Current Commercial Thinking

I recently gave a speech at a two-day conference in Dallas. The event was the Texas Bank and Financial Institutions Special Asset Executive Conference on Real Estate Workouts. The central focus of the event was how banks and CMBS (commercial mortgage-backed securities) servicers are handling the disposition of troubled real estate loans.

This topic is of keen interest to many who are trying to find distressed real estate to purchase. I sat in on the conference produced by the International Marketing Network for the full two days because the panels were full of global caliber speakers (except of course for me). Their comments provide a snapshot of the current sentiment of the top professionals that are daily making decisions whether to continue to “extend and pretend” or move forward with foreclosure. Here are my notes.

  • Buying houses from Fannie Mae is very difficult. They offer no due diligence, no title insurance. It costs a lot of money to do due diligence. Then you make an offer they accept and then they get an offer from a family and then turn the investor away. Then the family cannot get a loan, and FNMA goes back to the investor who then lowers their bid.
  • Small commercial real estate deals (less than $10 million to $20 million) are hard to finance. The buyers have limited equity. After they buy two to four deals, they may run out of equity, when they have to put 30-40 percent down. Also, banks have a limit as to how much they can loan to one borrower.
  • National Commercial Auctioneers sold 140+ single-family houses from the Houston Housing Authority that decided it did not want to be a property manager anymore. The properties sold at about 60 percent of the appraisal district’s value.
  • Special servicers are not anticipating any significant recovery in rents and values in 2012, so they are reducing their net present value assets of their nonperforming properties.
  • The bank regulatory environment is still intense. They are coming in and classifying lots of loans.
  • Banks are starting to be aware of shadow inventory, when a business is paying rent but not using some space. When the lease renews, they won’t be renting as much space.
  • A lot of borrowers are real estate operators where part of their stated income is from property dispositions. Without the income from property sales, their loans become classified.
  • Haven’t seen a lot of bulk REO sales, just one at a time.
  • New CRE originators have skyrocketed recently on a percentage basis. But the total volume is still small, except for life insurance companies. Selling property in Illinois takes a long time. They now hold bank as “owner” and make them clean up code violations.
  • A bank foreclosed on a property and found a $400,000 lien filed for unpaid water bills.
  • Another bank foreclosed on a marina that had lost its lease for the water two years ago and had EPA storage tank problems. Banks don’t like to take title; they prefer to sell at foreclosure auction. Banks can also sell the note and avoid taking ownership.
  • Volume of distressed asset sales is increasing. It’s largely difficult properties that can lose value. Properties that deteriorate or need significant management are being sold.
  • Bigger, higher quality properties are getting loans resolved. Unique properties and those in second and tier markets are coming through the workout system.
  • Volume of distressed sales was up substantially in 2011 and is likely to increase further in 2012.
  • Don’t expect bank closings to increase much in 2012.
  • Bankers not seeing any improvement in the market next year. “If we can package troubled loans and sell them in bulk, we will. You’ve got to know when to hold and when to fold.”
  • There is an estimated $350 billion in real estate loans in CMBS maturing in 2012. There is a sense that CRE is about to fall over a cliff and that properties are going to get repriced. Many properties are going to all-cash buyers at steep discounts.
  • 2012 is going to be the year when troubled real estate comes to market. Now is the time to sell.
  • $1.4 T CRE debt matures by 2014. There will be a lot of investor equity and debt financing needed to purchase these properties or renew the loans.
  • 2013 could be an ugly year for CRE if this troubled property can’t refinance.
  • Apartments are red hot. A 90-year-old apartment building in D.C. recently sold for a 4 percent cap rate.
  • Regulatory pressures will force banks and life insurance companies to stop the extend and pretend policy.
  • Investors are having a difficult time finding deals that make sense. Trophy properties are selling for low cap rates. But these are only about 10 percent of the market. The other 90 percent of the commercial market is still dysfunctional.
  • Rental markets for office and industrial are flat at best and sometimes still declining. The reason we may see a flood of deals come into the market is that owners are realizing rents may not get better in the next year or two, and it would be better to sell now.
  • The big banks are starting to be competitive on loan rates, making it hard for small community banks to compete for loans.
  • The idea of a “new normal” is starting to set in. The decision will be “how long are we going to wait to take our medicine.” Maybe it’s time to sell properties with distressed loans.
  • Some banks are now in a position to make real estate loans. Could see some growth in C/I (commercial and industrial) loans that are collateralized by real estate. C/I loans are not viewed as a real estate loan, even when a building and land are purchased.
  • Owner/operators will be most likely buyer for real estate because C/I loan can have real estate as collateral. Investors will continue to have a hard time finding financing in 2012.
  • 2012 will be a year of more confidence for special servicers. They have been unsure whether they should sell a property and take the loss or keep the property. Now it’s clear things aren’t going to get better soon, so it’s time to sell.
  • Some banks are restructuring a troubled real estate loan into an A note and a B note. The A note is a lower amount that is underwritten with conservative assumptions. The B note is a hope note, expected to be charged off the bank’s books. The idea is to get the A piece to performing status and write off the B piece. The bank would keep the A note and sell the B piece and be in good shape with the A loan. The A piece must be at a market rate of interest.

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