The hotel industry is undergoing major stress. With incomes down and unemployment up, families are vacationing less. Fewer vacations means lower hotel revenues.

Many hotels were bought or sold during the height of the commercial real estate market. Take for instance the Casa Madrona Hotel in Sausalito, CA, which sold in 2005 for an estimated $20 million.

The San Francisco Business Times is reporting:

Sausalito’s Casa Madrona was sold at auction today for a reported $11.4 million — the estimated opening bid.

The article also mentions that this one hotel supplies almost half of Sausalito’s hotel tax revenue. It is no wonder why so many city and county municipalities are in trouble.

The news out of New York today is that:

A group led by Tishman Speyer Properties has decided to give up the sprawling Peter Cooper Village and Stuyvesant Town apartment complex in Manhattan to its creditors in the collapse of one of the most high-profile deals of the real-estate boom.

The decision comes after the venture between Tishman and BlackRock Inc. defaulted on the $4.4 billion debt used to help finance the deal. The venture acquired the 56-building, 11,000-unit property for $5.4 billion in 2006—the most ever paid for a single residential property in the U.S. The venture had been struggling for months to restructure the debt but capitulated facing a massive debt load and a weak New York City economy that has undercut rents and demand for high-priced apartments.

via Tishman Venture Gives Up Stuyvesant Project – WSJ.com.

Unfortunately, this deal was done at the height of the market. The owners were expecting to be able to raise rents on many of the units to market rates. A lawsuit by tenants halted the owners’ plans and eventually the tenants won.

The interest reserve ran out earlier this year and the owners decided to turn the keys over to the lenders.

Now the property is whispered to be worth only $1.8 Billion, less than half the purchase price and less than half the $4.4 Billion debt used to finance the project. Many of the lenders are going to lose money on this project as well as the loss to the equity investors.

This project should serve as a monument to commercial underwriters to be careful when using forecasted rental income to determine value.

(Photo: stuyvesant town by dandeluca)

Page C1 of today’s Wall Street Journal is reporting that Blackstone Group, LP and CIM Group are attempting to acquire commercial real estate assets by buying the mortgages for a steep discount.

Private-equity firm CIM Group has teamed up with New York developer Harry Macklowe to help him regain control of what is regarded as one of the most valuable vacant lots in the world, according to people familiar with the matter.

This strategy is being used in a number of transactions. The success of this strategy depends upon the lenders willingness to take a loss on the property. Lenders that are in need of cash or understand that they are underwater on a property are more likely to take a discount.

In the case of the Drake Hotel site, a vacant piece of land doesn’t offer a lender much to work with. When Mr. Macklowe bought the lot it had a hotel on it which is more marketable. A lender is likely going to avoid a situation where they have to develop a piece of land.

The WSJ article also quotes Keith Barket from Angelo, Gordon & Co., a private-equity firm. Mr. Barket believes that the deleveraging of commercial real estate will take 3-5 years to complete.

It will be interesting to see if it does.

The problems with commercial real estate do not appear to be over. See TARP Panel Says Smaller Banks May Need Fresh Capital Update1 – Bloomberg.com

Smaller U.S. banks may need $12 billion to $14 billion in additional capital to cope with troubled loans still on their books, the Congressional Oversight Panel said today in a monthly report.

The weakness of smaller banks is evident in the number of banks that have been closed by the FDIC. That’s not to say that only small banks are being affected. Corus Bank seems posed for an eminent FDIC takeover.

Mish details the woes of some of Georgia’s banks in Zombie Subdivisions and “Pig In The Python” Shadow Inventory.

The Atlanta Journal Constitution is reporting fire-sale prices on some lots have dipped to 20 to 30 cents on the dollar as the Volume of ’subdivision’ vacant lots overwhelms banks.

You think it’s hard selling a house these days? Try unloading a subdivision. And not just any subdivision, but one with few if any completed homes and a weedy patch where the swim-and-tennis center was planned.

That’s the reality many Georgia banks find themselves in amid a foreclosure crisis that has claimed not only individual homes but also entire failed developments.

Real estate investors are seeing their equity erode. This is causing some of them to threaten/warn of imminent default. And we may continue to see more of these defaults as time goes on.

Phoenix From the Ashes?

The Dirt Lawyer may have identified the silver lining in all of this where he writes:

While I agree we are waiting for some properties to “die,” in a sense, I take a more phoenix-like perspective to the whole thing. After all, the property is reborn by its transfer to a new owner. So I like to think of this as the bottom of an evolutionary cycle, after which a lender dumps the property to a new buyer on the cheap or holds it for a while. As I keep saying, however, the problem, at least for many prospective buyers, will be finding money, because traditional lenders are not lending much and the CMBS market — well, we’ll see when or if that phoenix arises.

Where is the Market?

One of the most difficult tasks for commercial real estate professionals is determining where the market is today. Too few transactions, too much distress, unrealistic sellers, and opportunistic buyers make the demand for property and the proper pricing of property an exercise in futility.

Determining a rate of return commensurate with risk is difficult in these uncertain times.

Three news stories illustrate this point.

Retail Center in Vallejo, CA

GlobeSt.com is reporting that the First Grocery-Anchored Sale Closes, More to Come. The article details the sale of a 66,000 square feet Safeway anchored center in Vallejo, CA.

According to the article the property sold based on a 7.71% cap rate on current NOI. As well, the seller had an assumable loan at below market rates providing an attractive cash-on-cash return for the buyer.

The cash yield seems to be the bigger selling point. Dan Wald of Terranomics said that investors are requiring a 10% cash yield on investments.

While this property gives us an idea of the value, it is not a firm indicator. This center is well located at the entrance to a housing development. A superior location would induce a buyer to pay a higher price for the lower risk.

AIG Headquarters in Manhattan

CPN is reporting that the AIG Headquarters Sale Makes Splash in Quiet Manhattan Investment Market. (HT: David Stejkowski)

Youngwoo & Associates (YWA), a New York-based investment and development firm, together with Kumho Investment Bank (Kumho), entered into an agreement to acquire the AIG building, 70 Pine Street (pictured), and an adjacent office building, 72 Wall Street. The two buildings will total 1.4 million rentable square feet in the heart of Manhattan’s Financial District.

The rumored salesprice is around $100 million. This would value the property at around $100 per square foot.

While this may be the biggest acquisition in New York, the entire property is going to be vacated once AIG is wound down. This again doesn’t establish a firm enough foundation for other investors.

Office Building in Orange County, CA

The WSJ has an article explaing why Maguire Sells Office Site at 40% Off.

Maguire Properties Inc., a struggling Los Angeles-based real-estate investment trust, sold a newly developed office building in Irvine, Calif., for about $160 million, a price representing an estimated 40% discount to its construction cost.

The price of 3161 Michelson Drive, during a lean year for commercial real-estate sales, is the latest sign of the severe drop in values in the commercial real-estate market, which is threatening to become a major anchor around the economy just as it is struggling to come back to life.

This property like the AIG bulding suffers from vacancy issues. As well the seller was under pressure to reduce their debt load and needed to sell the asset.

The Bottom Line

Each of these sales while indicative of the current market demand and supply are not conclusive enough to determine a market pricing strategy.

Until owners begin to sell non-distressed assets, market pricing will be a moving target.

CoStar interviewed Hessam Nadji, managing director of research services for Marcus & Millichap Real Estate Investment Services, asking him his thoughts on the current recession.

Here are some of his thoughts on the length of the current recession:

We think job losses and the recession will end in 2009. We’re expecting that job losses will bottom by the third quarter, perhaps into the fourth quarter. For 2010, if you look historically, we’ve had plenty of instances where sharp declines and severe and sudden recessions have been followed by years of growth spike and better-than-average growth — especially the first year after a recession. But this time around, we still have a significant amount of consumer debt to unwind and we’re still dealing with a lot of headwinds in housing and corporate debt. I don’t think 2010 will bring an economic spike.

Nadji acknowledges that retail is going through some issues and may not recover until 2011 or 2012. He ascribes this to a problem of overbuilding in the retail sector.

On Distressed Property

We also need to know how much distressed inventory is going to appear and move through the market. I believe a lot of buyers with lots of cash are sitting on the sidelines looking for signs of an economic bottoming and waiting to see the scale of distressed property sales. Over the next six months, we’re going to get a better reading on the market because both financial institutions and owners of properties are still having stress and they’re going to have to decide what to do with those assets. I think there will be more motivation to sell at more realistic prices than there was a year ago.

…

One or two high-profile deals are not going to refine the market. Its going to take a little more volume, and a sampling of different asset sales in different places starting to trade, for it to become more of a widespread conviction that it’s time to get back in.

Using Cap Rates in Today’s Market

Nadji that cap rates are not as important as they once were in the realm of commercial real estate.

That’s not to say that no one thinks about cap rates anymore — they certainly use it as a metric — but you have to look at return on cash, number one, and using the new underwriting parameters to clear this market for financing, which requires more equity up front and much more realistic rent growth projections and occupancy projections. That would lead you to look at the return on investment for years year one through three in terms of cash flow, which is right now far more important than just a cap rate, which you can come up with in so many different ways.

RTC 2.0?

Nadji doesn’t believe that the current recession and distress in commercial real estate will lead to a second coming of the RTC.

Rather, the forces are working to minimize foreclosures, and therefore this notion of an RTC 2.0 that will bring quality assets to market at huge discounts may not materialize the same way.

He suggests that there are still quality deals available that have cash, can underwrite to today’s rent and occupancy rates, and are seeking to add value to their projects.

BusinessWeek is reporting that California’s Foreclosure Notices Soar.

Lenders filed a record number of mortgage default notices against California homeowners during the first three months of this year, according to the research firm MDA DataQuick.

The company blamed the recession and of lenders playing catch-up after a temporary lull in foreclosure activity. A total of 135,431 default notices were sent out during the January-to-March period, an all time high in the  company’s database which goes back to 1992. That was up 80.0 percent from 75,230 for the prior quarter and up 19.0 percent from 113,809 in first quarter 2008, according.

According to the DQNews.com article Golden State Mortgage Defaults Jump to Record High:

The median origination month for last quarter’s defaulted loans was July 2006. That’s only four months later than the median origination month for defaulted loans a year ago, in first quarter 2008. That suggests a period where underwriting criteria were particularly lax.

Of the 3.7 million home loans made in 2004, less than 1 percent have since resulted in a lender filing a default notice. Of the 3.7 million loans originated in 2005, 4.9 percent have triggered a default notice so far. Of the 3 million in 2006, 8.5 percent have so far resulted in default. A particularly toxic period appears to have been August through November 2006 which had more than a 9 percent default rate. Of the 2.1 million loans made in 2007, it’s 4.6 percent – a percentage that’s likely to rise significantly during the rest of this year.

The lending institutions with the highest default rates for loans originated in August to November 2006 include ResMAE Mortgage (69.9 percent of loans resulting in a default notice), Master Financial (64.6 percent) and Ownit Mortgage Solutions (63.6 percent). Of the major lenders, IndyMac has a default rate on those loans of 18.9 percent, World Savings 8.0 percent, Countrywide 7.7 percent, Washington Mutual 6.3 percent and Wells Fargo 3.4 percent. Less than 1 percent of the home loans originated in late 2006 by Citibank and Bank of America have since gone into default.

The DQNews.com article also reported:

Foreclosure resales have emerged as a significant market factor, accounting for 58.1 percent of all California resale activity last quarter. A year ago it was 33.1 percent. Foreclosure resales varied significantly by area, from 13.0 percent in San Francisco County to 80.8 percent in Merced County.

Real estate values have not settled in California. This new “wave” of foreclosure notices is going to cause uncertainty in the markets for a while. This combined with the “shadow inventory” of as many as 80,000 homes reported by SFGate.com will keep prices depressed and may drive them lower.

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.

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)