Some finance industry analysts have predicted that there will be a wave of commercial real estate defaults in the coming years as borrowers struggle to refinance amid tighter lending standards and a decline in property values. Alan Doyle of Larew, Doyle & Associates Inc., a boutique firm that serves an intermediary to real estate capital markets, answers five questions about the future of commercial real estate lending.
PBN: What will the impact be if there is a wave of defaults in the coming years? Is it the “ticking time bomb” that the news media has portrayed it to be?
DOYLE: Phrases such as “ticking time bombs” and “toxic real estate assets” clearly fan the flames of anxiety where it concerns commercial real estate. While the world won’t be coming to an end anytime soon, there unfortunately will be good reason for concern as many predict an increased flow of loans being transferred into the “managed assets” area of banks, insurance companies, etc., with a sustained recovery not expected for another 24-plus months.
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PBN: How are banks’ real estate portfolios holding up?
DOYLE: Currently, the loan portfolio of banks and many select insurance companies are doing quite well, as nonperforming assets represent only 2 to 5 percent of their portfolios. However, many noted professionals have indicated that in the next 12 to 24 months we will see the significant erosion in net operating income generated by these properties to meet their mortgage payments, as tenants shrink their space requirements to weather the ill effects of the economy, thereby causing what many have described as an “NOI avalanche.” When this starts to take place, it will push many currently performing loans into lender’s workout departments because the property can no longer generate sufficient cash to meet its monthly mortgage payments and/or the value of the property has dropped such that it no longer meets its required loan-to-value margins.
PBN: How did we get to this point?
DOYLE: The systematic dismantling of the commercial and consumer mortgage backed security (CMBS) markets rated by agencies, many of which were clearly asleep at the switch. On the commercial real estate side, CMBS originators, REITs (Real Estate Investment Trusts) and hedge funds pumped over $270 billion in mortgage finance markets in 2007 as compared to less than $20 billion in 2008. As defaults of mortgage-backed securities mounted in 2008, investors lost faith in the rating agencies profiling of risk and pulled out of the mortgage-backed securities market and are either sitting on the sidelines or have shifted their investment appetite to private placements.
On the consumer side, our well-meaning politicians who believed that homeownership was a right instead of an earned privilege, watered down the lending requirements of one of the nation’s largest residential mortgage buyers [Fannie Mae], enabling borrowers who previously would not have qualified for home mortgages to borrow vast sums of mortgage debt well in excess of their financial means. Again, in many cases these mortgage-backed securities were improperly risk-rated by rating agencies, as evidenced by a staggering level of residential mortgage defaults nationwide.
Inventory of new homes and commercial real estate grew quickly to feed the almost insatiable appetite for both given the readily available access to real estate capital over the past many years, all of which has come to a screeching halt by early to mid-2008 as a result of this sudden contraction in liquidity.
PBN: What is the outlook?
DOYLE: Over the next 24 months, not wonderful. With a reported $40 billion to $50 billion in commercial mortgages maturing in 2009, and another $190 billion to $200 billion coming due in 2010, it’s no surprise that lenders have already begun staffing their workout departments and highly skilled private groups such as Providence-based New Providence Group have become very much in demand in assisting lenders getting their arms around this flow of loans into their workout departments.
PBN: General Growth Properties, which owns the Providence Place mall, has filed for Chapter 11 protection. What went wrong for them from the financing end of things?
DOYLE: [Back in December], I had already felt that bankruptcy was the likely outcome. It’s no secret that the former CEO John Bucksbaum, the hard-charging son of the co-founder of General Growth Properties, couldn’t have picked a worse time to go on a shopping spree – acquiring the planned residential community and retail mall giant, the Rouse Company for $14 billion in a highly leveraged transaction in 2004. In the present environment in which demand for residential housing and new construction has come to a screeching halt; consumer spending has been substantially curtailed in response to eroding job security; and access to real estate financing has been truncated with the dismantling of the mortgage backed security “machine,” the chances of GGP working out their $8 billion in maturing loans outside of a bankruptcy setting was slim at best.
Despite GGP filing for bankruptcy protection, the continued viability of the Providence Place mall has little to do with their bankruptcy process and everything to do with local consumer spending habits. Therefore, GGP’s adverse financial condition will have no bearing on the viability of its regional malls.
