Ex-CNL Hotel Portfolio Update
Here is a good article from Bloomberg on attempts to restructure $1.5 billion of debt on the old CNL Hotel REIT portfolio, which was bought by Morgan Stanley in early 2007, and which CNL has no current association.  The $1.5 billion of debt is due on February 1 (Tuesday).  One billion dollars of the debt is associated with just five trophy properties, and some of the trophy properties in the portfolio include:

The properties are the Grand Wailea Resort Hotel and Spa in Hawaii; the La Quinta Resort and Club and adjacent PGA West golf course in La Quinta, California; the JW Marriott Desert Ridge Resort and Arizona Biltmore Resort and Spa, both in Phoenix; the Doral Golf Resort and Spa in Miami; the JW Marriott Grande Lakes and Ritz-Carlton Grande Lakes, both in Orlando, Florida; and the Claremont Resort & Spa in Berkeley, California.

At one point, the original CNL REIT owned the famous Hotel Del Coronado, located near downtown San Diego. 

This quote could have been said about any property in any property class that was underwritten in 2005 to 2007:

The Doral, Claremont, Grand Wailea, Arizona Biltmore and La Quinta resorts have all suffered from a decline in revenue per available room and low debt service coverage ratio, according to Bloomberg data from last month. 

“Based on operating figures for the first six months of 2010, none of the properties is performing above original underwriting,” Realpoint LLC, a Horsham, Pennsylvania-based credit-rating company, said in a January report about the five properties. 

I'll try to follow what happens to the debt negotiations later this week.

Total Realty Trust - A Rush to the Exits?
I just saw this 8-K, which was filed late last month.  In the fourth quarter, Dividend Capital's Total Realty Trust only met 7% of redemption requests.  The non-traded REIT filled the requests on a pro rata basis.  Another way to look at this is that 93% of redemption requests were not met.  I wonder if part of the redemption requests was due to Total Realty Trust having to disclose a net asset value (NAV) in early 2011.  Investors are probably suspecting that the NAV will be less than the redemption price, and are trying to get out before the redemption price is reset to the new NAV.

Houston Apartments
Back during the tenant in common boom of 2005 to 2007, it seemed like every other TIC deal was a Houston apartment complex.   I'm sure that most of the debt on these TIC transactions ended up in CMBS.  TIC sponsors, apparently, weren't the only people who thought Houston apartments were strong investments, as there is $777 million of seriously impaired loans (see article below) in Houston.  Here is a National Real Estate Investor article on the "sky-high" delinquency rate of loans tied to Houston apartments.   Houston's apartment loan delinquency rate is 21.5%,  higher than the national average of 16.5%.  Here is a strong takeaway from the article:

Of the $777 million in seriously impaired loans in the Houston apartment market today, lenders originated 71% of that volume during the notoriously lax underwriting period of 2005 through 2007, reports Trepp. That’s when the economy was booming and commercial real estate was riding high.


Local broker Jeffrey Fript, a senior associate in the National Multi Housing Group of Marcus & Millichap, says Houston’s high CMBS apartment loan delinquency rate doesn’t surprise him. After all, Houston is the fourth largest city in America based on population. 

Houston also was one of the most active markets for CMBS loan originations from 2005 to 2007, says Fript. “It’s a big market, and a lot of people refinanced with CMBS. Along with that comes a high delinquency rate.”

I will never cease to be amazed at the lemming nature of sponsors and investors.   They must think that if everyone is doing it, it must be OK.   It is so much easier to follow the easy money flow than to seek out other investment alternatives.  This follow-the-herd mentality is a problem with sponsors and investors.  Sponsors want an easy sale and investors want to invest where it is popular.  Throughout history this type of thinking (or not thinking) has been the source of bubbles, ponzi and pyramid schemes, and now "seriously impaired loans" sitting in troubled CMBS.

CMBS Debt Values Soar
Bloomberg has an article on commercial real estate debt this morning.  CMBS prices are increasing as investors are betting the worst in commercial real estate is over. Here are a couple of points I noticed:

Investors are buying bonds tied to hotel, shopping center and skyscraper loans as more financing becomes available to borrowers, helping halt a slide in real-estate values. U.S. commercial property prices, which have declined 42 percent from their peak in 2007, rose for the third consecutive month in November, Moody’s Investors Service said in a statement yesterday.


So-called junior AAA commercial-mortgage backed securities, which are less insulated from losses than senior and mezzanine AAA classes, have increased almost 21 percent to 87 cents on the dollar during the past three months, according to data compiled by JPMorgan Chase & Co. The bonds, valued at about 51 cents six months ago, are at the highest levels since June 2008, JPMorgan data show.

Enthusiasm for real estate debt is generating new debt issuance:

Sales of commercial-mortgage backed securities are poised to climb to $45 billion this year, according to JPMorgan, after banks arranged $11.5 billion of the debt in 2010. Rising sales make it easier for property owners with maturing loans to refinance. Issuance plunged to $3.4 billion in 2009 compared with a record $234 billion in 2007, according to data compiled by Bloomberg.

Real estate has always been finance driven.  When money is available, deals got done.   It is hard to know exactly how much the lack of financing comprised of the 42% drop in real estate prices over the past three years.  In 2006 and 2007, there was $203 billion and $234 billion respectively, of CMBS debt issuance, which led to a frenzy of commercial real estate deals, like the huge Equity Office Properties buyout in early 2007.  When the debt crisis started, the flow of easy debt stopped.  In 2008 and 2009, CMBS issuance dropped to $12 billion and $3 billion, respectively, or just 5% and 1% of the amount issued in 2007.  I would argue that the lack of financing played a larger roll in the price drop of commercial real estate than the recession.  This finance influence can be seen in the market for Class A commercial office properties and multifamily properties, where reasonable debt is available and the demand is strong and cap rates are low.  Lower quality properites are not afforded the same type of debt, and therefore cap rates are higher and demand is not strong, which has lead to a bifurcated market.  

The estimate of $45 billion in CMBS issuance for 2011 is good news.  While it's only about 20% of the 2007 level, it's a big improvement from the paltry levels of 2008 and 2009.  More debt will help the overall commercial real estate market and the existing CMBS market.

More Commercial RE Price Data
Moody's reported that its Moody's / REAL All Property Type Aggregate Index increased .6% in November (link from Calculated Risk).  This is on the heels of last week's CoStar report that showed a decline in November's commercial real estate prices.  There does not seem to be enough data to signal a definitive price move, either up or down, in the commercial market, although it seems clear to me that the downward spiral has stopped.  Calculated Risk's graph of prices since 2000 seems to confirm this:

(The link at the start of this post will take to you the Calculated Risk site, where you can enlarge the graph.)

Moody's reports that commercial real estate prices are off 42% from their 2007 peak.  That's the staggering point, and the graph provides visual emphasis.

Thoughts on IMH 
I get the sense that the Wall Street Journal is looking for scandal in real estate securities. A few weeks ago it picked on Grubb & Ellis, trying weakly to link it to other known problem sponsors, and today it targeted IMH.  The WSJ needs to look a little harder (heck, contact me and I'll point you in the right direction).  I have been writing about IMH for several years and re-read my previous posts this evening.  The WSJ article mocked IMH's moto of "Rule 1: Don't lose money.  Rule 2:  Don't lose money.  Rule 3:  Don't forget Rule 1 and Rule 2."  I noted this silly moto, too, nearly two years ago.

I missed that the SEC was investigating IMH related to transactions and relationships with the broker / dealers that sold the units in the IMH Secured Loan Fund.  I have no idea of what will come of the investigation, but I always thought, from a fee standpoint, IMH was not egregious.  If I remember correctly, IMH Secured Loan Fund's initial costs were much lower than non-traded REITs, and the points paid to IMH were paid by borrowers not the Secured Loan Fund (which, if you look at enough deals, you'll find this not common).   The consolidation of IMH Secured Loan Fund and the IMH management company made sense, because without it investors would have likely lost everything, and of course there is still a chance all could be lost.  The amount paid to IMH as part of the consolidation was $14 million in restricted stock, which is now the subject of a class lawsuit.   If IMH is not successful in working out its SEC issues and is unable to list its shares, get additional capital, and figure how to grow the business, the $14 million won't be realized.  As it now stands, investors have at least a chance of getting some return of their original investment.

My issue with IMH was its refusal, at least in its filings, to fully address the underlying problems in its portfolio.  Everything seemed rosy until it wasn't.  Even today, I would question the value of IMH's remaining assets.

The WSJ article focuses on the unfortunate investment losses of small investors.  Many investors put their money thinking it was a safe, income investment.  But to IMH's defense, it never obscured or hid its business plan, and the business plan had substantial risk.  IMH Secured Income Fund made pre-development loans to developers.  Developers went to IHM for pre-development loans because they couldn't yet qualify for development and construction loans from traditional lenders.   Put another way, the loans IMH Secured Income Fund were making were considered too risky for banks.  This is not saying the loans weren't sound and not made in good faith, just that banks did not make this kind of loan.

The loans were made to developers in many of the "hot" residential real estate markets, like Arizona and Nevada that have imploded on themselves.  Like the WSJ article noted, many of the loans were made on land parcels without any zoning or entitlements (one reason why banks don't make these loans).  No matter the market environment, pre-development loans carry high-risk, even with the collateral.  Throw in the worst housing crisis since the depression and the risk is compounded exponentially.  I am not saying the strategy was flawed, but that it carried significant risk.

IMH Secured Loan Fund paid high distributions, typically north of 10%, and repurchased shares from investors that requested liquidity.  The high yield was what attracted investors.   Investors need to question their brokers, especially on opportunities that offer out-sized returns, like the IHM Secured Loan Fund.  High returns NEVER come without high risk, and risk is a two-way street, both up and down.  This may sound snarky, but if someone figured out how to give high returns with low risk, Wall Street and institutional investors would have moved in and small investors would have been excluded.

The WSJ article was not as bad as its title implied.  It probably could have been worse for IMH.  The story of IMH is not over.  I will be paying attention to the SEC investigation and any potential outcome.  Then IMH needs to tap the capital markets, which will be the real challenge.  This will also be the real test of IMH's valuation assumptions.  The market is unforgiving and if the IMH's asset values are overstated it will be apparent quickly.  I am not sure of positive alternatives to IMH if an IPO is not marketable. 

IMH Smackdown
There is an article on IMH in today's Wall Street Journal.  Here is the link, sorry a subscription is required to view the full article.  I will have more comments on the article and IHM soon.

Trifurcation
I read the term trifurcation in this post on Calculated Risk, which was referencing CoStar's commercial repeat sales index, which dropped in November, erasing a portion of the gains seen the previous three months.  I had not heard this term before.  The commercial real estate market is strong for trophy properties in major markets, weak for smaller assets, especially those in secondary and tertiary markets, and then there are the distressed properties that are coming onto the market.  The post stats that there have been few commercial transactions, and the prices have been volatile.  It is difficult to make sense of any month-to-month change in commercial real estate prices.  I do think it important note that commercial real estate prices are up over 7% since their low earlier this year.

Better Late Than Never
Oil and gas sponsor NGAS Resources, Inc (NGAS) was acquired at the end of December by Magnum Hunter.  The transaction was valued at approximately $98 million.  I am not sure whether the new entity will offer oil and gas tax write-off deals.  Without doing any investigation, this sounds like potential good news for investors in NGAS's current investment programs.

Something to Think About
The last post noted that the former CNL hospitality portfolio traded at a 52% discount from its early 2007 sale price.  (I have no information about whether any of the properites have been sold since early 2007.)  For those of us that have short-term memory problems, early 2007 was the height of the real estate frenzy with trades happening at historical prices.  Here is my early 2007 post noting the transaction. 

Investors in the CNL hospitality REIT received a return of their original investment, plus about 2.5% premium.  This minuscule premium occurred at the peak of one of the great real estate bull markets.  This begs a larger question. If a large non-traded REIT only generated such small capital appreciation at top of a real estate cycle, what does it say about the chances of other non-traded REITs being offered and exisitng today of selling their portfolios at a premium?  It is unlikely that they'll get the benefit afforded to CNL hospitality by selling at the height of a pricing cycle. 

Old CNL Deal Makes News
The hotel / lodging real estate sector seems attractive to me, and presents some significant opportunities. Hedge fund Paulson & Co., seized control of the former non-traded REIT, CNL Hotels & Resorts, Inc.  This deal originally went full cycle in 2007, allowing investors to cash out near their original investment amount.  According to the Bloomberg article, Paulson restructured $600 million of debt, extinguishing $200 million and converting about $400 million to equity.  This is interesting:

Morgan Stanley bought CNL Hotels for about $6.7 billion, adding eight luxury U.S. resorts, including the Grand Wailea Resort Hotel & Spa in Maui; La Quinta Resort & Club and PGA West in La Quinta, California; and the Arizona Biltmore Resort & Spa in Phoenix.

The financing for the acquisition included $1.5 billion of senior debt, $1 billion of mezzanine debt and the $800 million of corporate debt, of which $200 million was previously converted to equity.

It looks like Paulson paid $3.2 billion for the former CNL hotel portfolio.  This is less than half (about a 52% discount) of what Morgan Stanley paid for the CNL assets in 2007.  I wonder whether how much of the original portfolio is intact.  This kind of deal is why the hotel sector is so exciting.

Office Improvement
Here is a Bloomberg article on a Reis Inc. report that states that US office space in the fourth quarter had its first gain since 2007.  Landlords added 2.5 million square feet of leased space.  There is plenty of information in the article.  The vacancy rate remained 17.6%, its highest level since 1993.  Asking rents in the fourth quarter were lower than a year ago, but are higher than in the third quarter.  Effective rents were also higher in the fourth quarter than in the third quarter.  Calculated Risk also discusses the Reis report and has a cool graph showing historical office vacancies.

Kicking The Can
I read this article from the Financial Times on commercial real estate over the weekend.  It confirmed what I believe is happening with many maturing commercial real estate mortgages, lenders are just extending mortgages rather than reworking them.  I think the scale of loan maturities, the likely inability of borrowers to obtain new financing, and the unwillingness for banks and CMBS servicers to realize losses play into the "extend and pretend" mentality.  This quote did not surprise me but is still eye-catching:

To understand this, look at some numbers compiled by the Institute of International Finance, the Washington-based banking lobby group. The IIF calculates that in March 2008, there was about $25bn worth of pre-crisis investment grade commercial real estate in distress. By March this year, however, that number had exploded to $375bn (and has probably swelled since). 

Thus far, the banks have “dealt with potential delinquency problems in part by extending loans until 2011-13”, the IIF notes. Or, in layman’s terms, they have swept it under the carpet. But while this avoided defaults, the IIF reckons that about $1,400bn of CRE loans must be refinanced before 2014. Alarmingly, “nearly half of these are at present ‘underwater’, ie have mortgages in excess of the current value of the property”, it adds.

It's sobering to think that half of the $1.4 trillion in commercial real estate loans due before 2014 are underwater.   Reworking debt - not extending it -  will be the overriding theme driving commercial real estate for the next three to four years.  Lenders are going to have to start getting proactive on their loan portfolios, and stop waiting until borrowers default to begin discussions.