Return of Lending
Obama's meeting with the "fat cat" bankers made news yesterday. Apparently, Obama pressed the bankers to make loans. This is all well and good, but talk can only go so far. There have been glimmers of hope that lending is going to return without presidential prodding. As I have noted before, the CMBS market is re-emerging. Now I see this article on Bloomberg discussing the return of Collateralized Loan Obligations (CLOs).

The idea of traditional banking exists on a limited level - i.e. making loans and collecting interest until the loans mature. This is portfolio lending and it limits banks' capital because they cannot recycle and grow capital until the loans mature. Bankers now want to originate loans, package them into CLOs or CDOs or CMBSs, and then sell these groups of loans to third parties. The collapse of the packaged loan market and the inability to price these securities sparked the financial crisis of 2007 through 2009.

In an ideal world, the bankers now know how to price these securities and they surely know how these loan packages perform in down markets. The collateral backing the loans will be more realistic now due to the drop in asset prices over the past two years. A return of securitized lending will help the economy. It will also help companies that need to refinance debt.

Fairfield's Bankruptcy and a Non-Traded REIT
Behringer Harvard's Multifamily REIT I has three multifamily properties that are nearing completion that were developed by Fairfield Residential. Fairfield Residential filed for bankruptcy this morning. To Behringer's credit, it looks like it has made moves to limit the impact of Fairfield's bankruptcy. It is worth reading Multifamily's recent 8-K filings. The complexity of Multifamily amazes me every time I read one of its 10-Qs. In a nutshell, the REIT invests in apartment developments via mezzanine loans that are then converted to equity, although Multifamily is now buying existing apartments.

The complexity is detailed here in an 8-K filing regarding of the properties being developed with Farifield:

Parties. The Baileys Project is owned by Behringer Harvard Baileys Project Owner, LLC (“Baileys Project Owner”), which is solely owned by Behringer Harvard Baileys Investors, L.P. (“Baileys Investment Partnership”). Baileys Investment Partnership is owned by Behringer Harvard Baileys GP, LLC (“Baileys GP”), by Behringer Harvard Baileys REIT, LLC (“Baileys REIT”), by BREOF Baileys, LLC (an equity investor unaffiliated with Fairfield Residential or us) (“BREOF Baileys”), and FF Investors III East LLC (an affiliate of Fairfield Residential) (“FF East”). Baileys Venture owns 99% of the economic interest in Baileys REIT and manages Baileys REIT. Baileys GP, the general partner of Baileys Investment Partnership, is wholly owned by Baileys REIT.

What?!?! Another way to look at this 90% completed property is that it is 414-units and the development cost is $143.2 million, or about $346,000 per unit. I know nothing about the Virginia sub-market where the property is located, but my gut tells me that $346,000 per unit is expensive no matter the ownership structure. And this is before adding the syndication costs, and worrying about selling or adding permanent financing....

Inland Western CMBS Pricing
The CRE Review is all over the Inland CMBS offering and is where I found this Reuters' link. The top two classes, representing $389 million out of the $500 million CMBS offering, were oversubscribed, and the final pricing was at yields at the low end of expectations. From Reuters:

The 10-year CMBS, just the third U.S. deal since issuance broke an 18-month void in mid-November, was oversubscribed, according to documents reviewed by Reuters on Wednesday.

Inland Western's two top-rated classes sold at yield premiums of 1.5 percentage points and 2.05 percentage points above an interest-rate benchmark, about a third of current levels on existing CMBS made at the height of the real estate boom. The yield spreads were at the low end of expectations.

I am finding it hard not to see why this is not good for Inland and commercial real estate in general.

Simon Clarification
Through The CRE Review I have more clarification on the Simon/Prime Outlet deal. Looks like the sales price is $283 per square foot and the implied cap rate is 6.7%. I still think this deal is positive for the commercial real estate market.

Commercial Real Estate Continues to Gain Traction
Simon Property Group's acquisition of Prime Outlets is a big deal. Here is the Bloomberg article on the transaction. Simon is gaining twenty-two outlet properties and now has sixty in its portfolio. Patching information together with help from The CRE Review, it looks like Simon is paying approximately $315 per square foot. Not sure whether this is a good deal or what the aggregate cap rate is. The Bloomberg article quotes an analyst saying that the deal is good for Simon. Six of the properties are in Florida, which is another good sign for real estate, since Florida has been in such a slump. The slow emergence of the CMBS market will generate more transactions like this. It is interesting to note that Simon's outlet malls generate more sales per square foot than its regional malls ($492 v. $438).

Big Week In The Non-Traded REIT World
There have been three big news items so far this week. First was the news that Piedmont Office Realty Trust has filed an S-11 as the first step in listing its shares on an exchange. I encourage you to go to Piedmont's website and follow the link to the SEC's website and read the S-11. The listing is not as straight word as you'd think. It involves a reverse stock split and dividing Piedmont's shares into four classes, where only a quarter of the shares will have liquidity initially, and the remaining shares will have delayed conversions to liquidity options.

On the heels of this news, Wells has filed Wells Real Estate Investment Trust III, a $5 billion office and industrial REIT. I don't think these two events are unrelated. I would question the financial advice to sell Piedmont, when it is listed, and buy Wells REIT III.

Inland's troubled Western Retail REIT refinanced %625 million of debt, and $500 million of it will be sold as Commercial Mortgage Backed Securities. Here is a link to the Wall Street Journal article and a key passage:

Inland Western Retail Real Estate Trust Inc., which owns some 300 retail properties nationwide, closed on Tuesday $625 million in new financing from J.P. Morgan Chase & Co. to pay down its existing debt. The bank is expected to convert the $500 million first-mortgage part of the financing into a CMBS offering and sell through private placements the remaining $125 million in "mezzanine," or junior, debt to investors hunting for higher returns, according to people familiar with the matter. A spokesman at J.P. Morgan declined to comment.

This reads like good news:

For Inland, of Oak Brook, Ill., the $625 million in new financing represents a big relief as it has about $789 million in debt coming due by the end of this year and another $1.5 billion maturing in 2010, according to the company's third-quarter report. So far, the company has refinanced almost all the debt maturing this year and a sizable portion of the debt coming due next year.

The debt is secured by 55 properties, has a 10-year term and a 75% loan to value, with the underwriting taking into account the current market values and potential for leases renewing at lower rates. I have not read what yield is expected on this deal.

Developers Diversified Sells CMBS
Here is a Reuters article on Developers Diversified's (DDR) sale of three tranches of CMBS. The largest tranche, a $323 million AAA-rated CMBS, was priced to yield 3.8%, which was a lower yield than expected due to high demand. DDR used the government sponsored TALF (Term Asset-Backed Securities Loan Facility). The two smaller tranches, $42.5 million and $3 million, did not use TALF and were priced at 5.75% and 6.25% yields, and came with ratings of AA and A, respectively.

This was the first CMBS deal since June 2008. The level of demand was encouraging. DDR bought one of the Inland REITs a few years ago and if I remember correctly, investors received approximately $12 per share in cash and $2 in DDR stock. The original investment was $10 per share. A large portion of that $12 per share in cash rolled in to Inland's American REIT, and was a primary reason Inland American raised so much money. DDR has also done business with Dividend Capital.

Article on Impending Doom in Commercial Real Estate
Here is a Bloomberg article on the "huge," pending commercial real estate crash. Really? Thanks for letting us know - three years too late. The commercial real estate crisis in now in its second year, and about a year ago cap rates jumped over one whole percentage point almost over night due to the credit crisis. Commercial mortgage backed securities are expected to approach record high default rates above 6% in 2010. The doom is already upon commercial real estate. In talking to various real estate professionals, I am hearing that cap rates have stabilized and are no longer increasing, which may lead stabilized values. Decreasing rents and higher lease expenses will put pressure on net operating income, which despite level cap rates will lower valuations.

Interesting Article On Manhattan Real Estate
Here is an exclusive Bloomberg article on a Manhattan office tower that was part of the whole Equity Office / Blackstone frenzy in early 2007. The current owner acquired the building in July for $590 per square foot, when it sold two years ago for nearly three times that amount. The building is now 40% vacant with rents down 30% from their peak and Manhattan vacancy rates their highest since 1996.

Inland Western's Math
As a parent, I am always telling my children to show their work when doing math homework. I think Inland Western needs to be admonished with the same advice. Here is the brief statement on Inland Western's fourth quarter distribution:

Enclosed is your portion of the third quarter 2009 distribution to Inland Western Retail Real Estate Trust, Inc. (“Inland Western”) stockholders. The board of directors declared a third quarter 2009 distribution of 2 ½ cents per share, payable on October 12, 2009, to stockholders of record at the close of business on September 30, 2009. Including this distribution, stockholders have received a total of 17 ½ cents in distributions in calendar year 2009. Assuming a purchase price of $10.00 per share, this level of distribution translates to a 1.75% annualized return. As each distribution is determined quarterly by our board of directors, the annualized yield is not necessarily indicative of future distributions. If you have invested through a trustee or participate in Direct Deposit or the Distribution Reinvestment Program, a distribution statement is enclosed in lieu of a check.

First off, the letter is confusing calendar year with the fiscal year, as it combines the fourth quarter 2008's distribution with 2009's distribution. How else could a 1.75% annual rate be determined if the third quarter's distribution was just paid? Second, a $.025 cent dividend on a $10 share price does not translate into a 1.75% annualized return. It translates into a 1% annualized return: ($.025 dividend X 4 quarters) = $.10 per share annual dividend, and ($.1 annual dividend / $10 per share) = 1% annualized dividend rate. Third, the letter does not state that the dividend has been cut, when it's clearly been slashed.

When sponsors play with numbers and language like Inland, it makes everything they publish suspect. I am open to and expect some sponsor spin, but this letter was too much for me. Inland's pronouncements on the mountain of debt Inland Western has coming due over the next year need to be read very closely. I hope Inland Western is not using the same obfuscated math as it figures out its debt payments.

Capmark Craps Out
I saw that real estate lender Capmark filed for bankruptcy over the weekend. Here is the Bloomberg article discussing the filing. Here are a few interesting factoids from the article:

Commercial property values in the U.S. have plunged since 2007 as employers cut jobs and the recession reduced demand for offices, retail space and rental apartments. The Moody’s/REAL Commercial Property Price Indices fell 3 percent in August from July, bringing the decline to almost 41 percent since October 2007, Moody’s Investors Service said Oct. 19.

U.S. office vacancies are at a five-year high, apartment vacancies are at a 23-year record, and retail centers are showing the greatest share of empty store-fronts since 1992, according to real estate research firm Reis Inc. All that unleased space makes it harder for landlords to pay their mortgages to lenders such as Capmark.

The article also states that commercial mortgage defaults are at their highest rates since 1994.

CMBS Defaults
Here is a reprint in its entirety of a Dow Jones News Wire article, published on WSJ.com, discussing Moody's findings on CMBS defaults:

Delinquencies among U.S. commercial mortgage-backed securities surged to by a record amount in September, according to Moody's Investors Service, highlighing the ongoing woes on the commercial real-estate market.

Occupancy rates and rents are falling, which, coupled with an inability to refinance debt, is resulting in an acceleration of woes for property owners. "After tapering off for two months, the delinquency tracker appears to have resumed an upward trend as expected," said managing director Nick Levidy. "The delinquency rate is likely to continue moving higher over the next several months as troubles compound in the commercial real estate sector."

September's delinquency rate of 3.64% compares with 0.54% a year earlier.

The commercial real estate market had held up better than the residential real estate market until it began to deteriorate quickly at the end of 2008 as the U.S. recession deepened. Retail and hotel properties have been hit especially hard.

The hotel industry posted the largest increase in September, rising to 4.97% from 4.18% in August. Multifamily delinquency rates continued to go up, climbing to 6.09% from 5.51%, the highest of any property type. The delinquency rate for loans on retail properties rose one-third of a point to 3.76%.

Moody's said delinquency rates continued to be highest in the South at 5.14%, up from August's 4.66%. The East was the only region with the delinquencies below the national average - with a rate of 2.14%, up from 1.84% a month earlier.

Arizona, Michigan and Nevada all have delinquency rates nearly three percentage points higher than any other state, with rates of 9.32%, 9.29% and 9.14%, respectively. Ohio was the next highest, at 6.22%.

CMBS was the prevalent form of commercial real estate financing from the early 2000s until the credit crisis started in late 2007 and CMBS stopped cold. The fate of the CMBS market will mirror commercial real estate. I have read research reports expecting the default rate to approach 6% to 8%, close to double the current rates.

MGM Cuts Condo Prices
Here is a Wall Street Journal article on MGM Grand cutting condo prices on its huge City Center project. Prices are being cut buy up to 30%. This makes some if people who plunked down deposits close on their condos. City Center is a monster project on the Las Vegas Strip - 67 acres - and is expected to open December. The project was on the brink of collapse earlier this year, which would have devastated a weak Vegas economy.

Starwood Gets Corus' Assets
Here is a Bloomberg article on Starwood and TPG winning the assets of failed bank Corus. Corus was a major lender on high-rise condominiums, and many of these loans are now delinquent or in foreclosure. I suspect Starwood will aggressively pursue the assets underlying all of Corus' failed loans.

Distressed Debt Articles
Here is a link to a Reuters article on CMBS and how investors are watching the Extended Stays and General Growth bankruptcies. Here is a Bloomberg article on the market's tepid response to distressed debt funds. The Bloomberg articles states mortgage REITs' unpredictable income is part of investor reluctance to them, which makes more sense than rejecting the investment opportunity. Private funds would probably have a better reception.

Condo Enabler Taken Over
Corus Bank, the large financier of condo developments, was finally taken off life support yesterday. After struggling for months, the Comptroller of the Currency stepped in and appointed the FDIC as receiver, which in turn entered into a purchase and assumption agreement with MB Financial of Chicago to assume all Corus' deposits. Calculated Risk has a good rundown here and here.

Corus financed high rise condo developments around the country, many that are now struggling. Here is an article from Wednesday's New York Times on a few of Corus' South Florida loan projects. Here are a couple of outtakes:

Whatever the outcome, Corus will go down as the great enabler of condo madness, and its travails are a harbinger of the pain yet to come in the troubled world of commercial real estate. More than any other condo lender, Corus epitomized the easy lending and lax oversight of the go-go years — and the pain of the ensuing bust. Its share price, which was nearly $13 in February of 2008, has plummeted into the land of penny stocks, closing at 25 cents Wednesday.

Corus barreled into hot markets like California, Florida and Nevada and then kept lending as those markets boiled over. Rather than diversify, it concentrated its lending bets by financing only a handful of big, risky projects. And it poured its idle cash into a small group of other banks and financial companies that were upended when the crisis struck.

And this:

Corus was not always so condo crazy. It used to be a sleepy family-run affair known as River Forest Bancorp. Then, in 1984, Robert J. Glickman took over from his father, Joseph C. Glickman, and began transforming the bank into a powerhouse in construction loans. Corus shut its student lending business, its trust operations and all but a handful of its Chicago area branches. It began catering to condo developers across the nation, offering developers quick loan approvals and attractive interest rates. Corus soon fanned out into hot markets like Atlanta, Las Vegas, Los Angeles and Miami. As the property market exploded, so did Corus. Its assets reached nearly $10 billion in 2006. But almost all the loans were tied to the condo market, and nearly 40 percent were for more than $100 million.

Robert Glickman kept reaching for more. Just off the Las Vegas Strip, Corus single-handedly financed a $108.2 million luxury development called Streamline Tower.

This passage is not a shock:

Then, of course, the bottom fell out. By late 2007, the share price of Corus was under attack on Wall Street. But Robert Glickman, whose family then controlled nearly half of Corus, rebuffed offers to sell the bank. Instead, Corus paid a special dividend that netted the Glickman family about $25 million, even though the payout ate into the bank’s reserves. By mid-2008, Corus was losing money and stopped making loans altogether.

The Times article points out that many big name real estate investors, including Barry Sternlicht and Stephen Ross, have been eyeing Corus for months, I suspect in hopes of getting its defaulted loans so they can buy the high rise projects at deep discounts. I am not sure how this plays out now, but I imagine those assets will be in play with MB Financial taking the deposits. This is one story that is not over.

Natural Gas Prices Continue to Plunge
Here is an article on natural gas prices. The price per MCF is approaching $2.50, near a seven-year low. The price of natural gas and oil, which had been somewhat correlated for the past few years, have been moving in opposite directions for most of the year.

Healthcare Reform Fiasco
I have watched the healthcare reform discussion with fascination this summer. There is so much misinformation being thrown around. Many people that are so worked up about a government insurance plan don't seem to understand the issue. There is no bill and any healthcare reform is still working its way through both houses of Congress, and any final bill will be dramatically different than the initial proposals. People are angry about a proposed bill that is still in committee and the numbnut pundits (showing how little they know) talk about proposals like they're law.

The whole death panel discussion, in my opinion, is a canard. Any good doctor is going to have a discussion with terminal patients about their wishes - and they will and should get paid for that discussion. It's a required conversation. Why not let the patient decide rather than having a spouse or child trying to figure out what they think the sick patient would want. That's what my parents did and it made things easier. When doctors start writing living trusts and wills than it's time for concern. All I know is that I want a doctor that is going to be honest with me and tell me what I need to hear and I will be pissed off if regulation prevents this conversation.

Any government insurance plan is going to involve premiums so it won't be a boondoggle for the homeless and illegal immigrants. Plus, people that choose to be uninsured can still go to the emergency room, where they have to be seen, and cost all taxpayers money. Oh wait, that's what the uninsured do now and is one reason healthcare is so expensive. As Benjamin Franklin said 250 years ago, an ounce of prevention is worth a pound of cure.

If find it funny that old people and veterans rail against healthcare reform and government run insurance. I wonder whether they know that Medicare and VA insurance are government run insurance plans. I think it's more that they want only government programs for themselves.

The fears of rationing are overblown. Anybody that has Kaiser knows healthcare is already rationed, and I saw this first hand with both my parents. The actuarial cost of letting certain patients die is cheaper than many treatments. The small amount of lawsuits and any related settlements are dwarfed by the cost savings of not treating some sick people. No private insurance will pay for a treatment that is not covered by Medicare. For all elderly people, Medicare is the default price and treatment benchmark. That's reality.

Most pundits on the left and right don't know a damn thing about healthcare. Here is an example from Ezra Klein's Washington Post blog that blazed across the internet yesterday of CNBC's Maria Bartiromo showing her ignorance on the most basic facts about healthcare:

Why Aren't You on Medicare?

A few minutes ago on MSNBC, Maria Bartiromo and Rep. Anthony Weiner had a shouting match over universal health care. If you like Medicare so much, Bartiromo snapped at Weiner, why aren't you on it?

Weiner is 44 years old.

Update: Here's the transcript:

REP. WEINER: Listen, Carlos talks about Canada. You talk about Europe. Let's talk about the United States of America, Medicare --

MS. BARTIROMO: You have to look at where there are public plans.

REP. WEINER: No. No. The United States of America, 40 percent of all tax dollars go through a public plan. Ask your parent or grandparent, ask your neighbor whether they're satisfied with Medicare. Now, there's a funding problem, but the quality of care is terrific. You get complete choice and go anywhere you want. Don't look at --

MS. BARTIROMO: How come you don't use it? You don't have it. How come you don't have it?

REP. WEINER: Because I'm not 65. I would love it.

MS. BARTIROMO: Yeah, come on.

Yeah. Come on.

Memo to Maria: Medicare is a government health insurance program for all people over the age of 65. A 44-year-old man cannot qualify for Medicare. It is a sad state when people are getting their information from Glenn Beck, Keith Olbermann, Sarah Palin and other pundits that don't know anything about healthcare or how it's priced. All the pundits know is that if they're a Democrat any Republican proposal is bad, and if they're Republican any Democrat proposal is bad, and the more inflammatory their comments - true or not - the better . This lame-brained mentality keeps things easy for the pundits.

It is amazing to me that how few doctors, pharmaceutical company and insurance company executives are on TV discussing the reform (I am not talking about the insurance company executives defending themselves for organizing protests at the town hall meetings). They will feel the immediate impact of any reform and should have input. Most importantly would probably have the best ideas about reforms since they deal with the system every day.

I find it funny that Republicans are now screaming to defend Medicare when they have been trying to kill it since it was enacted in the 1960s. Rick Perlstein's book Nixonland has a great discussion of the virulent Republican reaction to Medicare legislation.

I wonder why there is so little discussion of tort or lawsuit reform. Malpractice insurance premiums are probably a large part of the cost of doctors' doing business. The amount of added paperwork and added steps that doctors need to go through just to avoid being sued probably also add to the cost of healthcare. Doctors should not operate under the constant threat of being sued.

It will be interesting to see how the reform efforts evolve. I hope the debate gets more substantive but don't expect it too. The House and Senate are so fractious that healthy give and take are unlikely. Clinton and Gingrich reformed welfare for the better (and Medicare, too). And Reagan and Tip O'Neil got legislation done. That's what politicians are supposed to do. Ideologues from both sides of the aisle stuck in a vacuum refusing to budge for fear of offending a small but vocal minorities within their parties are bad for the country.

Update:
The healthcare debate keeps getting crazier. An apparent belligerent anti-healthcare protester had his pinky finger bit off by a reform protester last night. The anti-healthcare guy had his finger reattached under Medicare - a government-sponsored program. I would call this irony.

10-Q Season
Most of the second quarter 10-Qs are now available and I am just starting to read them. The Behringer Harvard Mulitfamily REIT 10-Q does nothing to allay my concerns. I will write more on this REIT later, but this 10-Q is worth reading if you have any interest in this investment. It is no where close to covering its distribution, and its positive cash flow item is a one-line figure from the REIT's various joint ventures. There is no detail and given the nature of the REIT's investments - mezzanine loans with equity conversions on development projects - I think this is an important data point.

Bernanke Re-Upped
Ben Bernanke is nominated for a second term as Fed Chairman. I think this is an excellent decision. You can say he was late to recognize the housing bubble and slow to respond to the financial crisis. But it would be hard to say that once he realized the depth and seriousness of the crisis, he did not act in an excellent manner. (There are other people that need credit, too, including former and current Treasury Secretaries Paulson and Geithner.) Bernanke's roll in solving the crisis will figure prominently when the history is finally written. His calm, financial acumen, historical perspective and respect in economic, financial and political circles helped stave off worst case scenarios.

Retail Cap Rates
I just saw this post on Calculated Risk. Cap rates for retail real estate are now above 8%. This figure is expected to rise in the the third quarter of 2009. The Calculated Risk post has a graph of cap rates since 2003. In looking at the graph, it looks like cap rates have jumped nearly 100 bps since late 2007.

Condo Conversion Disaster - Vegas Style
Here is a link to a Calculated Risk post on a condo conversion gone bad in Las Vegas. Here is a quote from the blog that is quoting an article in the Las Vegas Sun:

The property, which had a failed attempt at trying to convert into a condo-hotel because of Clark County regulations, sold for $604 per square foot when it first entered the market. The average price was $539,000, Murphy said.

Through June, the average resale price has fallen to $87,611 or $121 a square foot, Murphy said. With that drop in price has come rising foreclosures. Murphy reports that 201 of the 680 units or 30 percent have been foreclosed upon, and that number is likely to rise. The foreclosures have been running as high as 25 a month so far in 2009, he said.

At the middle of all this is Corus Bank, the condo lending king that will soon be a pauper.

Looking for the Half-Empty Glass
Here is the Bloomberg article on today's employment figures. I can't see anything bad in the numbers, and have not heard any naysayers, either.

DBSI Bankruptcy News
I was sent this link on DBSI. I would not be surprised to see some jail time for some DBSI principals. Here is an interesting couple of paragraphs from the article:

Earlier this year, the Idaho Department of Finance filed a lawsuit accusing DBSI of defrauding investors with a Ponzi scheme. The state also asked the bankruptcy judge to appoint a team of lawyers and forensic accountants to study the company's accounting records.

The judge named Joshua Hochberg to lead that investigation. Hochberg, a former Department of Justice attorney, filed his preliminary report with the court Tuesday. Some of the preliminary conclusions include accounting irregularities, questionable appraisals used to support bond programs, and improper use of loans made to DBSI, according to the report.

The bold and italics are mine. Sponsors issuing debentures are never a good idea, and this information seems to prove that point.

New Favorite Financial Blog
I am lacking on good financial blogs. I heard of this blog, Calculated Risk, last week and find it very informative. It has plenty of good commercial real estate posts along with good economic commentary, plus it's updated several times a day. I will likely quote it and link to it on a frequent basis.

Reading Between the Lines
Dividend Capital Total Realty Trust released an 8-K on Monday stating that it is closing its offering period on September 30th, about four months early. The REIT has too much cash ($540 million) and can't find enough property. Here is the key takeaway:

As of July 31, 2009, we held cash and cash equivalents in excess of $540 million. We believe that this strong cash balance is critical in the current market and positions us well to take advantage of investment opportunities in the future. However, severe market dislocation and current dysfunction in the credit markets has resulted in historically low commercial real estate transaction volume. As a result, opportunities to deploy our capital have not been as quick to emerge. In addition, and in light of market conditions, we have attempted to be prudent in the deployment of capital, which also has resulted in a slower pace of investments. In the meantime, our cash balance has a significant dilutive effect on our goal of funding the payment of quarterly distributions to you entirely from our operations over time.

I added the italics. I read that last sentence as a set-up for a distribution cut in the near future.

Countrywide in The New Yorker
The New Yorker recently had a great article on Countrywide and Angelo Mozilo. Unfortunately I can't link to the article, but it was in the June 29, 2oo9 issue and was written by Connie Bruck of The Predator's Ball fame. I thought the article was fair and I came way with more sympathy and respect for Mozilo (although it is hard to feel too sympathetic for a guy spending his days at his home along the exclusive Lake Sherwood Country Club). I just heard a congresswoman, Michele Bachmann, on CNBC blaming the whole financial crisis on Fannie Mae and Freddie Mac. But this paragraph from The New Yorker stood out when I read the article and I was reminded of it again listening to the congresswoman:

Mozilo and some of his executives believed they were in a new era, in which limits had become obsolete. In 2001, the Federal Reserve began cutting interest rates dramatically, bringing them to their lowest point in forty years, and fuelling a boom cycle, particularly for mortgage lenders. And Countrywide had a ready market for its enormous volume of mortgages in Wall Street, which supplanted Fannie Mae as the country's biggest buyer. "We frankly can't produce enough product for that market to be satisfied," Mozilo commented in April, 2003.

I will readily admit that Fannie and Freddie played a part in the housing boom, heck they were formed to buy mortgages, but it is naive to think the whole blame falls at their feet. The real bad stuff never went to Fannie and Freddie because their standards did not allow it. The toxic junk that started the implosion went to Wall Street-designed mortgage backed securities. When this junk failed, the collapse quickly spread to other mortgage products and exposed the lax lending standards and disregard for risk of the mid-2o00s.

Paulson & Company
I think the revisionist historians are too quick to point a finger at Henry Paulson, the Treasury Secretary last fall when the world's economy almost imploded on itself. It is my opinion that the work of Paulson, Fed Chairman Bernanke, current Treasury Secretary Geithner (who was President of the New York Federal Reserve Bank during the crisis) and others helped save the economy. They made up the rules as they went along due to the dynamic environment that gave little precedent with which to work. Things could have been much, much worse without the financial expertise and Wall Street experience of Paulson. I hate to think what things would have been like today if either of the two previous Treasury Secretarys, John Snow or Paul O'Neill, had been at Treasury last fall. What sparked this post, the announcement of a bi-partisan probe into the financial crisis, will likely yield little new information.

Goldman's Earnings and Real Estate
Goldman Sach's record earnings are all over CNBC and Bloomberg TV this morning. Goldman earned $3.44 billion in the second quarter. This paragraph from the Bloomberg article caught my eye:

Goldman’s earnings included $1.4 billion of writedowns related to commercial real estate, including $700 million of fixed-income writedowns, $500 million lost on equity investments and $170 million of impairment charges, Chief Financial Officer David Viniar said in an interview with Bloomberg.

The large banks are going to be grappling with commercial real estate for the near term. The Commercial Mortgage Backed Security (CMBS) market and how the large volume of loans in these securities are going to be dealt with will dictate the recovery or prolonged slump in commercial real estate.

Irony
Banks are notorious for their endless, unnecessary fees. Now the US taxpayer gets to charge a bank some needless fees. Bank of America is balking at paying the US government $4 billion in fees for the US government's implied backing of $118 billion of BofA assets. Here is the link to the Bloomberg article. I imagine BofA won't have to pay the whole fee, but I think it's funny that a bank is getting the same treatment it dishes out - and does not like it. BofA, welcome to your customer's world.

Signs...
The ten-year Treasury bond is near 3.30%, down from nearly 4.00% in early June, and oil is close to $60 per barrel. Early last week oil was at almost $74 per barrel. I can't help but think that low interest rates and low oil prices are good for the overall economy. I know why, but don't understand the market's short term fixation that higher oil prices show economic strength. This is too smart by half. Higher oil prices hurt the economy and will stop any growth in short order, take it from someone that drives a big SUV. The economy is still not strong enough to withstand high gas prices. Lower interest rates mean lower mortgage rates that help the housing market, which is just starting to show signs of a rebound.

Apartment Vacancy at 22-Year High
Here is a Bloomberg article on apartment vacancies. High unemployment is hurting the apartment market. Some markets like Las Vegas and Southern California are being impacted by the "shadow market" of foreclosed homes that are rentals (this was not in the Bloomberg article, but a similar one in the Wall Street Journal citing the same Reis, Inc. report). The national vacancy is now at 7.5%, up from 6.1% a year ago. Rising vacancies will cause increased incentives and hinder rent increases. As all real estate is local, you should read the article for details on specific markets.

More Oil and Gas
The revelations on the Provident deal have me thinking. I am amazed that a half a billion dollar Ponzi scheme has gone unnoticed by the media, except for some truncated versions of the SEC press release. Bernie Madoff and R. Allen Stanford have hardened the media. In one of the versions I read, linked here, it states that Provident was paying old investors with new investors' money. Not good, and like I said yesterday, the drop in energy prices has exposed the weak operators. Like real estate, tech stocks or any other asset experiencing rising prices, all oil and gas promoters were geniuses when energy prices were increasing. Weak energy prices will continue to separate the good from the bad.

I've read a fair number of oil and gas syndication offering documents and the independent research reports that accompany the deals. There is so much self-dealing, so many affiliated transactions and so many places to inflate fees and expenses, it is hard to truly understand oil and gas deals. The lack of transparency in an oil and gas deal is startling. What is the norm in oil and gas - absurd mark-ups and self-dealing to name just two areas - would never be tolerated from a real estate sponsor. I am convinced that the analysts writing the independent research reports on these deals don't fully understand their intricacies, and in some cases even the workings of the oil and gas industry. I am not sure the attorneys putting the deals together fully understand the deals.

I recently read an analyst report on a royalty program (not Provident) and the report contained nothing on the sponsor's operating track record. The sponsor's previous programs' distributions have fallen off a cliff. Some of this drop can be attributed to the decline in energy prices, but not all. The deals buy existing royalty interests from third parties (and possibly affiliates) that are marked up (and the sponsor keeps all distributions until it assigns the royalty interests to the offering, which was not in the report either). The sponsor could not tell me how many wells have had production stopped due to low energy prices, or even how many had stopped production. There was no mention in the report on the acquisition criteria and pricing for the royalty interests, neither was there information on the age of the targeted acquisitions. Oil and gas wells in the Southwestern United States have steep initial (approximately twenty-four months) decline curves and then relatively stable production there after for many years (fifteen or more). A gas operator that acquired lease interests and drilled wells based on energy prices before they dropped last fall may shut wells and wait for prices to improve once past the initial decline curve, and a royalty interest owner has no say in this decision. I think it is important to know the economic interest and price threshold of the wells' operators. On blind pools, like the offering I am writing about, older programs must be reviewed. The analyst had no understanding of the deal and its dynamics.

Oil and Gas Scam
The SEC is seeking an emergency asset freeze of an oil and gas sponsor in a $485 million fraud and Ponzi scheme. The company is Provident Royalties, LLC. Here is the bulk of the SEC's press release:

Washington, D.C., July 7, 2009 — The Securities and Exchange Commission has obtained an emergency asset freeze in a $485 million offering fraud and Ponzi scheme orchestrated by three Dallas businessmen through a company they owned and controlled, Provident Royalties LLC.

The SEC alleges that from at least June 2006 through January 2009, Provident made a series of fraudulent securities offerings involving oil and gas assets through 21 affiliated entities to more than 7,700 investors throughout the United States. Provident’s entities made some direct retail sales of securities, but primarily solicited retail broker-dealers to enter into placement agreements for each offering, and those retail broker-dealers sold the stock to retail investors nationwide.

According to the SEC’s complaint filed in U.S. District Court for the Northern District of Texas, Provident falsely promised yearly returns of up to 18 percent and misrepresented to investors that 85 percent of the funds raised through the offerings would be used to purchase interests in oil and gas real estate, leases, mineral rights, and interests, exploration and development. In fact, the SEC alleges that less than 50 percent of investor funds were used for their stated purpose, and the proceeds from later offerings were used to pay expenses related to earlier offerings and returns to investors in those offerings.

“Provident sold ostensibly safe securities such as preferred stock to thousands of investors,” said Ken Israel, Director of the SEC’s Salt Lake Regional Office. “But it was actually operating a Ponzi-like shell game in which assets were shuttled from one entity to another and investors were paid ‘returns’ from whatever money was available — usually that of the most recent investors.”

The SEC’s complaint charges Paul R. Melbye, Brendan Coughlin and Henry Harrison for orchestrating the scheme, as well as Provident, broker-dealer Provident Asset Management LLC, and the 21 entities that offered and sold securities. Although each offering was made by a separate entity through a separate private placement, the Commission alleges that the offerings actually involved a single plan of financing.

In addition to the asset freeze, the court has appointed a receiver to preserve and marshal assets for the benefit of investors.

The SEC’s complaint charges the defendants with violations of the antifraud provisions of the federal securities laws. The complaint seeks a temporary restraining order and preliminary and permanent injunctions, disgorgement of ill-gotten gains plus prejudgment interest and financial penalties. Officer and director bars are sought against Melbye, Harrison and Coughlin. Five affiliated entities that did not sell securities are named as relief defendants for purposes of disgorgement.

This does not look good. I heard that Provident barely made any distributions and that all funds had stopped distributions earlier this year. It should be interesting how this plays out. Today, natural gas is back under $3.40 per MCF. The low price of gas is wreaking havoc among gas sponsors. It reminds of that saying, which I will paraphrase: when the tide goes out we see who is not wearing a bathing suit. With the price of gas so low compared to the last few years, we are seeing what oil and gas deals were poorly structured, and in the case of Provident, apparently, who're the crooks.

Vornado Raising Capital to Buy Properties
Vornado, the publicly traded REIT, is raising up to $1 billion in a private equity fund that will seek to buy office properties in New York and Washington, DC. Vornado has committed 20% to the new fund. Here is the brief piece from the Wall Street Journal describing the new venture. This is a good idea and it may get real estate markets moving. I wonder if it will be able to acquire the assets at "distressed" prices. Vornado's stock is 60% lower than it was in October 2008, kind of making it a distressed security.

Oil and Stocks
Markets are confusing and the recent positive correlation between stock and oil prices show to me that no one will ever fully understand the mind of the market. The market has come to believe that rising oil prices are a positive sign for stocks. I do not get this thinking. The economic rebound is just beginning and higher gasoline prices could snuff out growth.

Update: The oil/stock correlation broke today. Oil dropped 4% while stocks rose half a percentage point. Don't look now, but natural gas is below $3.50 per mcf again.

Post Slacking and a Minor Medical Rant
The posts have been light. I have been working on a long post on health care reform, but am not sure I know enough about the various reform platforms to make an intelligent comment. I do feel that there are many factors impacting the price of health care. The problems facing health care include doctors and their secret, byzantine billing methods and holier-than-thou attitudes, insurance companies that perpetuate and abet the doctors, drug companies with their high prices and pills that cure or relieve any ailment (along with abetting doctors), and a nation of hypochondriacs. ("Help, I have a pimple on my ass and need an assendectomy, eighteen months of disability and a handicap parking sticker.") All four parties need each other in the current health care environment and changing this dynamic will be hard.

I am by nature against a national health care plan. (My dealings, however, with Medicare have been positive. It is a system that works and acts as a good safety net to most seniors.) I would like the "free market" approach to work. But try calling a doctor's office to get a price estimate before an appointment. You won't get one. It is disingenuous that a doctor's office does not know the cost of services. Doctors should provide an estimate, like an auto mechanic, and if more services are provided than the price increases. But people like their regular doctors and may not price shop before every office visit (imagine the nightmare of dragging medical records to each doctor). Insurance companies are actuarial experts and this expertise drives many medical decisions. Drug companies are big businesses, not altruistic enterprises, and they need to develop new drugs and new uses for existing drugs to survive (and deserve the opportunity to make a profit and have patent protections). All sides are going to have to play give-and-take to get any meaningful reform. Good luck.

I heard what I'd call a right-wing economist speak last week. He, of course, was against a national health care plan. But rather than have any serious comments or ideas on health care reform, he resorted to fear-mongering by saying that health care would be rationed. His example: if you're over 70 you won't get any major procedure, period; and if you are younger and need a knee replacement, for example, you will have to wait years. National health care is good unless you get sick (this is what is said about Kaiser!). This rationing notion is baloney and he knows it. I think everyone agrees that there are problems with health care. Democrats have the votes to get a national plan. Republicans need to step-up and push for real market reforms and not rely on scaring people with false information.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

TALF and CMBS
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.

More On MGM Mirage
Here is an updated MGM Mirage article from Bloomberg. MGM Mirage's stock has shot up since the CityCenter financing was announced. The stock (MGM) was trading around $8.50 this morning.

CityCenter Saved
MGM Mirage and Dubai World have reached an agreement with their lenders to continue to fund the construction of the massive CityCenter development in the heart of the Las Vegas Strip. A CityCenter implosion would have devastated the Las Vegas economy. If this transaction is a harbinger for real estate finance it is good for all of real estate. On the other hand, it could also be a case of "too big to fail."

This Should be Good
I heard about accounting issues at Grubb related to NNN's TIC business last week, and now here it is in today's Wall Street Journal's Plots and Ploys column. There is the entire section:

Will Grubb Report?

Two big, commercial real-estate brokerage firms report earnings this week. Will a third?

Grubb & Ellis Co., saddled by a 2007 merger with asset manager NNN Realty Advisors, has delayed its earnings filings twice in recent months. Investors will find out by Thursday if a third delay is coming. (Jones Lang LaSalle Inc. and CB Richard Ellis Group Inc. report their results this week.)

The cause for the reporting delays are accounting errors related to how NNN booked revenues related to its or tenant-in-common, or TIC, products before the merger. (Emphasis mine.)

This will be another interesting 10-K to read.

Zune 2.0
Microsoft announces a new phone to compete with the iPhone.

Total Realty Trust
I am reading Dividend Capital Total Realty Trust, Inc.'s 2008 10-K. It is another dreary read. I've more to read, but its real estate securities are in trouble. In 2008 Total Realty Trust wrote down $192.7 million of its real estate securities (which Total Realty Trust classified as "other-than-temporary impairment charge" on the financial statements). The original face value of the securities was $246.50 million, meaning that 78% of the REIT's original investment was eliminated last year. Looked at another way this is approximately 12% of the amount that Total Realty Trust has outstanding in investor share capital (159 million shares at $10 per share, or $1.6 billion in outstanding investor capital (I made no adjustment made for any dividend reinvestment shares that would be priced somewhat lower than $10 and would raise the percentage that has been lost)). The real estate securities included CMBS and CRE-CDO (commercial real estate collateralized debt obligations). Total Realty Trust has another $106 million of real estate loans that includes mezzanine loans and B-notes (not sure what this means) that did not have any impairment charge in 2008.

Despite the write-off, Total Realty Trust is still selling shares to new investors at $10 per share. This is not unique to Total Realty Trust. Other non-traded REITs are selling shares at $10 per unit and have assets that have declined in value (pretty much any real estate asset bought before 2008). I have calculated some potential Net Asset Values for the Total Realty Trust. I am not sure whether I am am going to post them, but even using a low cap rate, the NAVs I calculated are much less than $10 per share.

Trivia - Bank Failures
What state has had the most bank failures since the credit crisis started in the summer of 2007? My first thought was that the states hit hardest by the housing downturn - California, Florida, or Nevada - would have the most failures. I did not guess the winner - Georgia. Eleven banks have failed in Georgia since the summer of 2007. Since the crisis started there have been fifty-three bank failures and California has had eight, Florida four and Nevada five. Not sure why Georgia has had so many failures.

Natural Gas
I just saw that natural gas prices are at $3.32, their lowest since September 2002. Natural gas has fallen 40% so far this year on increasing supplies and falling demand.

Wolf in Sheep's Clothing?
I am reading the Behringer Harvard Multifamily REIT I 10-K, and it is an interesting read, to say the least. Before I get too far into this post, here is an excerpt from the Behringer Harvard website on the REIT's objectives:

Behringer Harvard Multifamily REIT I, Inc. is a real estate investment trust created to primarily acquire a portfolio of high-quality multifamily communities, including conventional multifamily assets, such as mid-rise, high-rise, and garden-style properties; age-restricted residences (typically requiring tenants to be 55 or older); and student housing.

Behringer Harvard Multifamily REIT I, Inc. is for investors seeking:

• Capital preservation
• Capital appreciation
• Current cash distributions
• Attractive total returns
• Portfolio diversification
• A mid-term holding period

• REIT Strategies–The REIT will focus on acquiring a blended portfolio consisting of core, stabilized, income-generating assets; assets for repositioning, renovation, or redevelopment to core status; and development assets for stabilization to core asset status. Development investments may include making an equity investment in the project or making a mezzanine construction loan with a right to acquire equity in the project.

Reading the above information you'd think that the REIT would acquire quality apartment complexes that generate enough cash flow to allow the REIT to pay distributions to investors. But the last sentence needs to be read carefully because it appears to be the key sentence: Development investments may include making an equity investment in the project or making a mezzanine construction loan with a right to acquire equity in the project.

Multifamily has made ten apartment investments and nine are developments. Here is how the 10-K describes the investments:

We have made ten separate investments in multifamily BHMP CO-JVs. Nine of the properites are in development projects and one is an operating property. As of December 31, 2008, the BHMP CO-JVs have made ten mezzanine loans related to the development projects and seven equity investments in Property Entities, with equity purchase options for all Property Entities.

That is a lot of development, and a lot of projects that are not generating rental income. The properties are in Texas, Virginia, Colorado, Maryland, Nevada and Florida. The mezzanine loans look like they have options to convert to an equity position in the project entities. The mezzanine loans look like they are at interest rates of 9.5% to 10%, with maturities before the end of 2012. (These seem like low interest rates. A mezzanine loan could generate interest income of 10% to 20% or more, and involve points of an additional 2% to 4%. Maybe the REIT took a lower interest rate due to its equity option.)

All the REIT's investments appear to be with an affiliated entities. One development is in Florida and two are around Las Vegas.

This is a complex deal. The affiliated transactions, European money partner and third party developers add to its complexity. It is going to take me several posts to wade through it all, but I wanted to get the analysis started.

A couple of final points. I am not sure where the cash flow is coming from and whether all the mezzanine debt is paying current income (v. deferred interest). I would not be surprised if some of the loans reserve interest payments for a certain period. The REIT is developing properties in a tough environment, especially in markets like South Florida and Las Vegas. There are legacy issues, too, as most of the REIT's projects were started (and budgeted) before 2008. This is an area for investigation as the values may have changed.

The REIT is not coming close to covering its dividend. It was 6.5% and only covered 58% by FFO according to the 10-k, but for some reason the dividend was raised to 7.0%.

More posts will be coming over the next few days.

A Chapter 11 Kinda Day
General Growth Properties filed for Chapter 11 due to the weight of $27 billion of debt. It is the largest property bankruptcy ever. General Growth has been struggling for nearly a year to refinance its debt. It is the second largest mall owner in the US with over 200 properties in 44 states. A fire sale of General Growth's mall assets is not expected.

MGM Mirage's fate took another twist today as Carl Ichan and Oaktree Capital Management, owners of hundreds of millions dollars of MGM Mirage debt, have told MGM Mirage that it should file for bankruptcy. Here is an updated article with more detail than the first link. According to the article, Kirk Kerkorian, 53% owner of MGM Mirage valued at $900 million, would have his equity wiped out in any bankruptcy filing. Kerkorian's stake in MGM Mirage was valued at $14.9 million at the end of 2007. The battle is still forming and the objectives of Ichan and Oaktree, who are not working together, are not clear. There is more at stake here than the huge egos of Kerkorian and Ichan. The $8.6 billion City Center development, which is the root of MGM Mirage's financial problems, is important to Las Vegas and other casinos. It is a huge project along the Strip. If this project were to go dark, Las Vegas' recession will get worse and last longer.

MGM Mirage
MGM Mirage's City Center looks like its original partner is throwing it a life line. Here is an article from the Wall Street Journal. Let's see if the two can work out a deal. It is me or does the picture of Kirk Kerkorian make him look like a Seuss character, maybe The Grinch or the guy from Green Eggs and Ham. "Say, I like green money from Dubai, I really, really like green money from Dubai."

The Near Future
I went back to re-read and post about this article. I saw that the article is dated April, 1, and almost thought it was an April Fools story. But it is not. The story is amazing, and I can't get it out of my head. A partnership between two outfits called Normandy Real Estate Partners and Five Mile Capital Partners acquired the John Hancock Tower in Boston for $20 million. The partnership acquired the senior portion of $700 million in mezzanine debt for $20 million and and agreed to take over the exisitng first mortgage of $640.5 million.

The property was acquired in 2006 by private equity firm Broadway Partners for $1.3 billion. (Why is it called private "equity" when Broadway used $640.5 million of a first mortgage and $700 million of mezzanine debt and no apparent equity.) When Broadway could not make the mezzanine payments, Normandy and Five Mile foreclosed and were handed the keys while assuming the exisitng first mortgage. So, the way I read this article, Normandy and Five Mile acquired a building that sold for $1.3 billion two years ago for $20 million. I want to be a buyer of mezzanine debt. (If figure that if the Hancock Tower has lost 30% of its 2006 value, Normandy and Five Mile still have $250 million in net equity in the property, acquired for $20 million.)