Ed Padilla

Finance: Still Paralyzed

Jun 222009

For approximately 12 months, conventional wisdom has suggested that the wide bid-ask separation between sellers and investors would soon disappear and transaction activity would significantly increase at a lower pricing point. Continued deterioration of fundamentals as evidenced by a steadily increasing CMBS delinquency rate (now at 2.1%) would seem to support this forecast. But, as if defying gravity, transactional activity remains stagnant with capital ready to invest but not enough sellers willing to sell at price points required by investors.

There seems to be several explanations for this continued paralysis. Existing assets (equity and debt) are generally held by more strongly capitalized owners than during past downturns, enabling these owners to hold assets until the economy starts to recover and capital markets become more liquid. Government infusion of capital has strengthened financial institutions’ balance sheets thereby reducing pressure to sell assets at substantial discounts and making loan extension and restructuring more likely. Delinquent CMBS loans are turned over to special servicers who often hold the subordinated bonds and, to the extent permitted by the documents, would rather restructure or hold assets than sell at prices that would wipe out all but the senior position.

So the bid-ask remains wide and activity remains stagnant. Will this continue until current owners’ perceived values are supported by a recovering economy and more liquid capital markets or will more owners need to market assets at lower prices indicated by some recent trades? Let us know what you think.

Business Management: Words of Wisdom

Business Management No Responses »

Jun 082009

Here are some words of wisdom from a mortgage banker who has been through the cycles before. They hold truths for everyone in the real estate business, not just mortgage bankers. Whether you have been through tough times or not, you will get something out of these suggestions.

1. Don’t wait for the phone to ring. Pick it up and set up meetings.

2. Stay close to your lenders.

3. Chase relationships not deals.

4. Find the new buyers.

5. Be responsive.

6. Be an expert and know what you can get done.

7. Don’t get down. And if you get beat, get up, dust yourself off and get back in the game.

8. Remember, in any field there is the 80-20 rule: 80% of the business is done by 20% of the people. Be in the 20% or find a new field.

9. Remember, you are in this business by choice; strive to be your best.

10. Market and brand yourself. Your name should be known by every real estate professional in town.

11. Suppress your ego. You are a service provider. Be humble and the best at bringing people together and you’ll be rewarded.

12. Always check before you give an answer of “No, I can’t” or “Yes, I can” get that done, unless you know for sure.

13. Don’t be a zombie. Zombies show up every day and go through the motions but they are the walking dead. Know what you need to do each day to drum up new relationships and do it.

14. Stay organized and follow-up.

15. Don’t take any relationship for granted. There are a lot of hungry competitors that are calling all your clients. Make sure you inform your clients about new sources before they hear about them from someone else.

16. Have (in writing) 4 or 5 simple goals to accomplish each day that lead toward your long term goal.

17. Be at ULI, ICSC, NAIOP, etc. and network.

18. Celebrate your accomplishments!

Economy: We Forgot About Risk…Again!

Economy No Responses »

Apr 272009

I recently attended a conference where a speaker offered his theory for the cause and severity of the current financial meltdown. He said, “The ‘fuel’ for the downturn was a huge savings glut that required investment and the “oxygen” was a systemic ignorance of risk.” This is not a new story, but the size, scope and number of businesses and asset classes impacted has been far greater than previous ones. Margins and returns were razor thin and 30-1 leverage was utilized by some for purchase of assets. Investment decisions were based on the notion that values had almost no prospect to fall and capital would flow freely for expected investment periods.

Will lessons be learned or will memories become short after the recovery, now forecast by many economists for the first half of 2010? Will more federal regulation and oversight be required to “assist” in minimizing future bubbles?

There will be a need for some additional action by regulatory authorities. As far as the financial markets generally, additional capital requirements and transparency for such financial instruments as credit default swaps should be considered. In the CMBS world, the selection of rating agencies for specific transactions by a government related entity, i.e. the SEC, may be necessary to help revive bond buyers’ confidence.

Do the readers think this additional government oversight is needed? What are your suggestions?

Finance: Musical Chairs – Managing and Matching Debt to Real Estate

Finance No Responses »

Apr 202009

Where were you when the music stopped? More hard lessons are being learned every day in our industry about the risk of high leverage short term debt. As tempting as it is in good times to leverage development and acquisition activity with short term lines and other high leverage debt, the price can be very high in a downturn. Commercial real estate and short term exit/finance strategies are not a good match.

NorthMarq Capital’s mortgage servicing portfolio of $37 billion is comprised largely of fixed rate transaction based financing with staggered maturities. Even our shorter term financings that we now service were generally conservatively underwritten. Our overall 30 day delinquency rate is slightly over 1.0%. We cannot overstate how fortunate we feel that our clients largely chose to finance their properties in this manner.

Many commercial real estate owners are in the enviable position of minimized exposure to the current credit/value crunch because they effectively matched long term fixed rate transaction debt at levels that cash flow even in today’s environment. The best operators staggered their maturities so that no more than 10% of their portfolios mature in any one year. Some owners kept their development/acquisition activity in balance with their financial capabilities. What may have seemed at one point as very conservative financial management now appears so prudent.

So why would anyone make that short term bet? The flexibility, pricing and ease of bank financing at the height of the market; the misplaced belief that the lender/banker will always be there to extend the loan at maturity; the confidence that one will see the point to sell or convert to more conservative financial structure before the music stops and values drop? In the rear-view mirror all those concepts look ill-conceived. Some refused to make the bet.

What did those owner/developers see or believe that others missed? Perhaps the simple understanding that values don’t always go up. YES, IT IS POSSIBLE THAT VALUES OF ANY PROPERTY TYPE WILL BE LOWER IN THE FUTURE. Seems fundamental, but some are just now admitting to the concept. Whether we are talking commercial real estate or any other asset, the hard lesson is that values have always been cyclical and always will be. If you can time the market, high leverage can work. If you guess wrong, creditors will occupy your life. Maybe we forgot these basic concepts because the positive run had lasted so long; many were not even around to see the last meaningful downturn from 1989-1991.

It is a luxury to focus on cash flow and not worry about values in this down cycle. Some real estate owners are in that situation but in most cases it’s no accident they had their chair picked out before the music stopped.

Economy: Unsung Heroes at Freddie Mac and Fannie Mae

Economy No Responses »

Mar 302009

The multi-family divisions of Freddie Mac and Fannie Mae – “the other side of the house” – rarely receive the credit due to them. It is estimated that 22-28% of American households live in rented homes. The large majority of these households fall squarely into the lower to middle income brackets. Their ability to find safe, well maintained rental communities often depends on the health of the apartment market. Critical to that marketplace is the availability of debt that helps finance the construction and acquisition of rental communities. Clearly, apartment operators/owners are willing to invest in rental properties if they have confidence in the availability of capital and ultimate value of these properties.

Not only have Freddie Mac and Fannie Mae dominated this marketplace maintaining the flow of capital while others have left, they have done so while maintaining exceptional underwriting standards and related loan delinquency performance. In fact, their delinquency rates are consistently well below 1% and each multi-family division makes hundreds of millions of dollars of annual profits.

Unfortunately, the multi-family divisions are frequently overlooked as the continued political fallout is on the homeowner/residential side of the businesses. In fact, if the residential sides of Freddie Mac and Fannie Mae were in such good financial shape as multi-family, the political conversations would be dramatically different. Speaking as one company who produces those apartment loans for Freddie Mac and Fannie Mae, let’s hope our representatives in Washington do not inadvertently hurt an effective division as they try to deal with the other side of the house.

Finance: Where Will Needed Debt Capital Come From? Can CMBS Make a Comeback?

Finance No Responses »

Mar 232009

Over the next several years, hundreds of billions of debt capital will be needed to refinance maturing loans, and when market fundamentals rebound, additional debt will be needed for new acquisition and development projects.

The future role of the agencies, which provided a lion’s share of debt capital for the multifamily market, is somewhat uncertain as the present conservatorship expires at the end of 2009. Smaller regional and community banks have begun to provide some debt but larger banks remain paralyzed. The number of insurance companies providing debt has diminished and the ones quoting are very conservative. But even if non CMBS sources start to approach “normal” volumes, that still falls short of the expected demand.

The securitization of commercial and multifamily mortgages is critical to providing needed liquidity and, after the market for existing CMBS paper strengthens and market fundamentals stabilize, I expect CMBS new origination to occur, hopefully by 2011. But, in my opinion, prior to a CMBS comeback certain underwriting and regulatory changes will be required for the return of bond buyers’ confidence. These changes include:

* Underwriting needs to adjust from the past to reflect the risk of commercial loans. This will require originators to have to “skin in the game” and not be rewarded simply on volume of securities packaged and sold.

* Rating agency models need to be more conservative with more attention made to the underwriting of individual loans rather than the past reliance on diversified pools and subordination levels.

* REMIC laws need to be revised to allow for greater special servicer flexibility on such matters as extensions, restructurings, assumptions, and the post closing collateral adjustments.

* Some exceptions from market-to-market accounting should be considered for investors electing to limit their ability to sell bonds for some time period.

So, what do you think? Will CMBS come back? What changes do you anticipate? Let us know your thoughts.

Economy: Sector Slicing or Market Dicing?

Economy No Responses »

Mar 162009

Let’s stop talking about how bad everything is for awhile. Let’s think about getting onto the next phase: Recovery. I’m not suggesting the “when”, because we have all heard pundits taking shots at that. The range I have heard is somewhere between 6 months… and never. That’s probably correct. I would like to solicit opinions on how the recovery will start, not when. Will it be a regional thing? Will the Southwest (Phoenix, Vegas, etc.) lead us out the way they led us in? Or will the Rust Belt get a huge boost from the governmental incentives to the auto industry? Will California lead us out, just because they are so big, and just so cool? Or Florida? New England?

If you think the recovery will come from a part of the country, or the world, let us know by sending a reply to this blog. We are looking for interaction.
If not a region, will it be a sector? Multifamily seems to be the last sector standing. Will it be like accounting…Last in, first out? Or will the stimulus plan take hold in Industrial real estate first? If you think a particular sector of the commercial real estate market will show life before the others, let us know. Take your pick and give us your reasons by placing a reply on this blog.

Finance: Government Policy Reinforces Irresponsible Behavior

Economy, Finance No Responses »

Feb 242009

Do you ever feel alone when you read or watch the news? The only one paying income taxes at the prescribed rates? The only one that resisted the urge to buy a bigger house? The only consumer that lives within your financial means? The only business or investment manager with morals and ethics? The only one that is not looking for a government bailout? The only one not getting anything from the bailout?

You are not alone. In fact 80-90% of Americans are with you. 80-90% pay taxes and their home mortgage and hope the government covers the core areas we expect them to cover. Unfortunately, we watch personal and corporate irresponsibility get confused with those that are rightfully worthy of our help. Yes, some people were taken advantage of, some are so unfortunate that health issues or job issues have caused them harm and yes, we need to protect those victims of predatory financial practices. You could even go so far as to say that some companies are long time American success stories and may need a hand to reach those levels that allow them to continue to employ our neighbors and pay taxes; and yes, we should reach out to help all of them, if it is in our collective interest.

However, too often we see the government rushing to the rescue of the undeserving. Whether it’s real estate speculators, bank executives, businesses without a viable model or the family in the bigger house with the fancy cars that lives well over the edge of financial responsibility, why are we there to bail them out or otherwise give them tax advantages? Is it in our collective interest? Are we reinforcing behavior that we find admirable? Where is the logic of “saving” firms that created unsustainable entitlements for themselves? One scary thought is that those responsible to decide where the bailout money goes are the same politicians that have the United States on a similar track as the U.S. auto industry – a model burdened with entitlements and financial mismanagement that ultimately is not sustainable.

Personal responsibility and accountability seem to be pushed aside for the risk-taking executive, the incompetent and the overleveraged consumer who knew or should have known that there was risk associated with their behavior. During the good times those individuals reaped the rewards. Now they stand with hands outstretched looking for compensation as shareholders are wiped out or for debt forgiveness as other Americans continue to make their payments as agreed. I don’t pass judgment on the behavior; risk takers are rewarded when they are right. But why are we bailing them out when they were wrong?

What Can We Expect From The ‘Stimulus’ Package?

Economy, Finance No Responses »

Feb 162009

Don’t expect government infrastructure jobs to bail out the commercial real estate industry. A recent story on the Inland Empire area of California shows the limitation of a government-created job market. The 9.5% unemployment rate in the area matches Detroit as the worst in the nation. At the same time, Riverside (one of the Inland Empire communities), has almost $1 billion worth of public-works projects underway or planned, from widening roads to building a new jail. The area illustrates both the promise and the limitations of President Obama’s spending proposal to pull the U.S. economy out of a recession through government infrastructure projects. The commercial real estate market will more closely follow unemployment and investment in the sector, not infrastructure spending.

The fundamental economic problem cannot be solved by government employment and contracting. You don’t have to go far for an example. I visited Havana, Cuba a few years ago and as I watched thousands of people out walking and chatting into the early morning hours on a Tuesday night, I asked my uncle who was born and still lives in Havana, “Don’t these people have jobs to go to in the morning?” He responded, “We all have jobs. We all work for the government. Tomorrow we’ll get to work around noon and do the same thing we are doing right now – chat.” The city of Havana looks like something out of a zombie movie with buildings falling apart after decades of neglect and decay and people spending most of the day without any particular purpose other than looking for something to eat. The system is so dysfunctional Cuba actually imports sugar, one of the few natural resources it enjoys and formerly its largest export. Now the Cuban government’s most effective resource is asking others for aid.

Ultimately the private sector will carry most of the weight to resolve the recession. America needs to make something, invent something; we need to provide a service with value. The government must put more effort into making it compelling to invest, grow and create an environment where businesses are motivated to hire and consumers have the confidence to spend.

Investment and spending will drive us out of this cycle. Uncertainty, fear and lack of confidence along with expanding the national deficit and debt will prolong it.

CMBS Redux?

Uncategorized No Responses »

Feb 062009

Perhaps the biggest challenge the Commercial Real Estate industry faces right now is the lack of capital. All those billions of dollars pumped into the system over the last 10 years by CMBS have evaporated. In many ways, there was too much money. That led to heated competition among lenders to “win” deals by increasing loan-to-value ratios and reducing underwriting requirements. It also was a huge factor in the rapidly increasing prices paid for real estate as low interest rates allowed cap rate compression. I don’t have a crystal ball. I have more questions than answers. But perhaps some of the readers can chime in this week.

Where is the money going to come from? Will CMBS ever be back? If so, how will it be structured? I have heard talk about guarantees, either by the government or private sector entities, of triple-A traunches in order to restart the engine. Does that make sense? Where are these guarantors going to get the kind of liquidity for those guarantees to be worth anything? If it is government, what is in it for the government? What’s in it for the taxpayer? What kind of oversight is needed? How will Rating Agencies get paid?

Let’s hear from the readers this week, even if it is just to ask more questions.