Peter Pays Paul

According to the WSJ.com in Condo King Corus Weighs Its Options, Corus Bankshares, Inc.

is one of the few lenders to report that the Treasury Department intends to reject the bank’s application for funds from the Troubled Asset Relief Program, or TARP.

Ouch! The bank must be in trouble if they are admitting that they were rejected by the Treasury Department.

Corus has about $2 billion in unfunded construction commitments and that in the event of a federal takeover, regulators wouldn’t be obligated to fund these commitments.

This would be a major disaster. The article doesn’t specify how many projects this is spread over, but imagine if all of them were forced to stop mid-project.

Corus funded condo projects nationwide could come to a standstill. Depending on the FDIC’s decision, some of these projects could languish incomplete for a long time.

This is shaping up to be a huges mess.

I’m taking a few things home to read this weekend. Here they are if you want to print them out and read them too.

• Marcus & Millichap 2009 Real Estate Investment Outlook – Marcus & Millichap provides 12 pages of data for you to chew on.
  
• Everything You Wanted to Know about Credit Default Swaps–but Were Never Told – More than a 5 minute read from RGE Monitor – Home of “Dr. Doom” Nouriel Roubini.
• Putting Office Rent Declines into Historical Perspective – Torto Wheaton Research gives there thoughts on the direction of office rents are headed.

See you on Monday!

WSJ.com is reporting that GE recently took ownership of a an apartment portfolio in Alabama in Risky GE Apartment Loan:

General Electric’s massive real-estate operation likes to brag about how its lending business is among the most conservative around. That isn’t the case in at least one deal.

GE Real Estate, a unit of GE Finance, foreclosed Jan. 6 on a portfolio of 2,284 apartments in Alabama. Brooklyn, N.Y.-based Collins Group LLC with backing from New Jersey-based Lightstone Group bought the apartments in late 2006 for $155 million. GE lent Collins $148 million in a two-year bridge loan, according to several people familiar with the matter. That would put the original loan-to-value ratio at 95%, not very conservative.

As this deal demonstrates, the purchase price and rent assumptions made by the borrower were not feasible to support the debt load on the property.

This is an example of some of the wild deals that were done in 2006 and 2007. Many smart investors are going to sit on the sidelines until these deals are cleared out of the market.

Jonathan Miller over at Trend Czar has an interesting post on the near term pain in commercial real estate. He also suggest niche markets that commercial real estate brokers and other commercial real estate professionals should focus on in 2009.

For brokers and other intermediaries, business won’t suddenly ramp up for quite a while unless they specialize in helping broken borrowers find refinancing or fire sale foreclosed properties for lenders.

Near-term lawyers can do well on the workout front and representing various tranches, special servicers, borrowers and lenders who are tangled up in all the CMBS and CDO litigation on the horizon. But before that happens banks and institutions have to begin writing down their portfolios. That will captivate all of us before 2009 is over.

Trend Czar: Debt Burdens–Stream of Consciousness.

Calculated Risk’s post More CRE Woes: Multifamily housing details that loans on multifamily properties have seen an increase in delinquencies.

Apartment to Condominium Conversions

Some of this can be attributed to the reconversion of condominium conversion projects.

During the heyday of low interest rates and the housing bubble. Developers were buying apartment buildings, upgrading the units, filing a condominium map, and then selling the complex as condominiums to buyers. Often this was less expensive than buying land and building a brand new condominium project.

Condominium to Apartment Conversions

With lending criteria tightened, demand for condominiums has dramatically fallen.

Developers are being forced to offer these projects not for sale but for rent in order to make loan payments on their construction loans. These condominiums are being returned to rental status.

Rental Supply and Demand

Initially the condominium conversion projects decreased the available supply of rental housing, as apartment projects were bought for conversion. A decrease in supply lead to increasing rental rates.

Today, the opposite is happening. Condominium projects that are rented are increasing the supply of rental units and rental rates should decrease.

Calculated Risk’s post from Friday, The Residential Real Estate Market, details this exact scenario.

Adding to the woes are the fact that thousands of vacant single family residences are still on the market. As these are absorbed demand for rentals is likely to decrease again pushing rental rates even lower.

Residential real estate had a tremendous run up in value and is severely overbuilt due to the easy access to consumer credit.

Commercial real estate, unlike previous downturns, did not commit the same error of overbuilding for the most part.

However, the macroeconomic factors of a stock market crash, tightened credit market, and a lack of consumer spending negatively impact commercial real estate.

According to CoStar Group’s article This Year, Pain To Replace Gain , 2009 will see a contraction in the demand for office and retail space.

CoStar’s CEO Andrew Florance presented a 2009 State of the Office Market review and reported that as many as 1,200 properties were either delinquent or past maturity. (Past maturity loans are not necessarily a bad thing. While the loans are in technical default, many lenders are happy to accept monthly payments while the borrower seeks to refinance the loan.)

Florance has one of the most poignant quotes from anyone in the midst of the wave of bailouts.

“The market needs to establish a new bottom before a recovery can take hold,” Florance cautioned. “The sooner we reach it, the better off we’ll be. If property values need to fall to X, it’s better to get there in 18 months not five years.”

This quote is filled with wisdom. Artificially inflating real estate values through bailout money or other funds will only prolong the downward movement. A hands off approach would allow the market to reach bottom sooner. We may feel the pinch now, but a prolonged painful slide would be avoided.

The Wall Street Journal reports in Dirt Lawyer is not impressed by this massive number (sic).

An unusually high number of the underlying CMBS loans that are going bad were made and securitized in the past three years. That is a sign that investors overpaid greatly for those properties and that underwriting standards were loose. In many cases banks lent money based on future income assumptions rather than current cash flows, experts say.

Only time will tell how good/bad 2009 will be. The sooner we reach the bottom the better for all involved in commercial real estate.

Photo credit: AdobeMac

The New York Times is reporting on the spreading vacancy issues in commercial real estate. Office and retail sectors are being hit the worsth.

Much of this affect is due to the prediction that 2009 is going to see a contraction in the U.S. economy. Companies are not looking to expand into new office space. In fact most companies are cutting back on staff and are paring down the amount of office space they are willing to use.

Houston, like Dallas, held up while many other cities were showing the strains of an economic slowdown. But job growth and the brisk business of oil and gas exploration have come to an abrupt halt.

Vacant or unfinished shopping centers dot the highways. Among the 8.4 million square feet of office space under construction or recently completed in the metropolitan area, 80 percent has not been leased. As a result, the vacancy rate is 11 percent and rising.

This is a very well written article and paints a valid portrait of the situation commercial real estate owners are facing. It is well worth the read.

(HT: Calculated Risk)

Mike Shedlock from Mish’s Global Economic Trend Analysis has a great article about the potential for municipalities across the nation to file Chapter 9 bankruptcy.

Mish’s Global Economic Trend Analysis: Massive Surge In Municipal Bankruptcies Coming.

John Moorlach, the accountant who predicted the 1994 Orange County bankruptcy sees Up to 10 Municipal Bankruptcies in Coming Year

Even more infuriating than the policy makers inability to demonstrate fiscal responsibility is their willing to stick both of their hands in the dole. Mike quotes the St. Petersburg Times article Double dipping rises despite outrage.

This year some of Florida’s public officials are giving a whole new meaning to the phrase “home for the holidays.”

It’s a new crop of double dippers, taking advantage of a loophole in state law that allows them to “retire” by taking 30 days off and return to work in their old jobs with a salary and a pension. Many also collect a lump-sum “retirement” payment that can reach hundreds of thousands of dollars.

It is sad that we live in an entitlement culture. Everyone thinks that society owes them something.

As Margaret Thatcher said of “society”,

There is no such thing! There are individual men and women and there are families and no government can do anything except through people…”

Politicians and people that demand something for nothing are holding back the more productive members of our society.

California’s cities may be some of the biggest casualties of the real estate bubble:

RIO VISTA, Calif. — California may soon have more bankrupt towns on its hands.

The city of Vallejo, Calif., gained national attention earlier this year by filing for Chapter 9 bankruptcy protection. Now, two neighbors are fighting to avoid the same fate, as the state’s economic crisis spreads.

More California Towns Face Bankruptcy

City Income

Many of the cities and towns in California derived a major portion of their income through two sources.

First, fees paid by developers to expand the city and tap into existing services. As the housing market took off developers could afford higher fees. Cities realized this and decided to charge higher fees.

The second major source of income is property taxes. Since the passage of Proposition 13, California homeowners only experience a significant bump in tax revenue when a home sells or when additions are made to it.

During the wild and woolly days of the housing bubble, houses were selling fast and property values were skyrocketing. Cities saw their incomes increase as they collected more and more property taxes.

Political Wisdom

As a model to other Americans, the city politicians realized that a greater income should not go to waste. “We have more revenue therefore we should spend more money. And we should project to spend more money each year into the future,” these wise politicians said.

The wily politicians noted that to fuel demand for housing, their public services should be top notch. In order to attract the best and the brightest police force and firefighters the politicians decided to promise them the moon.

City Expenses

So the police and firefighters received great salaries and great benefits. Some of the cities could not afford their own pension plan, so in order to attract qualified public servants they joined up with the California Public Employees’ Retirement System (CalPERS). The city’s cost of joining CalPERS was less than the cost of offering a similar retirement guaranty independently.

Municipal police and firefighters often have contracts with guaranteed pay increases.

Now that the housing madness has cooled, city revenue has not grown. However, city expenses, related to salaries, are increasing. [Begin Sidenote: Sounds like the auto industry. End Sidenote] In many cases city revenue may actually fall. As housing prices fall, tax payers can ask for a reassessment of their taxes which may lower their tax burden.

This powerful combination of flat or falling revenue and increasing expenses is forcing some cities, like Vallejo, to file chapter 9 bankruptcy.

Insult to Injury

Let’s return to CalPERS:

Pacific Grove, a coastal town south of San Francisco, already faces a budget crisis. Now losses by California’s giant pension fund could make the pain worse.

“Calpers could bankrupt us faster than anything else,” says Mayor Dan Cort. City officials say other towns face financial stress unless the California Public Employees’ Retirement System is able to quickly recover from its investment losses.

Calpers Losses Add to a City’s Stress – WSJ.com.

Since July CalPERS has lost almost 25% of its value. This marked loss limits its ability to pay current and future employee retirement guarantees. In order to make up for the short fall, CalPERS may charge cities more in the future in order to recoup and adjust for the losses.

Coming Full Circle

CalPERS has been in the news lately for losing tremendously on investments in, wait for it. You guessed it residential real estate. Ouch!

The cities and CalPERS made bets that real estate would continue to go up. Now they are paying the price for foolish planning.

Square Feet Commercial Real Estate Blog details some of the difficulties that commercial real estate owners may have if they want to refinance or sell with US Treasuries at such low returns.

Treasury Yields Create Defeasance and Yield Maintenance Nightmare | Square Feet Commercial Real Estate Blog.

I first learned about defeasance in October of 2007. (Not something we use every day.)

The idea behind it is that a mortgage investor wants a guaranteed yield or return for a specified amount of time. If they are repaid early on the mortgage, the yield is affected. In order to maintain the yield a clause is written into the loan that the borrower has to buy a basket of “safe” securities to replace the payments that investor would have received over the life of the loan.

Defeasance was mostly used on CMBS loans. This calculations are so complex that defeasance companies have sprung up to help borrowers accomplish this feat.

With US Treasury yields at low levels, investors have to purchase massive amounts of Treasuries in order to generate a yield to replace their interest payments.

This additional cost limits the ability of an owner to refinance or sell their property.