Tuesday, June 23, 2009

Bed Bugs
The second hotel chain in as many weeks has run into major problems. Last week Extended Stay Hotels filed for Chapter 11 bankruptcy and this week Red Roof Inn defaulted on $367 million of mortgage debt. Both Extended Stay and Red Roof were bought by their current owners in 2007, at the height of the commercial real estate boom. Including the $367 million in defaulted mortgage debt, Red Roof has $1.2 billion of total debt. There are forces at work against the hospitality industry, including tight credit markets (this is especially tough for deals done in 2006 and 2007), and the recession that has lead to higher vacancy rates and lower Revenue Per Available Room (RevPAR), a primary hotel industry metric. In addition, there were way too many hotel rooms built between 2004 and 2008, and the limited service niche in which Extended Stay and Red Roof operate may have seen the most rooms built.

I don't know the specifics of the Extended Stay or Red Roof acquisitions, but I would guess that the financing was based on pro forma projections that included ever increasing RevPAR (2% to 3% per year), stable occupancies and stable expenses. The debt was also made in an easy credit environment with no expectations of a change in the finance markets (steady growth in RevPAR and net income would lead to higher valuations that would allow the borrowers to easily sell the hotels and repay the debt or refinance the debt).

In more hotel news, the swank W Hotel in San Diego, and the luxury resort St Regis in Orange County were both given back to their respective lenders. Again, both experienced high vacancies and lower RevPAR, and the owners were unable to make their debt payments. The W Hotel was bought for $96 million in 2006 and had a $65 million mortgage. The owners, Sunstone REIT, say the hotel is worth much less than the $65 million mortgage. The St Regis story is similar, declining RevPAR does not allow the owners to support the current mortgage payments.

There was clearly overbuilding in residential real estate. In general, there was not the same boom in commercial real estate - there was just too much money to be made on the residential properties. Hotels, in my opinion, were the exception. There were way too many hotels built (again, all based on linear pro forma financial statements). Combine this with the ridiculous financing and it's a wonder that more hotels are not joining Red Room and Extended Stay in default or bankruptcy.

Monday, June 22, 2009

Radio Star
I was on the Southern California radio on Saturday (600 KOGO) to talk about commercial real estate. It was fun. You can trust your kids to set you straight, as they told me I sounded nervous and had too many "ahhs," "umms" and dead air. Not good, but I think they got a kick out of hearing their dad on the radio. The final question I was asked was for my prediction on a commercial real estate rebound.

I am always playing Monday Morning Quarterback and later Saturday, as I thought about my answer, I realized did not expand enough on what will trigger a comeback. I said that a return of the finance markets will play a large part in getting the commercial real estate back on track. This is only partially true. The second key for commercial real estate is a recovering economy. In the current weak economy, commercial real estate is seeing increased vacancies and flat or declining lease rates, which signify lower valuations. A return of real estate financing will allow for sales that are not distressed (because distressed sales comprise the majority of the sales occurring in today's market). The availability of financing alone does not mean that prices will rebound, it just means that buyers and sellers will have a better idea of the market, and that distressed sales will no longer dictate the market. Commercial real estate won't rebound until financing is available and the economy improves, driving demand for real estate space.

Wednesday, June 10, 2009

More on Georgia's Bank Failures
I mentioned the large number bank failures in Georgia in April and the Wall Street Journal gives details today. Georgia has had more bank failures than any other state, and more failures are expected. This helps explain why there are so many Georgia bank failures:

Georgia had 334 banks at the end of 2008, not counting branches of banks based elsewhere, such as Bank of America Corp., of Charlotte, N.C., and Wells Fargo & Co., of San Francisco. Since 2000, 112 banks and thrifts were started in Georgia, the third-highest total in the U.S., after California and Florida.

Rob Braswell, commissioner of the Georgia Department of Banking and Finance, the top regulator of banks that have Georgia charters rather than federal ones, said that if most people with banking experience applied for permission to open a new bank, "it was hard to say no when they had such an abundance of capital." Mr. Braswell has 62 examiners to monitor more than 150 state-chartered banks.

Bad real estate has played a part, but Georgia did not have the price increases seen in places like Florida, Arizona, Nevada and California. A bad situation could be much worse.

Wednesday, June 03, 2009

AIG To Sell Headquarters
Here is an article announcing that AIG is selling its headquarters at 70 Pine Street, and an adjacent building. No sales prices are listed. I imagine the price will be below market because AIG is vacating both buildings. This story is so AIG, sell a building with a huge pending vacancy. No one is going to pay top dollar for these two buildings. (I found the picture on photobucket via a Google Image search.)

70 Pine Street was built in 1932 and is currently New York's third tallest building (I guess the measurement goes to the top of the spire). I like the Art Deco style. Here is a link with some more information on the building. It has a neat 30's era picture, too.
REIT Equity Expectations
I just saw this on Bloomberg. I realize it is an advertisement for the REIT industry, but it brings up a good contrast. Even if public REITs don't raise $582 billion over the next few years, it shows the advantage they have over non-traded REITs. Over the past two years public REIT prices have dropped significantly. Here is a quote from CNBC on the REIT decline:
REITs have fallen precipitously over the past two years. In 2007, the FTSE National Association of Real Estate Investment Trusts All REIT Index fell 17.83 percent, then dropped 37.34 percent in 2007. While the index is down more than 10 percent in 2009 after negative months in January and February, March posted a 4.41 percent gain and April saw a rise of just under 28 percent.
The share value drop has prevented REITs from raising equity in the capital markets. Non-traded REITs with their ongoing equity offerings have been raising capital at steady, but slowing levels. Now, the publicly traded REITs appear ready to re-enter the public equity markets. The opportunities in real estate outweigh the negative of selling shares at prices well below 2007 values. They will be able to raise capital much faster (underwriters committing hundreds of million dollars), than the public non-traded REITs. This will allow the publicly traded REITs to deleverage their balance sheets, which in a paradox will allow them to borrow more, at attractive rates, due to their strengthened balance sheets.

With their new equity, the publicly traded REITs will be able to take advantage of real estate opportunities created by the credit crisis and the recession. Non-traded REITs will keep plugging along, but they are at a disadvantage to the big, publicly traded REITs that can raise several hundred million in an afternoon. I felt that the non-traded REITs held an advantage for the past eighteen months or so, as the publicly traded REITs had abandoned the equity markets. It appears that this advantage will disappear soon.

Monday, June 01, 2009

Wells Timberland Hits Debt Deadline Early
Here is some good news, Wells Timberland has paid down its mezzanine loan to below $45 million as of May 14, 2009. It needed to have the principal paid down to $45 million by June 3oth. It's good that Timberland achieved this goal six weeks early. The next milestone is to get the mezzanine loan down to $30 million by September 30th.