Wednesday, December 31, 2008

Philadelphia Update

The American Commerce Center appears to be heading in the right direction, while the markets do anything but that…there is no lead tenant as of yet.

Same goes for Cira South (Rendered at right) and Brandywine. Brandywine is reportedly still in discussions with Blackrock to move some 1,000 employees to our fine city.

Poplar Hotel is too big according to the NLNA. It was also changed to an extended stay boutique, which has many concerned of the possibility that it goes condo one day.

Good thing the NLNA Zoning Committee cannot control Center City, because the Zoning Board just approved a 28-story Monaco, an appropriate redevelopment solution to the long dormant Boyd Theater.

The speed at which the planning process in Philadelphia works, these projects will probably be ready when the credit markets are up and running again in 2010.

Llenrock Group

The Second Wave?

Receiving much attention the past week or so was a report aired by CBS 60 Minutes indicating that the next wave of foreclosures would be coming as a result of ALT-A and Option ARM’s. ALT-A loans were mainly used by the self-employed, and individuals with undocumented income to purchase a home at more traditional terms and rates, providing either asset verification, or partial income verification.

Option ARM loans generally had a low teaser rate, which determined your pay rate, but also had a charge rate, which determined the actual interest cost charged, the difference being added to your balance. Golden West, out of sunny California is generally credited with the creation of the Option ARM. They were successful through many real estate cycles, by employing a rigorous underwriting process, and significant due diligence on their contracted appraisers. It has been said that if the subject property was near a high-power transmission line, or freight train track, your loan would not be approved.

The report goes on to give examples of shoddy mortgages falling within these classes, and how the level of defaults will meet or exceed the current carnage in the subprime asset class. Whether or not they are correct is yet to be seen, and is as good a guess as any. However, the causes will be very different. The defaults will be driven by normal default scenarios involving job loss, disability, and rapid deterioration in home values. To paint them as similar to sub-prime is incorrect, as sub-prime were as easy to get funded as a freshman applying for a credit card on campus. These loans, like many other asset classes are more of a victim of the times, rather then their own demise.

And as always, just like a river, those seeking credit will find the path of least resistance ($ WSJ Subscription required). Or maybe a redesign is in order?

Llenrock Group

Thursday, December 18, 2008

Leverage and Lenders taking Sponsor Risk

The generally accepted driver of the financial crisis is leverage, made capable by virtually free money, thanks equally to our Federal Reserve, and the trusting buyers of virtually anything Wall Street could produce. The combination of a 0% to negative real return, and demands to maintain a minimum return threshold pushed normally conservative investors into new un-chartered markets of initially private MBS and CMBS, graduating to BBB-rated tranches, CDO's, CDS's, TRuPs and the various structures and exposures allowed by them.

As more and more reports are published on struggling CRE owner/operators, a pattern is emerging. For example, this well-known and respected NYC investor decided that he could take his equity off the table, and continue managing a noteworthy property, thus completely eliminating any chance at a loss, and preserving unlimited upside. That does not sound like a bad position to be in, especially with stringent rent controls in place tying management’s hands. Saying the owner hedged himself would be a severe understatement. In just 16 months the transaction generated a cool $93,000,000 profit on a $26,000,000 equity investment. In essence the entity that should be bearing the risk has transferred it to their lender at the most aggressive time in terms of property valuation and finance. The lender accepted unimaginable risks, while capping their upside.

What is particularly odd is that the borrower cashed-out, while the lender under-collateralized the property by allowing a $19,000,000 cash-flow reserve.

What are most interesting are the opinions that he remained a conservatively leveraged owner. What this indicates about the newer-vintage owners of real estate is quite scary, and should give pause to those claiming we have reached a bottom. The lax standards at the top of the bubble are postponing a long market digestion, which is both good and bad.

Llenrock Group