"Sitting on the Fence"

Will commercial real estate values cause another wave of bank failures? Are we heading into a deepening recession or depression? Should I jump in and buy now?

I have been struggling to come up with definitive answers to these questions as the pace of change has created a very tumultuous environment.

I was convinced, as recently as two months ago, that there will be a major collapse of commercial property values. To date it seems that the drop is manageable as CAP rates have risen from sub 6 to over 8 on good quality properties.

We continue to assume falling rents and rising vacancies in our analysis models of commercial deals and loan requests. Perhaps the impact of the residential bloodbath was so severe that it caused a massive reaction by the FED and thus has made the commercial loan impact less of a concern at this time.

Investors and lenders have been forced to focus on their residential portfolios and this distraction has caused them to back off on enforcing their rights when commercial loans are defaulting. We need to comprehend that the volume of commercial loan debt is less than one-third of its residential counterpart. This may make it possible that the bad debt can be absorbed by our economy without the catastrophic impact many fear. This becomes even more likely if the economy actually is growing and the recession is declared at an end.

My belief is that there will be many more bank failures ahead, especially on the regional level. The most likely candidates are those lenders who have a portfolio of loans originated in 2003-2007. For those lenders, as with private individuals, the difference between a recession and a depression is whether it is you or your neighbor. In the private sector, if your neighbor loses a job, it is a recession; if you are losing your job, it’s a depression. For a public financial institution, depression starts when regulators come in and ask questions about the portfolio’s health and valuation- it is at this point that jobs are on the line.

I still sit on the fence thinking things may improve because I have seen, first hand, how many investors with capital are beginning to jump in on any real opportunity. One recent example was a bank sale of an apartment community being liquidated on an all cash basis for a $10mm opening bid. There was a 5 day window to bid- 35 bidders qualified with proof of funds during that short period. I am always working with our institutional partners and I have seen how little attention an “all-cash” and “quick closing” offer gets because many sellers are well aware that the money is readily available.

I recently read that at an Expo in Munich, Germany, there was overwhelming interest by European investors to jump in on the US Real Estate discounts. In the 2008 Expo there was very little attendance and no interest for those exhibiting. Our international relationships have also surfaced and are now requesting that we bring them deals to partner on. There is no question that the aggressive focus is on distressed assets only. However, earlier in the year this was not the case as people were looking for blood.

Now looking over to the other side of the fence, there are plenty of clear indicators and opinions that we are only in the 3rd inning of the value declines and that the worst is just around the corner.

The following are some of the key considerations:
- During the next 15 months approximately $2 trillion of commercial mortgages will be maturing
- Between April and August 09, the value of commercial loans placed in “special servicing” doubled to $50 Billion
- Office and retail vacancies are soaring
- Rents are declining in all sectors
- Flow of new credit remains very tight
- In recent years large project loans have been broken up into layers of securities and if they go bad they will have a very wide impact
- Many projects are standing in various stages of completion and will take months of recovery to justify their completion
- Mark to Market has not been enforced and many lenders are reluctant to reduce values

The market can be kept afloat by the willingness of lenders and the Fed to do modifications, etc. and “extend and pretend”. The idea behind this is to put it off for a later date and not bite the bullet today. Many will argue that things cannot actually improve unless the bad debt is dealt with now and taken out of the system. The prolonged down market is caused by the band-aid approach. The jury is out on this theory.

In summation, I do not feel like we need to jump into deals due to a fear that the “Ship of Opportunities” will sail away if we don’t. However, I must admit that the anchor may be close to being pulled up making us more aggressive in pursuit of investment opportunities in the very near future.

“Still on the fence- but looking for a soft spot to land”. Decisions, Decisions, Decisions.

Gil Priel
Managing Director
Peak Corporate Network

Avoiding a Commercial Real Estate Crash (May 09)

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

The Fight of the Century: Round 1 (Oct 2008)

Turmoil on Wall Street- a direct hit to the head of credit markets, Lehman declares bankruptcy- another blow, Merril Lynch sold, AIG being supported by the US Government, Taxpayers pick up the tab on a $700B rescue plan- blow after blow, how much longer can our fighter keep standing???

Top financial leaders, including Greenspan, have called this crisis “a once in a century event.” This has not been limited to our shores, as the Global markets have also absorbed serious punishment. Most countries are struggling to “liquify” their credit markets as lenders are holding on to every cent they have available.

The immediate impact to lenders has been that even traditional delinquencies for “lower risk” borrowers are on a steep increase. This is the case as so many fall behind on their mortgage obligations. For the higher-risk borrowers, the story gets worse. There is no capital available to keep them in their homes and avoid foreclosure. The FHA alternative has strict guidelines that are prohibitive to most borrowers. The problems will continue to increase as property values are driven down by the inability to obtain any financing alternatives. This, in my opinion, is the reason that we are likely to be in a declining lending environment for several years to come. Only the reduction of inventory, the stabilization of values and credit being released will eventually lead us out of the crisis. 2010 is my estimation for reaching a stabilization point.

Stabilization will be greatly affected by the regulations being proposed by government, thus making it tougher on lenders. The stricter guidelines will only exasperate the decline in property values and increase foreclosures. The borrowers who truly need the most help are locked out.

I would like to share something with you that is really at the root of the problems we are all facing today. We recently received a submission for a short-term loan on an investor owned home. The loan request was in line with our guidelines and at a very low LTV. We received a complete credit package including an appraisal just completed by a licensed appraiser.

We were prepared to fund the loan and, as a standard precaution, we sent our analyst to perform a property inspection. The appraisal was a complete fraud, showing multiple shots of the interior and exterior of the property and provided documentation of the home being in average condition. The house was a disaster beyond description. The reason I bring this up is that it is exactly the problem that led to the inflated real estate values we witnessed over the last few years. Many appraisers were asking- “What value do you need?” This complete breakdown has to stop and there must be strict legal action implemented. We are pursuing every avenue against the appraiser and broker.

As lenders, we have very little confidence in what we receive. This makes us pull back from lending, increases our costs and ultimately hurts the borrowers who need our funds. I hope everyone does their part to stop the widespread fraud in the current lending environment. Without gaining the confidence of lenders, credit availability will continue to be scarce. If I sound angry it is because I am. I only hope that you all get angry as well and help put a stop to such activities.

All the unprecedented actions taken by the government are geared to one thing: find the bottom and begin to re-build confidence. Our fighter needs to get off the mat.

The mindset of people needs to change before that can happen. Cheap, easy money was available to everyone to spend on luxuries, college, home improvements and vacations. Institutions also used the cheap money to expand their operations and banks were happy to lend as the capital kept flowing in. This is no longer the case and this reality needs to filter through and establish new spending habits. If there is nobody left to finance the previous lifestyles it will probably be “Big Brother- the Government” that will need to keep pumping money in to avoid a complete collapse. All the success that was built on cheap money will lead to further declines in other industries and this will unfortunately be Round 2 of our fight.

I believe the next 6-12 months will be the key in trying to predict what the future will be. The questions to be answered are: If some of the bad debt is pulled out of the banks and other institutions will they suddenly be willing to loosen the grip on credit flow? If housing stabilizes, will lenders jump back in and lend on higher LTV’s? One thing is certain, if that fails to happen we are looking forward to a prolonged recessionary period.

That is the most difficult projection to make. At Peak Capital Group, we have been actively pursuing some of the distressed assets held by Banks. We are buyers of REO’s as well as Non-performing notes, both commercial and residential. Our analysis remains very conservative with an eye toward further declines. We are also lending to opportunistic borrowers who need quick access to cash or property owners trying to salvage their deals. We are clearly one of those lenders that remain very well capitalized but holding back to a degree, primarily due to a market confidence lapse. Although we have reduced our loan production, we are still active and will remain so in our market.

I do look forward to being the creative solution for borrowers as well as sellers of properties and debt instruments. I also look forward to our fighter getting up and landing a strategic blow to the negativity that currently prevails.

Gil Priel

The Mattress or the Bank? (May 08)

I have been thinking about all of the IndyMac customers running to the bank, standing in line for hours, worried about their life savings.

This has played out over the airwaves and media so many times. It is a sad scene that may be repeated many times in the coming months.

While the FDIC does its thing (insuring most customers), there was still a real loss of over ½ billion dollars for some people that are now devastated.

These unfortunate consumers’ answer to my question would have certainly been; YES! It is time to keep the money under the mattress.

The other answers of course include being aware that there is a limit on FDIC guarantees and to stay below it in each institution. However, I do believe that these turbulent times require consumers to look again at their long term objectives and the value that real estate holds for their plans.

Having been through at least three significant cycles, I am always amazed how values seem to come back or exceed the last high. Real estate does not suddenly vanish. There are few cases of cities disappearing and land becoming worthless. These down cycles present the opportunity we all ask for when prices are skyrocketing. I can’t tell you how often I’ve heard, “The next time it goes down I will jump in full blast.” Then it goes down and our fears and dire predictions take over leaving us on the sideline. This psychology can make or break investors.

There are areas that residential values have fallen up to 75% in less than 18 months!!! I am not talking about the rust belt in Ohio either. I am talking about the Southern California suburbs. Nobody needs to wait for what is believed to be the lowest possible price. My advice has been that if a property is available at a steep discount from the high water mark and is the type of property you would be happy owning for the long term, it may be time to step up. It is clear that there is action on the listings in the depressed areas like Stockton, Riverside, etc. Our valuation department has seen a dramatic change in responses from agents in the field. They are seeing offers and some even indicate they are seeing multiple offers. I am not saying that this is the bottom of the market and it can’t go lower. However, the sword has fallen a long way and catching it now may make good economic sense in the long run.

I am not as confident in matters relating to commercial property values. I do believe there is a significant downside risk remaining in that market. Things have not adjusted to meet return expectations and lender credit tightening. It is the time to take extra precautions and be sure that you are buying at a discount to today’s value. With a strong cash position it is possible to take advantage of collapsing leverage deals and make a prudent purchase that will stand up in the long term.

Our fund continues to be active in commercial bridge loans and residential loans. We look for safe underwriting and liquidity. We are also making an effort to be a source of financing for loans being called by lenders who cannot wait it out or have urgent cash requirements. Recently, we have concluded several construction completion loans, letting the borrower go forward with projects that would have been grounded.

I can summarize by telling you that real estate investments remain a very attractive place to put your money and you will sleep better knowing your money is safer and because your mattress will not be lumpy.

My best wishes,

Gil Priel

"Riding the Whitewater" (May 08)

Where are we now and where are we going? I can only relate the current market conditions with a river rafting trip I went on. The trip went from smooth water to different grades of rapids from 1 to 5. Being a veteran of real estate cycles I believed I had experienced the toughest cycles over the last 30 years. This was clearly not the case when it comes to current residential property values in California, Florida and most of the Southwest.

Like the river, we are flowing downhill and at an alarmingly increasing speed. We are in a level 5 rapid and I still don’t see the calm water ahead. The question is whether there is a bend in the river, with calm smooth waters, or are we heading into a waterfall?

The experts are telling us many different versions of where we are in this downturn. UCLA forecasts we are not in a recession, Buffet indicates we are. Bush does not want to call it a recession but acknowledges we may be in one. Other economists are lining up with either conclusion. The reality is that everyone agrees things are very bad and will probably be getting worse. The conclusion is that housing is in a deep slide and will be very slow to recover.

There have been several high-profile articles, among them the Wall Street Journal features, that are starting to paint the picture of a bottom in the market. In addition there are the government backed organizations that are stepping in, along with FHA, to make it attractive for new buyers to step in. This all is very important to the psychology of building up demand for purchases.

Personally, we have witnessed increased activity on the residential side now that values have hit the current levels. Builders and brokers I speak with have indicated that there is activity in many markets that were hardest hit like Stockton, Sacramento and the some of the San Bernardino sub-markets. This does give a ray of hope if we are trying to define a low point in values. The concern remains that there is a continuous stream of foreclosures that show no sign of decreasing. I for one, am not ready to concede we are at a bottom, and expect further deterioration in values before we hit bottom.

Investors and users should be preparing to step in over the next 6-12 months when they find the right property, in the right location, at bargain pricing. There should be an extended period of flat values until we see some appreciation so there is no rush to buy.

On the commercial side of the business, It is clear that we have not seen values decline in a significant amount. There is a serious absence of securitization for lenders which will translate to credit tightening and much lower loan to value amounts. The lenders we have met with are consistently telling us that they will not do loans that were clearly in their guidelines just a couple of months ago. This reluctance to lend will perpetuate a more serious decline in commercial investment properties. I would expect CAP rates to increase by 1-2 points in the near term.

The outcome of the river ride is unclear at this time. The FED is taking actions to be aggressively boosting confidence, in the hope of avoiding further erosion. This can only be successful if there is concurrent credit relaxing by all lenders and an influx of liquidity. Just today we hear that the senate has passed the housing rescue bill authorizing $300 Billion in loan guarantees for at risk borrowers refinancing. This kind of support by legislation is critical in bringing liquidity into the market.

At Peak Capital Group, we are being conservative in our underwriting with both residential and commercial loan requests. However, as portfolio lenders we remain ready and willing to lend to borrowers that can benefit from quick access to capital and still have sufficient equity and the ability to assure repayment. We have also expanded our interest in REO pools as buyers and lenders.

We are in the raft with our oars ready to ride it out.

Until next time.

Gil Priel

Take a look at this report - SoCal Deals Abound In Foreclosure

"The Transition Year 2007"...something from Jan 2008

I strongly believe that we will look back at 2007 as the year of change. Not only in the direction of real estate but also in the fundamental way lenders can operate. The days of easy credit and high LTV's will at best go into a long hibernation for most capital sources.

As I reviewed 2007, it became clear that after the residential sub-prime meltdown the tightening managed to trickle into commercial lending by July. Spreads increased, Libor increased and the need to find lenders willing to jump in became a long shot. The commercial sector nationally has started to show weakness although there are still pockets of strength.

At Peak Capital Group, LLC our ability to respond quickly and creatively has made us a source of funds for many borrowers and brokers that were left out in the dark. As a portfolio lender with an institutional partner, we are not driven by the need to securitize our loans or search for new capital sources. This gives us a strategic advantage going into this year. As lenders face up to bad debt on their books, they will be forced to sell off their assets at steep discounts.

As an opportunistic lender, we can provide the needed capital for different situations. Our short term financing can serve as the bridge to keep a deal from falling apart and give a seller the time needed to maximize his return. Equally our funds are available for a buyer in need of immediate capital in order to take advantage of a distressed situation. The key is our flexible underwriting allowing nationwide cross collateralization, nationwide lending and quick turnaround times.

Our most complex deal was structured by crossing six commercial properties spanning 3 states. We were able to underwrite the deal and fund it in less than 7 days. The borrower was able to finance 100% of the purchase price needed for two deals and get a good discount from the seller by closing quickly. These type of transactions will become more frequent as the REO market accelerates. Having immediate access to capital will be the "gold" for success in the coming years.