Buying Distressed Properties

I recently read a Realpoint report about CMBS liquidations.   This reviewed sales of CMBS deals went bad and how they performed.   This was a pretty eye-opening report.    According to this report over $10.9 billion in CMBS were liquidated with an average loss severity of 40%.   However this amount has been increasing over time.

For CMBS properties liquidated during 2010 the average loss on sale was 48.9%, for multifamily properties it was 52%.  These losses include loss of income during the foreclosure process and costs of owning and holding the REO, but even with that it shows a substantial discount from the previous loan amount to the current sale price.  Considering these deals were made at 80% or better LTV these properties sold for 50% or more from the previously appraised value.  Pretty substantial discount.

looking at specific transactions from 2010 the losses ranged from over 100% to just making money on a few deals.   However, most deals did have losses of over 50%.   Examples include properties in Atlanta at 88%, Miami at 135% and Memphis at 82%.  These were real losses for someone and real opportunities for others.

For me the interesting thing about this is how low the prices of these deals were and that there are opportunities in today’s market.    So far we have not seen many deals hit the market, but given the large number of CMBS deals in he default/foreclosure pipeline they will be coming.  When bidding on these deals don’t be shy I don’t know how active the bidding has been, but if you are thoughtful you might be able to pick up a real bargain.

CMBS lending – Will it ever come back?

There as been a great deal of discussion about the future of CMBS and other types of securitized lending.  Will it ever come back? When will it come back? What will it look like when it does come back?   I have gotten a lot of questions about this since I wrote a blog posting on the Freddie Mac CME program.    Let’s get real, CMBS is not DEAD, but it is too early to know anything what the future will bring. 

 

Why am I so sure that CMBS is coming back?   Its simple, the capital markets are where the money is.    Lending has gotten too big to do it the old way with banks or insurance companies taking in money and then lending it out the back door.   And the ability for banks and insurance companies to get direct leverage from their own balance sheet is being limited not expanded.   Only through access to the capital markets will they be able to leverage their expertise and balance sheet to satisfy borrowing demand.   Once the general markets stabilize and there is confidence that the economy is strong, then CMBS will be back.  As long as the issuer can show they are really underwriting their loans and making “good” investment decisions the security investors will return.  They may require a higher interest rate, but they will return.

 

The most discussed issue relating to securitized lending is how to align the economic interests of the banks or originators and the security investors.  There have been many ideas discussed to accomplish this and its how CMBS was in the bad old days of the late 1990’s.  At that time the groups that originated the loans often bought the “B” or risky piece of the security so they made sure the loans were well underwritten and documented.  While its important to align the economic interests of the investors and originators (lenders) there are some legal issues that might be harder to overcome. 

 

You have probably heard the worries from lenders’ about the General Growth bankruptcy.  This is directly testing the issue of single asset entities.  In securitized lending each borrower is set up in a single asset entity so if it goes into default or bankruptcy the lender can cleanly foreclose on the property.   General Growth is a mall owner/operator which is the sole owner of a number of single asset entities.  These entities were set up for individual properties in order to accommodate the CMBS loans.   When General Growth went into bankruptcy it also took most of the individual single asset entities into bankruptcy.  They did this even though many of these properties were generating enough cash to pay their debt.  The concern of lenders is that the court might use cash flow and/or value from one entity to pay obligations of other entities.  In effect this would negate the benefit of single asset entities and make it harder for someone to lend on “just the real estate” and not the overall borrower.    How this will play out is still unclear, but this concern is buzzing around in the world of lenders.

 

Another, and from my perspective more worrisome, legal concern for securitization was recently highlighted in NY Times article Looking for the Lenders Little Helpers.   This showed how attorneys are claiming that the securities holders are really joint venture partners of the lender because the loans were created solely for the purpose of creating the securities.   This is an interesting approach and if it wins in court has the risk of putting the security holders and issuers in legal bed with the originator or lender.  This is effectively removing the holder in due course protection of a note holder and will mean the holder is liable for improper acts of the loan originator and could be responsible for statements, side agreements and promises of the loan originator.   This is a big deal.   From the article it sounds like courts are buying this argument for single family loans.  Whether this will fly on a commercial or multifamily deal is unknown, but its something we should keep watching.

 

If these legal issues do become the force of law it will drastically change the way securitized lending will occur.   It will also change how Freddie Mac, Fannie Mae and HUD financing occur since these lenders rely on the same legal standards.  However, these are issues that can be overcome.   Solving some of these issues may require new legislation or a different type of underwriting.  It may change how CMBS is originated or who does it and it will change what types of loans are available to the borrowing public.   However, I have herd it quoted that almost ½ of all lending in America was done on a securitized basis.  With the kind of money that generates we will find a way to save the baby and not throw it out with the bathwater.