firm in competition with other bankers and it devised clever solutions to help clients. Many of these solutions, in hindsight, appear imprudent and risky, but not criminal.

Friday, May 01, 2009

Alphabet soup for the real estate industry. I hope it helps spark transactions in the CMBS market and allows for refinancing of loans that are coming due. Without an easing of credit, good real estate owners are going to run into trouble.