Just focusing on cleaning up "sub-prime" residential garbage will not bring us back to the days of the real estate boom. The collapse of residential home values is only part of the story. The bigger, and more pressing, financial emergency is on the commercial side of the real estate market.For some time, the U.S. commercial real estate disaster has been developing like a catastrophic hurricane, swirling in warm waters, gathering intensity, getting ready to hit hard.
Ignoring the reality of a commercial real estate collapse is following the same steps that allowed the free fall in home values. A failure to act in a cohesive effort to pre-empt the impact of a collapse of investment property values will only result in an economic fate similar, or worse, than what we’ve seen in the residential market.
This is a critical time for commercial lenders. Helping honest, qualified borrowers keep their investments is particularly vital to the survival of commercial lending – but perhaps more importantly – has ramifications that will positively affect the economy as a whole.
Back in 1991, during the last real estate down cycle, my own company negotiated a reduced payoff on our office building. The lender received full current value for their loan and we were able to structure a sound deal allowing us to keep the building and ultimately sell it for a substantial profit in a better market. It was this good faith spirit of negotiation that made the deal work out then and can serve as a model for us now, as we brace ourselves for the perfect storm.
Lenders, investors, developers, and many others, will all need to work together to build an infrastructure strong enough to avoid a total collapse of the market.
Initially, the mezzanine lenders will be most affected. They’ve made huge capital investments behind securitized senior loans that took the safer portion (lower LTV). These lenders are not small Mom & Pop lenders; they are huge institutions like GE and Transwestern Insurance.
Recent transactions, like the sale of the Hancock Tower (a premier office skyscraper in Boston) is a perfect example of risky lending practices. The property was sold for $661 million, representing approximately 1/2 of the purchase price less than three years ago. It was clearly acquired during the peak period of value but it is still a trophy property. A 50% drop in values is not at all rare if the property is among the “crème of the crop” in the city. Analysts, lenders and appraisal experts all agreed it was safe to jump in at that price. As part of the original financing package, a half billion dollars were lost by the mezzanine lender, in addition to several hundred million in buyer’s equity.
This is not the only example of the brewing storm and our new reality. There are glaring examples in Las Vegas, Los Angeles, Miami, New York, Phoenix, and most cities nationwide. According to CoStar, there are almost 20,000 distressed office properties in the 50 largest U.S. business markets.
The same factors that led to high valuations in the home market were prevalent in commercial lending. Plenty of appraisers gave willing lenders what they needed to support "out of whack" values. Wall Street money needed to be funded and since values were never going to decline, the call was "bring me your loan and we'll show you the money."
I observed this first hand over the last few years in my capacity as Managing Director of a private investment fund. I was angry to be termed the "value butcher.” I tried to be conservative on valuation, rejecting many loan requests that were gladly gobbled up by other lenders who were not lending their money and receiving huge bonuses based on the volume of funding.
Things have got to change; both in the way we originate new loans and how we handle existing loans that are already facing peril.
In Washington, Treasury Secretary, Timothy Geitner, has presented new rules and proposals that are still being defined and digested (along with all other new Obama Administration policies), based on the hope that the economy will turn around and real estate values will recover before loans are due.
The key is to bring all the powers that be together and infuse liquidity into the market based on real value. Solutions need to be implemented that help borrowers and lenders work out a current loan without forcing it into a default status or creating another future toxic asset.
The good news is that there are solutions. I know through my own company’s network of services, we’ve been heavily involved in providing other specific solutions including: Short-sale (allowing a sale for less than the debt), Short-refi (same but with refinancing), Note sales, Discounted payoffs, modifications including reducing loan balance, rate and or terms, Equity Participation with lender and payment plans.
We saw the need several years ago to help homeowners negotiate a solution with their lender to keep the borrower in their home or allow them to sell it to a new buyer at a fair price. These requests were met with deaf ears and only in the last year, or so, has there been a willingness on the part of lenders to work with the borrower.
In today’s economy, all the rules must change and solutions must be implemented quickly in order to keep the level of defaults and foreclosures at a minimum and sustainable level. A flood of failed loans and projects need to be prevented from hitting the market and causing a catastrophic jolt to a reeling economy. These measures in conjunction with the governmental efforts have a solid chance of making the recession shorter and build a solid foundation for a safe and speedy recovery.
Gil Priel, Co-Founder
Peak Financial Partners
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