As an increasing number of commercial property owners face upcoming debt maturities, more of them have started to use threats of strategic default as a bargaining tool in negotiations with lenders.

Knowing how reluctant lenders are to take back assets, borrowers of every kind, from big publicly traded REITs to private players with only a handful of centers, have tried this gambit, industry insiders say. Whether or not the strategy works depends in large part on the type of lender and the condition of the property.

 Here is a great article to read from Retail Property Magazine, that fills you in on all the detail …

Here is a story that, unfortunately, keeps repeating itself time and time again. It’s also a story that speaks volumes about where the commercial real estate market truly is today and the challenges that developers and bankers face. 

The only three  questions that remain are: (1) How low will prices go down?; (2)When will the tide turn?; and (3) Most importantly, what are developers and bankers to do?

CASE STUDY: The Enclave in Silver Spring, MD just  saw a first time appraisal reduction in July 2010 that dropped the estimated value of the property to $114 million.

This follows a $150 million loan on the appraised value of the property of $284 million in February 2007. That’s a 60% reduction in value, and that’s on top of an impressive $65 million renovation of the 1,119-unit apartment complex, completed in October 2008.

THE MARKET: There were a total of 241 first time appraisal reductions in July 2010, including 23 loans that had a balance greater than $30 million.

UNDERWATER: The Enclave, with a balance of $150 million, saw its appraisal drop $36 million below the money owed on its outstanding loan. Coincidentally, $150 million is the same amount Stellar Management paid for the property in 2003.  

What’s old is new again. Just posted to www.ZeroHedge.com, is a fairly comprehensive and enlightening recap of the recent International Monetary Fund (IMF) report which documents their stress testing of 53 large banking holding companies and published its findings last month.

This report and analysis is not only objective, but it’s consistent with many postings on this Blog. All of these assessments although negative, on their face, they are critical so that you can maneuver your real estate ventures in the days to come.

Read these reports from the right perspective and there are opportunities that abound. It is just a matter of where the opportunities are and when is best to strike.

The report concluded that despite restoration of some stability, there remain certain important risks to the U.S. financial system and economy mainly coming from the real estate sectors:

• Further increases in nonperforming loansdue to high unemployment rate and significant weakness in the real estate sectors
• Credit quality in the commercial real estate (CRE) sector - About $1.4 trillion of CRE loans will mature in 2010–14, nearly half of which are 90 days or more past due or “underwater.”  
• Housing prices- The very high level of underwater mortgages increases the risk of strategic defaults and further losses to banks and mortgage backed security (MBS) investors.

Market perception of sovereign risk, sluggish growth, and mounting fiscal deficitsand debt are also identified as major risks to the economy and the financial system.

IMF noted financial institutions will face rollover riskswith large loan maturities in 2011–13, which could bring rapidly rising foreclosures and bank losses. The small and medium-sized banks, which are most heavily exposed to the commercial real estate sector, are causing the most concern.
Since bank balance sheets remain fragile and under-capitalized (Figure 1), under an “adverse scenario”, small and regional banks as well as subsidiaries of foreign banks would incur $1.113 trillion of cumulative loan losses from 2010 to 2015 and need as much as $76.3 billion(i.e. a TARP 2.0), additional capital to meet a tier one ratio of 6% .

Under the “baseline scenario”, cumulative loan losses would have been $860.9 billion, and need $40.5 billion additional capital. (See table)

IMF also noted the securitization market could become a drag on the economic recovery:  

“Almost all of the recent issuance of U.S. private label MBSs has comprised re-securitizations of formerly “AAA” senior securities (so-called “re-remics”), with the Fed’s TALF responsible for much of the 2009 issuance of other asset backed securities (ABSs).”

And to make things even more depressing, IMF warned that

“The economy and some key financial markets continue to depend heavily on fiscal, monetary, and financial policy support, and the output gapis expected to remain wide for many years.”

Other research reports also paint an equally gloomy picture. According to an analysis by Realpoint, reported by HousingWire, delinquencies in commercial mortgage -backed securities (CMBS) in the US increased to 7.2%, and more than triple the rate a year ago. In May, the total delinquent unpaid balance for these loans reached $57.3 billion.
Realpoint forecasts by the end of 2010, the total amount of unpaid principal balance could grow between $80 billion and $90 billion, and the delinquency rate could reach as high as 12%. Earlier in the year, Trepp reported that these spiking delinquencies could cause bank failuresto increase as much as 30% in 2010 (You think we don’t have enough problem banks bankrupting FDIC already? see Figure 3)

While the $40-80 billion capitalization numbers probably will not take the entire U.S. economy into a double-diprecession, they will likely put a significant drag on GDP and earnings in the financial sector, as well as the broader equity market for the next two to six quarters.

With the easy year-over-year earnings beat coming to an end, the best of the earnings may have already come to pass. As such, now would be a good time to take some profit off the table for another day, another entry point.

(Note: The full IMF report is available here.)

Everyone in the real estate development industry are trying to read the tea-leaves. Will there be disaster or can the unthinkable be avoided?

With more commercial mortgage-backed securities (CMBS) loans on the verge of default this Fall 2010, Special Servicers are being forced to accelerate these loans through the Real Estate Owned (REO) process to avoid building a shadow inventory similar to the one in residential. Here are the facts that we all have to contend with:

• Eight (8)  — 5 year, interest-only loans in CMBS portfolios that hold balances greater than $20m  — are likely to default once they mature in August 2010.

• The loans are proving difficult to refinance in the current market environment due to a lack of liquidity, and it’s raising the likelihood of a special servicing transfer for a modification or extension, according to Fitch.

• In August 2010, Fitch expects 115 loans worth $1.3bn in balances to fall into special servicing and more to come through the rest of 2010

• Peaking defaults are expected in October 2010 at 181 loans at $2.1bn

• The total loans expected to fall into special servicing is anticipated to hit more than 772 loans worth $7.8bn.

Analysts at Deutsche Bank found that the number of new transfers into special servicing will continue to outpace commercial loan workouts. But once properties are ready for liquidation, valuations on commercial real estate are missing the mark. More recent appraisals are needed on these properties to narrow the gap between liquidation expenses and proceeds.The analysts projected an 18% delinquency rate on CMBS. Since the beginning of 2010, the balance of loans at least 90-days delinquent has increased every single month.Some experts believe that the implications for special servicers are potentially dire: if they wait too long to foreclose or restructure loans, the number of loans in their portfolios will continue to build, so even when they finally resolve an asset it might not even make a dent.

As just reported by the WSJ, there exists a little known legislative “fix” in the “mix” that just may shore up the troubled commercial real estate industry.

According to sources in the know on Capital Hill , there is legitimate momentum in both chambers of Congress, with the House version actually having a shot at getting a vote as soon as this Fall, September 2010.

The Problem(S):

• As we all know by now, the deep recession has sent delinquencies on commercial real estate loans soaring as high vacancies have dried up property owners’ revenue. In fact, commercial real estate prices have plummeted by 40% in some markets from the highs seen in 2007.

• As we have reported in this Blog on many occasions, trillions of dollars of commercial real estate debt are coming due over the next few years amid a crash in property values that is making it difficult for owners to sell or refinance. This phenomena, better known as Extend and Pretend, is a temporary solution, but one that would rather be eliminated if a better, more secure solution could be crafted.

• Large banks  – such as Wells Fargo, J.P. Morgan and Bank of America —  that aggregate commercial real estate loans into bonds have been unwilling to hold smaller loans, even for a short while, before packaging them for investors. The federal guarantee would spur them to purchase such loans, injecting liquidity into the market.

• Community banks – who are largely at risk due to significant commercial real estate loans in their portfolios – could use the proceeds to make new loans, helping to buoy prices.

The Proposed plan:

• The yet-to-be  introduced legislation would authorize a temporary plan that would trigger the U.S. Treasury to provide as much as $15 billion to $25 billion in guarantees on new loans to the sector.

• Under the measure, Treasury would guarantee bonds backed by small-balance loans financing strip malls, office parks and other commercial properties.

• In exchange, Treasury would collect fees in the amount of 2% of each underlying loan in the bond.

• To qualify for the federal backing, it is proposed that the bond would have to carry an investment-grade rating and each underlying loan in the security would have to be for $10 million or less. The program would phase out after three years.

the Opposition: The plan is likely to face resistance from lawmakers trying to rein in spending. How legititimate is the risk and possible failure of all the banks and the overall impact to the economy is Commercial Real Estate should faulter? Is this legislative initiative worth it? What are your thoughts?

We look at Architect Billings as a sign of where the economy is going; a true leading economic indicator.  Here is a potential green-shoot to take note of. Frankly, given the weakness of the economy, any positive news is worth reporting.

The News: The regions architecture community is busier than it was at this time last year but still faces an uncertain future, according to the American Institute of Architects.

Reading The Tea Leaves: The index reflects a lag time of between nine and 12 months from when construction will start on the projects being designed by architects, meaning the regions construction industry could also be in for a slow year. So this is quick way to look ahead to see what the future holds for the rest of us.

The Numbers: The index for billings for architects in the institutes South region, which includes Maryland:

• AIA billings increased in MD. from 45.9 in May 2010 to 46.7 in June 2010.
• Both figures are up from June 2009, when billings stood at a lowly 40.5.

The national billings index for June 2010 was:

• 46, up from 45.8 last month and from 37.7 in June 2009.
• The AIAs project inquiries index increased to 57.7 in June 2010, from 55.5 in May 2010 and from 53.8 in June 2009.

Finally, some good news. Commercial real estate markets across the U.S. continued on their trend of improvement in the second quarter 2010, according to Moody’s. The news is more than welcome, in that some upward pricing movement is always a good sign for the market, if not for the industries psyche. But the long-standing problems are hardly resolved.

Clearly supply is quite limited, given the quagmire that banks and other investors face. However, if pricing rises, this could help those who are seeking and qualify for refinance deals to get better property values in the days to come.

More Limited Supply: The supply pipeline of new properties continued to shrink across all sectors, with improvement in the balance between supply and demand in six of the seven sectors that make up the market, Moody’s says in its latest Red-Yellow-Green® study.

• Office: While vacancy rates continue to rise due to the poor absorption experienced in 2009, demand going forward is on the upswing and the pace of growth in vacancy rates should begin to flatten and possibly contract in the coming quarters. All the sectors but one showed better market conditions and had higher Red-Yellow-Green® scores than they did in the previous quarter. A greater share of markets—46%–are now in yellow territory than in red territory—43%– while share of markets that are green rose from 17% to 21%.
• Multi-Family: Rose five points from Green 81 to Green 86, mainly because the sector’s vacancy rate decreased from 7.4% to 6.5%.
• Retail: Gained an additional four points this quarter to increase from Yellow 56 to Yellow 60. Though its vacancy rate rose again from 12.4% to 12.8%, the supply-demand imbalance contracted to a mere -0.1%, from -0.3%.
• Industrial: Gained another 14 points this quarter moving its score from Yellow 41 to Yellow 55. High vacancy remains intact as the composite vacancy increased slightly from 13.9% to 14.0%. The increase in score can be credited to both projected absorption and the construction pipeline moving in favorable directions

The Senate just passed, and the President is ready to sign, the Financial Regulation (FinReg) Bill, which will signficantly impact home buyers and lending guidelines. Amongst the changes impacting consumers is the creation a Consumer Bureau at the Federal Reserve and the requirement that lenders ensure a borrower is able to repay a home loan by verifying income, employment, and credit history. To read the full story, please click here …. KEEP THIS IN MIND: Under the financial regulation bill, at least two (2) categories of mortgages likely will see a dramatic decrease in their availability:

• 1st: Interest-only loans and stated-income loans. Both loan types likely would fall short of the government’s definition of “qualified” mortgages and therefore be avoided by many in the lending community.
• 2nd: Yield Spread Premiums.The bill also severely limits the industry practice known as “yield spread premiums,” which in many cases incentivized mortgage brokers and loan officers to sell higher-interest loans to borrowers. The reform bill will no longer allow commissions earned by mortgage brokers and loan officers to be linked to the interest rate, but rather the loan amount. Once the bill takes effect, the total commission and additional fees charged by lenders and others in the mortgage process will be limited to a maximum of three-percent (3%) of the loan amount, not including the real estate commission.

Talk about the housing dominoes now falling at a fast pace. Banks repossessed a record number of U.S. homes in the Q2 2010, but slowed new foreclosure notices.

• There is a six-fold increase in homes starting the foreclosure process, and …
• 1 in 78 homes received at least one foreclosure filing in the 1st-half 2010 and ….
• Nearly 1 Million Homes Foreclosed on in 2010!

And the only reason for any degree of slowing down the foreclosure process is so that the banks can manage distressed properties on the market, according to real estate data company RealtyTrac.

The Root Problems: Job losses and wage cuts persist, making a sustained U.S. housing recovery elusive, and providing no relief to stemming foreclosures.

Housing By The Numbers:

• Banks took control of 269,962 properties in the second quarter 2010, up 5 percent from the prior quarter and a 38 percent spike from the second quarter of last year.
• Repossessions will likely top 1 million this year.
• The housing sector still sits on over 5 million seriously delinquent loans that, odds are, will at some point go into foreclosure.

Some Historical Perspective:

• In 2005, the last “normal” year in housing,  about 530,000 households got a foreclosure notice and banks took over a comparatively minuscule 100,000 houses.
• This year more than 3 million households are likely to get at least one foreclosure filing, which includes notice of default, scheduled auction and repossession.
• In the first half of the year, foreclosure filings were made on 1.65 million properties. That was down 5 percent from the last half of 2009 but up 8 percent from the first half of last year.
• One in every 78 households got at least one foreclosure filing in the first six months of this year.

MARYLAND UPDATE >> The number of foreclosure filings in Maryland more than doubled in June 2010, while the state’s foreclosure rate also ranked 13th overall for the first half of 2010.

• Maryland’s 6,304 foreclosure filings in June 2010 was nearly a 104 percent increase from the same month last year.

• From January to June 2010, Maryland’s 28,293 filings was a 56.2 percent increase from the same period a year earlier.

• That comes out to 1.2 percent of Maryland homes receiving a foreclosure filing during the six-month stretch.

When banks fail, who’s getting their hands on the distressed properties taken over by the Federal Deposit Insurance Corp (FDIC)?

Here is one of the pieces of the distressed market puzzle ……

Read the full WSJ article.

The Opportunity: A partnership between Colony Capital LLC and a minority-owned investment firm won the bidding for a $1.85 billion portfolio of distressed commercial real-estate loans auctioned off by the FDIC.

The deal, the second-largest bulk sale of commercial-property debt under a public-private partnership.

Terms of the transaction: Los Angeles-based Colony and New York-based Cogsville Group LLC agreed to pay 59 cents on the dollar, or $445 million, for a 40% equity stake in the assets consisting of 1,660 commercial-property loans held by 22 now-defunct banks, including Community Bank of Nevada, First Bank of Beverly Hills and New Frontier Bank.

The Details: The FDIC retained the remaining 60% and offered seven-year (7 Year), zero-interest (0%) financing to the Colony-Cogsville group, which reduces the venture’s upfront cash input to $218 million.

• This deal is the first public-private setup in which a minority-owned firm has taken a stake, albeit a small one, during this economic downturn.
• Cogsville, an African-American-owned firm, contributed $16 million to the $218 million investment, for a 7% stake in the portfolio.

Read the full overview, here ….