Class 6: July 15, 2010

Cities are starting to look at penalizing banks for not managing foreclosed assets. Banks do not want to asset manage though because they do not do it well. You would think we would learn from our mistakes in the 80s. Instead of just foreclosing and then turning around and putting it on the market maybe banks should branch out and have a property management division within their business plan. The way things are now though banks just let the property sit in their portfolio for long periods of time without maintaining the property or getting it ready for resale.

Obviously one of the biggest problems with commercial property today is that a lot of them are “underwater”. In other words the borrower or property owner owes more than the property is worth. A lot of this has to do with the perfect underwriting that went on before the crash. Properties were underwritten with 5% annual increases in rent with zero vacancies and then valued with really low cap rates. This is not realistic however and when the crash happened borrowers could no longer make their loan payments. This is a problem when cap rates rise drastically and when most commercial loans have five year balloons and as these balloons come due it will be hard for borrowers to find refinancing.

We talked at length about a few topics and articles that seemed to contradict themselves. One of the articles which talked much about the things in the paragraph above, but 2010 is just the start of all the balloon notes coming due. This means 2011 could be the big “shitstorm” of when commercial real estate really starts to tank. This notion directly contradicted with an article that said institutional investors are starting to turn away from stocks and look at ‘alternative’ investments with commercial real estate being one of them. The same article went on to say that professionals in the industry see it getting worse in 2010. The majority of those asked believe 2011 will be the turnaround year while others think it will be 2012 or 2013. So why would institutional investors be so interested in commercial real estate? The answer is that they see it better as long term investment. It stated in this article that an Oklahoma Teacher’s Fund made a 24.5% return in 2009 with 70% of their money in stocks. So why would you want to go to real estate when they can earn that kind of return in a down economy?

Atlanta is the worst in the country when it comes to problem CMBS loans.

I mentioned in an above paragraph about how lenders and owners etc. used to underwrite properties to meet a perfect standard. Now that there is more conservative underwriting standards and bottomed out property values J.P. Morgan Chase and Bank of Scotland may be treading back into the commercial mortgage backed securities market.

Not many property owners own their property free and clear, but for the ones that do they may have an opportunity to sell their properties on a quicker timeline. This could be done utilizing seller financing. By offering better rates than a bank, a seller can entice possible buyers to purchasing their property.

Workouts- Negotiations between the lender and borrower to restructure a loan. The lender does not want to hold the real property because of the costs. So ways of negotiating a workout is to change the terms or maybe an interest-only payment. An idea discussed that I really liked is to relieve the borrower from payments for an agreed on amount of time and in exchange the lender would receive a portion of the appreciation upon sale of the property. Also a lender could also basically take control and really monitor the operations by watching what checks an owner writes or picking which tenants can and cannot occupy the space.

The final thing we discussed is the tax implications of debt relief. If a lender relieves a borrower of debt than the borrower has to report that debt relief as taxable income. I tried to provide some insight to tax implications as I have heard my uncle and dad talk at nauseam about a workout my uncle is doing. To put it simply the mortgage is worth way way way way more than the property, but if foreclosed upon then the mortgage balance is recognized as the gain per se, not the value of the property. And if the lender grants relief of the debt than there will be huge tax burden for the investors of the property.