Fearing an onslaught of troubled commercial real estate loans in 2009 in the absence of normalized credit markets, leaders from trade associations across the industry have banded together to request federal assistance. But is there enough political will at the U.S. Treasury to rescue once high-flying lenders and developers on the heels of bailouts of the banking and auto industries?
In a letter to the U.S. Treasury dated Nov. 26, 2008, 12 commercial real estate industry associations requested federal assistance in the form of an “extension of the Term Asset-Backed Securities Loan Facility (TALF) to guarantee, finance or purchase highly rated, asset-backed securities collateralized by newly or recently originated commercial real estate mortgages.”
The industry states that some $400 billion in commercial real estate mortgages will come due through the end of 2009 at a time when credit is essentially frozen. However, researchers can only estimate how much commercial real estate debt will mature in a given year, according to Clint Myers, a strategist at Property & Portfolio Research. The Boston-based researcher estimates that $250 billion in commercial real estate loans will require refinancing in 2009, considerably less than the $400 billion estimate by the trade associations.
Even Property & Portfolio’s estimated demand will strain the supply of available leverage during the current credit crunch, and that in turn will create stress for property owners with maturing mortgages. “This will potentially force default upon property owners that hold good, cash-flowing property,” Myers says. “This would not happen in a normally functioning credit market.”
Michael Grupe, executive vice president for investor outreach with the National Association of Real Estate Investment Trusts, explains that under the TALF program the Federal Reserve provides lending capacity of $180 billion, on which the Treasury provides $20 billion in credit protection for the Federal Reserve, for the securitization of lending backed by credit card debt, auto loans, student loans and loans guaranteed by the Small Business Administration.
At the time the TALF facility was proposed last month, the government had also mentioned that it could be expanded to include commercial real estate mortgages, according to Grupe.
“Our sense is that they are predisposed to such a program. Whether it is implemented through the existing program or a new companion program would be something that the Treasury and the Federal Reserve would need to determine,” Grupe notes.
The trade groups would also like the government to provide liquidity to unsecured commercial real estate loans through the corporate bond market. It is not clear how this would be done, but unsecured loans would probably be subject to a bigger discount at the point they are purchased by the government, Grupe notes.
The ailing retail sector clearly favors government assistance. “What this letter is proposing is that the highest-quality mortgages be guaranteed by the federal government so that banks would start refinancing good loans again,” says Michael Kercheval, president and CEO of the International Council of Shopping Centers (ICSC).
ICSC has been in direct conversations with the Treasury department, legislators and the Obama transition team, says Kercheval. “What we’ve been told is that a decision on this could be made early in .”
The problem in the retail sector is that the majority of mortgages on shopping centers are balloon mortgages, where most of the principal is due at maturity. “If there is nobody out there to refinance that mortgage, the loan is technically in default,” he says. In the case of default, in theory, banks could take back the property.
What happens if this doesn’t go through? “That’s our big concern,” says Kercheval. “We think that this will be unlike the heart attack or stroke that’s killing the auto industry, but rather like a slow, insidious cancer, with bits and pieces of the industry dying off.”
Not everyone in the retail sector supports a bailout. Jeff Green, president of Jeff Green Partners, a Mill Valley, Calif.-based retail real estate consulting firm, doesn’t think the shopping center owners have a case for federal assistance. “The retail real estate industry should be in a correction, meaning we have too much square footage allocated to retail,” Green maintains.
“There has got to be a correction, and I think this is a natural correction,” continues Green. “You can’t try to guarantee loans so that the amount of square footage that exists in retail now exists later. There are no retailers for it, and there is not demand for it.”
Howard Davidowitz, chairman of Davidowitz & Associates Inc., a New York City-based national retail consulting and investment banking firm, is even more skeptical about the bailout. “Look at the problem the auto industry had. They had dramatically more of an effect on the economy, they had union power. My view is that the country is suffering bailout fatigue,” he says.
Davidowitz predicts that healthy real estate investment trusts, like Vornado, are already looking beyond 2009 and at the consequences of a still-broken financial system, which could create a crisis situation. As for the Troubled Asset Relief Program (TARP) money, Davidowitz says banks have already spent it, or will spend it to cover write-downs on credit cards, commercial loans and residential mortgages. “So if you are in commercial real estate, you cannot look for the financial services industry to support you as they have in the past because they haven’t got that TARP money, it’s already spoken for.”
In the lodging sector, there is more optimism. “It’s a terrific idea to ask for relief,” says Joe Epstein, president and founder of hotel lender First American Realty Associates based in Fairfield, N.J. “If we don’t ask, no one will know our plight. There are a slew of hotel loans coming due without any significant capital in the marketplace available for refinancing.”
Ironically, says Epstein, hotel real estate has performed fairly well so far because, for the most part, the loans were correctly underwritten at origination. “But the question is, are they good enough to attract refinancing?”
“While some refinancings and new loans are being made on really good deals, in some cases the lenders are imposing unique post-closing covenants,” explains Epstein. “For example, in addition to typical debt-coverage ratios, the lenders are insisting on liquidity covenants in which the borrower must put 10% or so of the loan value on deposit, or in a joint financial statement for the life of the loan.”
Analyst Lisa Pendergast, managing director at RBS Real Estate Finance, argues that there is a systemic problem within commercial real estate finance that could be addressed effectively through the TALF. Due to market volatility, yields offered on existing CMBS are high by historic standards. Lenders would have to charge interest rates in the teens on new conduit loans today, which wouldn’t leave enough loan proceeds for most borrowers to refinance their existing loans.
Government assistance could spur equity investors that are waiting on the sidelines to buy up commercial real estate to instead purchase existing AAA-rated CMBS bonds, Pendergast says. Once CMBS is selling again, spreads will come down and lenders will be able to offer lower interest rates on new conduit loans, providing more proceeds that will better enable borrowers with maturing debt to refinance. “Where the government is going to help is in what rate we can offer,” Pendergast says.
As for followup, Kenneth Reed, a spokesman for the Commercial Mortgage Securities Association says that CMSA representatives have already met with senior officials at Treasury to discuss “ways to alleviate market illiquidity and explore solutions to jump-start the market.” A third meeting is scheduled with Treasury after the New Year.
In the interim, Treasury is asking CMSA for specific TALF-related suggestions as they move forward in their decision-making process. “We are interested in extending relief efforts to commercial real estate capital market finance,” says Reed. “We’re equally interested in structuring any relief to make it meaningful, and we have come up with suggestions that may work well for the market.”