One example of what might become an all too common phenomenon this year occurred on Jan. 6 when a court ordered the 509,000-square-foot Shenango Valley Mall in Hermitage, Pa., into receivership at the request of its lenders. Receivership is a strategy often employed by lenders for assets in financial distress, whereby the lender asks the court to appoint a third party to manage the property and get its finances in order until a longer-term solution can be found.
The Shenango Valley receivership came after the mall's owner, New York City-based Lightstone Group, defaulted on $74 million in cross-collateralized mortgages, including one on Shenango Valley, in September. To help the lenders, Jones Lang LaSalle's value recovery services group has stepped in to assess the condition of the mall and advise on the best course of action, be it a discount sale, a capital infusion, a joint venture or some other method of recouping lost value.
The mall, with an occupancy level of between 70 percent and 80 percent, is in decent shape compared to some other properties he's seen, according to Greg Maloney, CEO and president of Jones Lang LaSalle Retail, an Atlanta-based third-party management firm. Over the next few months, the company will review the mall's revenues and expenses, pay all outstanding bills, make sure the asset is being managed properly and come back to the lender with a recommendation for the best solution going forward.
Shenango Valley is one of four malls to come into the Jones Lang value recovery group's hands since December. Altogether, Jones Lang LaSalle now has 16 commercial properties under receivership and 7 additional properties in various states of distress that it's monitoring while the lenders decide what to do next.
For the company, this isn't a new business. It's always had professionals with receivership experience on staff, according to Maloney, who himself has a 15-year receiver track record, but after last year's RECon conference in Las Vegas, the firm decided it was time to consolidate its forces into a new unit. The creation of the value recovery services group was announced this November.
Jones Lang isn't alone in attempting to tap what could become a booming business. Other companies have started new distressed asset businesses or bolstered existing operations. Savills LLC launched a distressed real estate division. Cushman & Wakefield, Inc. formed a resolution group. Grubb & Ellis, Inc. started a financial services asset management practice. Sperry Van Ness put together an asset recovery team. In addition, CB Richard Ellis and Marcus & Millichap Real Estate Investment Services each consolidated existing distressed asset networks.
“The only transactions that are happening are the ones where there is some level of distress, whether a broken capital structure or an asset with an underlying issue,” says Jeffrey W. Baker, executive managing director with New York-based Savills.
Increasingly, it appears commercial real estate, where $3.4 trillion in debt is outstanding, according to the Mortgage Bankers Association (MBA), will face a reckoning not unlike what has occurred in the residential real estate market. Cheap and freely available debt fueled the commercial real estate boom. Often, commercial real estate loans were structured with interest-only payments for years, with balloon payments at the end. However, in many cases, borrowers refinanced before those payments came due, in a strategy similar to what subprime borrowers did after teaser periods on their mortgages expired. On the residential side, when house prices stopped rising and the availability of mortgages decreased, delinquencies and defaults spiked. Borrowers facing balloon payments are either finding they can't get refinancing at all or when they can, the terms are conservative, with lower assessed values and loan-to-value ratios requiring new infusions of equity.
That's where distressed asset specialists plan to go into action. Most of the firms currently offering solutions aim to be full-service providers for lenders. After evaluating assets and advising lenders on how best to recoup value, these firms have the capability to manage distressed properties in an attempt to raise cash flow, arrange capital infusions in the form of joint venture partners or, if need be, take the assets to market through auctions.
How the firms get paid depends on the scope of the services. For example, Marcus & Millichap, which does not offer property management for distressed assets to avoid conflicts of interest, gets compensated only when it has closed a sales transaction, according to Bernard J. Haddigan, managing director of the firm's retail group and head of its special asset services division. But a company that secures a contract to manage a distressed asset could also gain revenue that way.
The need for these services is only expected to grow. The bulk of the loans made at the height of the market, in 2005 and 2006, have not yet matured, according to Haddigan. Many mortgages closed during those years featured floating rates and will put significant strain on owners over the next five years. For example, almost half of the commercial mortgage-backed securities (CMBS) loans due to mature in 2011 are floating rate loans, according to research from Marcus & Millichap and Standard & Poor's. Altogether, approximately $45 billion in CMBS loans will come due in 2011, $60 billion in 2012 and $43 billion in 2013.
Another issue is that real estate fundamentals have begun to degrade as a result of the broader recession. In the third quarter of 2008, the national retail vacancy rate stood at 13.3 percent, according to Property & Portfolio Research and by the third quarter of 2009, the rate could rise to 17.3 percent.
With virtually no new credit available, some owners have been unable to refinance their properties. In the third quarter of 2008, the most recent period for which data is available, commercial/multifamily mortgage originations fell 53 percent compared to the same period in 2007, according to the MBA. Originations for retail properties fell 30 percent. The CMBS market, in particular, which accounted for up to 70 percent of all real estate lending during the boom years, has remained stagnant since June.
Currently, there are already 134 retail assets across the nation with a total value of $4.7 billion where owners have filed for bankruptcies, defaulted on mortgages, or had the property enter foreclosure, according to Real Capital Analytics, a New York City-based research firm. Of those, 18 properties, valued at $217 million, have reverted back to lenders. In addition, the firm identified 1,225 properties, or $23.5 billion, in retail assets that show potential for distress.
Not your father's downturn
But the new crop of special services professionals will face some challenges in handling the wave of distressed assets now coming along, according to Frank Liantonio, executive vice president of capital markets with Cushman & Wakefield and part of its resolution group. The last round of massive commercial real estate dispositions happened in the 1990s. Then, the government took bad assets from defunct savings and loan associations and formed the Resolution Trust Corp. to dispose of almost $400 billion in bad real estate debt. At the time, the securitized debt market for real estate properties was virtually nonexistent. It was the Resolution Trust's own success in creating and selling shares in limited partnerships and securitizations that contributed to the explosion of mortgage-backed securities later.
Today, after a decade of uninterrupted growth, there is approximately $812 billion in outstanding CMBS loans, according to the MBA. Retail properties account for about $240 billion of those loans. The issue that creates is that loans that have been securitized have multiple claims to the cash flow as opposed to when there was a more straightforward one-to-one relationship between lender and borrower.
What's more, the real estate crisis of the early 1990s was not exacerbated by a global recession and a global credit crunch, notes Liantonio. “This financial crisis starts at 5:30 in the morning, when I turn on the news and hear what happened in Europe, and ends at 9:00 in the evening, when the Asian markets are about to open,” he says.
As a result, a lot of banks have been bolstering their asset management teams in case the firms end up holding properties longer than anticipated. Putting all these factors together, it will likely take up to three or four years to resolve the current logjam.
A longer version of this article appears at retailtrafficmag.com/features.