Inside commercial hard money lending.
The FDIC has leased 200,000 square feet of space in Irvine. I wonder if this is a sign of things to come or just a coincidence?
FDIC to open temporary office in Irvine – Los Angeles Times.
(HT: Calculated Risk)
There are a couple of key points:
# as vacancies are rising, rents are falling – and any commercial loan based on a overly optimistic (added) "pro forma" analysis is in jeopardy of default.
# new non-residential investment in offices, malls and hotels will slow sharply.
As example, in Chicago there are several new buildings just being finished:
Adding to the vacancies, three major developments are due for completion next year, flooding downtown Chicago with another 3.6 million square feet of office space.
But the good news for landlords – and bad news for construction related businesses – is there are "no new office buildings on the horizon for 2010 and only one … planned for 2011." This fits with the Architecture Billings Index released earlier today.
I’ve written before about the government’s unintended consequences.
Today we read:
As we mentioned yesterday, a bit of a fight has broken out over whether it is irresponsible for journalists and others to advise homeowners about the options that the government’s bailout programs are opening up to them. But the fact is for a lot of homeowners it makes perfect sense to stop payments on mortgages…and it may even pay to stop any overtime work or have one of the earners in your household quit.
You Might Want To Think About Stopping Your Mortgage Payments and Reducing Your Income.
(HT:Tom Vanderwall)
Imagine that little retail center near your house.You know the one.
It has your favorite coffee shop, the weird home decor shop, a woman’s clothing boutique, the nail shop, and the national auto parts store.
Over the years you’ve seen the stores change. Different shop owners have come and gone. The coffee shop has been there for a while. The woman’s clothing store is only a year old.
As you drive by you notice a “Going Out of Business” sale going on in the home decor shop. You’ve talked with the owner of the woman’s boutique and she is having a rough time making a profit.
If these two stores close their doors, you wonder who is going to fill this space. What is going to happen to the owner of that little retail center? Where will he find tenants?
Americans are spending less money these days. We built our economy upon the model of consumption and borrowed to fuel that consumption.
With the well of cheap financing depleted, spending has come to a screeching halt. Retailers nationwide are taking a hit. The recent headlines have featured the likes of Circuit City, Mervyn’s, Shoe Pavilion, and Linens ‘n Things.
When a retail store closes or “goes dark” the landlord will feel the pain of having a vacant store. (Some leases do have a provision that stores can close but while the tenant continues to pay rent.) This means that she does not have as much rental income to pay the bills she faces for owning the property.
I shared here the most common method to value income producing property. The most important numbers to determine value are Net Operating Income (NOI) and the Capitalization (Cap) Rate.
Rental rates and the assumed vacancy rate will affect the NOI. NOI is then used to calculate the value of the property based on an expected return to the investor, the Cap Rate.
So how would a 10% decrease in rents, a 5% increase in vacancy, and a 1% increase in Cap Rate affect a properties value?
Notice that the value decreases by 26%.
Also notice that the change in the maximum loan amount decreases by $1.08 million. If the borrower needs to refinance under these new assumptions, the borrower will need to come up with over a $1 million to close the loan. The foreclosure process and bankruptcy are not far away.
Currently, some institutional lenders have begun to underwrite retail loans along the lines of this scenario. They are forecasting decreasing rents and higher vacancy rates.
Some lenders are incorporating a higher cap rate as well. (One developer I know said that he hasn’t started a retail project unless it underwrote at a 8% cap rate or higher because of historical cap rates, even during the boom times.)
Unless, a retail property absolutely must be refinanced now, the wise real estate investor would be best served to hold off until cooler heads prevail.
One of the major reasons that capitalism is successful and socialism or communism fails is that it takes into account human selfishness (sinfulness).
Each individual, barring some major spiritual catharsis, is going to do what is in their own best interest. The economic theory of capitalism takes this into consideration. Socialism denies this and believes that those in the central government WILL not act selfishly or shortsightedly.
Richard Thaler and Cass Sunstein argue that one of the major causes of this catastrophe was a failure to consider human weakness.
We think their mistake was to neglect the role of human nature. To prevent future catastrophes, regulators should focus explicitly on how to provide safeguards against two all-too-human frailties explored by decades of work in behavioural economics: bounded rationality and limited self-control.
The NY Times has an interesting article on the California town of Mountain House that sprang up during the housing boom. The first homes were sold in 2003 and according to the article 90% are underwater on their mortgages.
The NY Times also has a map of the locations where homes are worth less than their mortgages.
Thomas Cooley and Lee Ohanian argue that the road out of the cycle we are in should be marked by less regulation and less restrictive policies based in the reality of history and not the fiction of theory.
Brian S. Wesbury and Robert Stein detail some of the unintended consequences that government intervention has had in the current economic strain.
Take, for example, the extension of unemployment benefits enacted in June. Normally, jobless benefits are available for 26 weeks. The extension, which will last temporarily through early next year, added another 13 weeks. Following this, between June and October–in only four months–the unemployment rate has risen from 5.5% to 6.5%, a full percentage point.
What’s odd about the jump in the jobless rate is that it has been accompanied by an unusual increase in the number of people who say they are looking for work. Normally, when the unemployment rate leaps upward we see a decline in the share of the population either working or looking for work (what economists call the participation rate).
…
Another example of unintended consequences is the new ability of the Fed to pay interest on bank reserves, a policy it has long wanted to implement to give it more accurate control over monetary policy. Regardless of how much sense this policy may make over the long term, it may be undermining the growth of bank lending right now. Excess reserves by deposit-taking banks typically hover at about $2 billion. In October, these excess reserves were at $268 billion. So with one hand the government is injecting capital into banks to boost lending, but with the other it is enticing banks to hold extra cash as reserves.
During my morning reading two articles in the Wall Street Journal stood out to me and indicated that credit is not flowing the way that it had in the recent past.
I believe that this is a sign that the economy is deleveraging itself. We are likely in for a period of economic deflation followed by a period of inflation due to the governments massive printing of money.
First, this article regarding asset backed bond woes. These asset backed bonds are car loans, credit card loans, student loans, etc. wrapped up into bundles and sold to investors as a rated bond.
In October, only one deal of $500 million was sold, compared with $50.7 billion done the year before. That is a huge decline and means that far fewer consumer loans are being made. We should see a drop in consumer discretionary spending in the coming months.
Second, this article highlighting the rise in requests for trade financing to boutique firms. These boutique firms are thriving with the slow down in lending from banks.
One of the difficulties is that “They have no guarantee that the buyer’s bank will accept the seller bank’s credit because of solvency issues…”
Currently, banks don’t trust one another and do not want to lend to one another.
I believe that the government’s intervention has added to the problems.
The Fed began the term auction facility in December of 2007. This allowed banks to borrow from the Fed without other banks knowing who was borrowing. Borrowing from the Fed in the past had been seen as a last resort and a cause for concern to other banks. With transparency removed, banks become distrustful of one another and slowed interbank lending.
I mentioned here that banks are lining up to get TARP funds because they don’t want to have a negative public opinion, and not necessarily because they need or want the funds.
Until the government takes a “hands off” role to the current financial system, there will be fear, mistrust, and hesitancy that will prolong the economic downturn rather aid it.
Commercial Mortgage Lender for Owens Financial Group a California based hard money portfolio lender.
phone: (925) 280-5388
