Making Lemonade

Thursday, March 4, 2009

"Dislocations and carnage like this yields lots of human suffering," said developer Jon Davis. "But if history is any indicator periods like this also yield opportunity ... to create new wealth."

Davis, chief executive of The Davis Companies, moderated an oversubscribed NAIOP breakfast event this week, "Finding Opportunities in Distressed Debt: Turning Today's Lemons into Tomorrow's Lemonade," at the Mandarin Oriental Hotel.

"The wave of distressed debt has swung through the Sunbelt and South and is on the way up the East Coast," said Doug Landry, a principal at Vanasse Hangen Brustlin, Inc., sponsor of the event.

The Mandarin for some reason couldn't handle 400 people and PowerPoint screens in the same ballroom, so eager real estate execs followed along, reading the tiny type on printed handouts.

Beside the fact that there's little money available to borrow, values are unclear, and there's something of a standoff going on. "The odds are the sellers are going to give before the buyers do," said Davis. "So there's going to be a change in cap rates."

David Iannarone, managing director of CWCapital Asset Management, said he measures business by how busy the air shuttles are. They haven't started canceling flights yet, but, "I pretty much sit wherever I want." Another measure is the look of business men, who tend to quit wearing ties when they're prospering. Looking out at the crowd, he said, "I'm sorry your businesses aren't doing well."

CWCapital Asset Management is the asset management and special servicing company of CWCapital Financial Services, a commercial mortgage company, and is special servicer on more than $175 billion in assets and loan manager for more than 15,000 loans. CW Capital has offices in Needham and in New York and Washington.

"There's a general fear we'll all turn into Japan," and this will last, Iannarone said. The problem is nothing is selling. "Until you start moving assets out you will not see the bottom. There is a problem beyond real estate."

CWCapital handles a lot of bridge loans, but as Davis noted those loans are now often "bridges to nowhere." "As a general rule, we're looking for the borrower to put money into it," said Iannarone. "We do not do 'hope'. That's not part of our business plan."

The other big group CWCapital deals with is CMBS, conduit loans repackaged into commercial mortgage-backed securities. The master servicer is the guy you deal with when things go well; the special servicer gets it when they don't, and that's CWCapital's business. Iannarone said he thought commercial real estate would lose 30 to 50 percent from its 2007 peak value.

Pam McKinney, principal of Byrne McKinney & Associates, Inc., which has the unenviable job of appraising properties during a period when there are few transactions, said the drop would be 25-40 percent "for the worst of it." "The best there is is the least impacted" -- that standard "certainly continues to hold," as in the past, she said.

How do things get valued? "We're shifting to putting more reliance on income valuations," she said. "We are certainly expecting and have been seeing our institutional clients writing things down," in some cases for 2-3 years already, more aggressively in the last 6-8 months. "Institutions are not approaching a cliff like they were last time."

Attention has of course shifted from development to refinancing and institutional valuations, she said. "The current downturn's going to play out more slowly and indifferently than it did in the early '90s," McKinney said.

Boston -- unlike the Las Vegases and Miamis -- has avoided overbuilding this time.

"We don't really know what to expect on the regulatory side," she said. "US regulators may not even call the tune, given how much debt is held" offshore.

The big question immediately is less "what" the value is than "When is the value going to be more advantageous? We're on the front edge of that here in Boston."

Paul O'Donnell, a partner at the law firm Hinckley Allen & Snyder LLP, said, "We're not seeing the rush of activity you might expect. People say it's coming."

Some are terming what's going on today in troubled assets "workout light." "Lenders are not being as aggressive as they were in the last downturn. We have to reevaluate what we consider distressed debt."

In some cases, "There's nothing wrong with that loan, but frankly the banks want those loans of their books," because the property is valued at less than it used to be. Vicious cycle.

"Fear dominates the airwaves," O'Donnell said. "There's no debt financing for companies when they go into Chapter 11, so they're turning rapidly into liquidations."

O'Donnell recalled author Tom Wolfe's image in "A Man in Full," the character who wore a skull and crossbones on his suspenders and turned he heat up on the hapless borrower. Not the case today, he said, as "deal lawyers become workout lawyers."

Jay Hart, managing partner of CrossHarbor Capital Partners, explained DIP loans -- debtor-in-possession financing that a company gets when it is in bankruptcy and needs capital. It gets senior priority among lenders.

In the 1990s, Hart said, the emphasis was NPA, or the ratio of nonperforming assets to total assets. Now, "TCE, or tangible common equity," is what they focus on."

Davis said an estimated $1.4 trillion dollars has to roll over in the next four years, or somehow be addressed. The Davis Companies, one of the largest privately held real estate firms in New England, has a portfolio of 4.5 million square feet and now has a portfolio of $150 million of mortgage loans, which it has acquired and is servicing.

The panel agreed that one of the big problems with Washington's solutions so far is the details aren't being explained. "The horror show for me is Barney Frank being the chief loan officer, and nationalization might lead to that," said Hart. "There isn't enough balance sheet in the world to cover all these loans."

Hart described on specific resolution: A portfolio of construction loans of $732 million at an Arizona bank was bought by a Minnesota bank -- for 28 cents on the dollar.

In another case a $15 million loan on an unanchored Las Vegas shopping center wasn't deemed worth $1.5 million.

But, he said, "There are performing loans out there that trade."

"We try to preserve the existing debt on the property," said Iannarone, because some debt actually makes property more valuable. "We can't always do that."

O'Donnell said he agreed with the recent sentiments of Warren Buffett: "We're going to swing back from these complicated financial instruments and derivatives. The opportunities are going to be in the basics."

For those with cash, "The opportunities out there are incredible right now," said Hart.

Iannarone said some borrowers are out of cash. "You can put money and work with them for equity. You're going to work harder for your money," but, "There's money in the smaller assets. People focus on the larger assets."

Hart also defended TARP, the money shoveled to the big financial institutions last fall. "People say TARP didn't work. If we didn't have that there would be bread lines around this hotel."

But the Obama administration needs to provide those details. "As long as I don't know the plan, things will remain locked up," he said. "I'm not going to sell an asset if there's a chance Washington is going to pay me par."

"It's confidence," said McKinney. "There isn't any."

"It's taking too long," said Iannarone. "It doesn't have to be perfect. We have to get to the bottom."