Thursday, September 25, 2008

Even in Bankruptcy Buyers & Sellers Disagree

If you (like myself and many others) thought Lehman Brothers' bankruptcy would force them to sell off real estate assets at fire-sale prices think again. Even under the pressure of a very public meltdown Lehman was able to bargain with Barclay's to split the difference between two different appraised values on Lehman's million-square-foot, 7th Avenue Manhattan headquarters. An appraisal prepared for Lehman Brothers valued the building at $1.02 billion while Barclay's appraisal came in at $900 million.

This is a scenario we've been seeing a lot of in the markets in general, and until transaction volume picks up and the economy achieves some level of short-term stability we won't be surprised to see more and more variation among appraisals and values in general.

Llenrock Group

Wednesday, September 24, 2008

The Trouble with Marking to Market

At first read this article sounded like really good news for the economy in general and the real estate industry in particular. It's basic premise is that many banks' balance sheets look worse than they really are because of laws requiring them to 'mark to market' their mortgage holdings. After a few quarters of major write-downs most banks' balance sheets now represent a worst-case, fire-sale scenario even if they plan to hold their loans to maturity or work them out. Given the lack of volume in the secondary markets, it is often impossible to accurately mark these assets to market in the first place meaning that the write-downs we've seen so far are likely far from how things will eventually shake out. In some cases the write-downs will probably turn out to be insufficient, but in many other cases I suspect that a year from now banks will have extra capital freed when marked-down assets turn out to be more valuable than expected. Even Sam Zell points to this marking to market as a major cause of our current problems.

The bad news is that for now no one can tell what these assets are really worth so we must, by law, go with very conservative estimates. This means that even those healthy banks who don't need to fire-sale their assets look sick and will be restrained in new lending until things shake out and they know what their true balance sheets look like. This could take a while, so sit back and relax through the next few months, or if you're more proactive and sitting on a pile of cash get out there and pay top-dollar for mortgage assets and get these markets rolling again! Oh wait, I think Uncle Sam might just do that for you, that's fine...

Llenrock Group

Wednesday, September 17, 2008

What a Week...And it's Wednesday

During the past week we've had a whole year's worth of financial markets drama including the bankruptcy of Lehman Brothers, Bank of America's acquisition of Merrill Lynch, the last-second government bailout of AIG, and the subsequent drop in stock market values worldwide.

For the commercial real estate industry, this week should serve as a reality check for those who have refused to accept that property values must come down as the general economy continues to weaken. Any property owner with a Lehman Brothers mortgage, AIG property insurance, or with Lehman, Merrill, or AIG as tenants should be feeling at least a tiny bit nervous. On a more market-wide basis a huge amount of investor capital has been wiped out by the decline in the stock markets, and the capital that is left will be even more cautious about entering the real estate markets. This will mean even stricter underwriting for all types of investments going forward, and a continuing denominator effect for institutional real estate investors who are limited in the percent of their portfolio allocated to commercial real estate. We have already begun to see more onerous terms from some of the lenders we work with even while things are still shaking out.

The good news is that the disruption in the markets should finally force the sale of a significant number of assets and set new pricing levels that make sense in today's markets. Once investors figure out where prices are, under the new reality, transaction volume should increase going forward even if the dollar amount of transactions declines alongside pricing. We've already seen one 'distressed' asset sale due to Lehman's bankruptcy with Barclays' agreeing to buy Lehman's NYC headquarters along with two New Jersey properties for $1.5B.

As is always the case in a downturn there are certainly opportunities in the current turmoil, and finding them should provide for an interesting market going forward.

Llenrock Group

Monday, September 8, 2008

Fannie & Freddie - Winners & Losers

While early indications are that the GSE bailout announced this weekend will have little direct effect on Fannie Mae and Freddie Mac's multifamily lending, there will certainly be indirect consequences for commercial real estate. A few potential scenarios to keep an eye out for:

  • Today's drop in consumer mortgage rates to a sub-6% level not seen since mid-May could bring home-buyers back into the market. This would go a long way towards turning around the overall economy, but may hurt multifamily rental fundamentals given that some percentage of current renters are would-be homebuyers waiting for mortgage rates to improve.
  • As the spreads for GSE bonds narrow investors will be forced to balance the reduced risk of an explicit government backing with lower yields. The investors who still have an appetite for higher-yielding, real estate-backed debt may eventually restart the securitized debt markets.
  • Equity-investors in the GSE's, who's positions have been wiped out by the bailout, will be licking their wounds, but the ones who got out early may have free capital to reallocate to REIT's or homebuilders, two equity real estate plays that look pretty beat down.
The continuing Fannie & Freddie saga should be fun to watch no matter what happens.

Llenrock Group