Even though the financial system is still extremely fragile, it appears that we are enjoying a modest recovery both nationally and globally that is buoyed by continued low interest rates, declining job losses, inventory recovery and moderate retail sales.
The combination of these factors should stave off a double-dip recession.
So now is the time to jump in and get your feet wet.
The fear that frozen capital markets colliding with trillions of dollars of maturing debt will be catastrophic has not materialized. The reason: There is plenty of capital in the system for the best companies, sponsors and properties.
There is, in fact, a bidding war erupting to provide debt for the refinancing of Boston Properties Inc.’s Metropolitan Square, a class A office project overlooking the White House in Washington, D.C.
Life insurers and major banks are swarming all over Boston Properties for the right to lend $150 million to $175 million of fixed-rate debt at 6%, which is $256 per square foot. This will put $25 million to $50 million in Boston Properties’ pockets through a cash-out refinance.
Also, in October, 46 different banks, led by JPMorgan Chase & Co. and Bank of America Corp., showed up to participate in a $3 billion credit facility for Indianapolis-based retail developer Simon Property Group Inc. to pay down debt.
That’s 46 banks, folks!
Raising Money
The other phenomenon that has stemmed the tide of doom and gloom has been the ability of the stronger real estate investment trusts to raise money through equity and unsecured debt offerings to the tune of more than $35 billion in 2009.
The funds have used this capital to pay down debt and strengthen balance sheets.
Real estate investment trusts may be the catalyst for the comeback of secured debt markets, as well.
The end of 2009 saw the first two issues of commercial mortgage-backed securities since the market collapsed in mid-2008.
Developers Diversified Realty Corp. executed a $400 million transaction, secured by Developers Diversified Realty properties. The loan was originated by Goldman Sachs & Co.
Shortly thereafter, Bank of America issued $460 million in commercial mortgage-backed securities, secured by Fortress Investment Group LLC properties.
The Goldman deal was supposedly 20 times oversubscribed, which indicates that there is again an appetite for commercial mortgage-backed securities.
The indications are that all of the big banks want to jump in again.
The new commercial mortgage-backed security may look and smell a little like its predecessor, but there will be many differences—not the least of which will be lower leverage, higher spreads, tighter underwriting and more investor-friendly provisions.
Other sources of sorely needed liquidity have been public non-traded real estate investment trusts and mortgage real estate investment trusts.
Seven or eight initial public offerings were floated last year for mortgage real estate investment trusts, which were able to raise significantly more money at a better price than expected.
This has enabled the real estate investment trusts to outbid private capital on federal distressed assets in some cases, such as Colony Capital LLC’s recent $1.02 billion purchase of Federal Deposit Insurance Corp. notes.
Life insurance companies also should be back in the market with a vengeance as the doom and gloom predicted for their commercial mortgage-backed securities investment activities hasn’t materialized.
According to a recently completed study by Barclays Bank PLC, Bloomberg and Property and Portfolio Research, “Some of the country’s largest life insurers should see little or no actual losses from their CMBS holdings.”
Indeed, most insurance companies are back in the market.
Interest Rates
Low interest rates have been a savior for the market. Bank of America is predicting that the 90-day London Interbank Offered Rate will only be 0.6% at the end of 2010 and 10-year Treasuries will be at 4.25%. That’s only 50 basis points higher than today’s rates.
Banks appear to be earning their way back to solvency due to an extremely low cost of capital while charging high credit spreads.
Banks also are failing more slowly than anticipated, with less than 200 bank failures nationally since 2000, compared to more than 1,000 bank failures in the savings and loan crisis of the late 1980s.
The lower number of banks failures is partly due to reluctance to recognize loan losses and partly due to the FDIC’s liberal approach of endorsing the “extend and pretend” philosophy, which, while it has its benefits, also hinders price discovery and discourages new loans and sales.
Flip Side
Even though less than 200 banks have officially failed, more than 500 banks were added to the FDIC’s watch list in the last couple of quarters, so this trend could reverse quickly.
And commercial real estate sales are down 49% to $49 billion in 2009 compared to a year earlier, the lowest number in more than a decade, according to real estate tracker Real Capital Analytics Inc.
The availability of capital and the unwillingness of banks to thoroughly clean up their balance sheets in the short run, with support of the regulators, is going to thwart what was believed to be the greatest buying opportunity in our lifetimes—or at least since the Resolution Trust Corp. days.
So what could be the other shoe to drop?
Homes lost approximately $500 billion in value in 2009, which was a welcome relief from the $3.6 trillion lost in 2008.
Commercial mortgage-backed securities delinquencies continue to increase, even though there was a smaller rise in December 2009 than in the previous months.
Many fear that the 26-year high unemployment rate of 10.2% could still go higher with more layoffs in the months ahead.
The national office vacancy rate, which is close to 15%, could climb to 20% or higher if companies consolidate their space to reflect smaller workforce levels and space needs.
James Chanos, whose $6 billion hedge fund, Kynikos Associates LP, made billions forecasting the collapse of Enron Corp., thinks that China’s hyper-stimulated economy is headed for a crash.
There are issues in Dubai, Spain and Greece that could be affected by a sudden rise in interest rates, the cessation of stimulus from the federal government or rising debt burdens.
Opportunities
So where are the opportunities in the coming years?
First of all, stop spending all your time searching for that once in a lifetime incredible deal or trying to raise money to buy those deals. Will there be some? Sure. But dramatically fewer than anyone predicted, and, when they do surface, there will be multiple bidders chasing up the values.
Thinking way outside the box is what it’s going to take.
Follow President Obama’s agenda—healthcare, infrastructure, energy, welfare, education, housing, senior care and bail-outs. That’s where the money will flow.
And focus on the three Rs.
n Rethink: Literally unlearn everything you learned over your career. The game has changed permanently, as have the rules. In underwriting, it’s not loan-to-value anymore. It’s debt yields. Gross potential revenue has given way to tenant by tenant analysis. Net worth means nothing until contingent liabilities are analyzed. Lastly, replacement costs and previous loan balances are absolutely irrelevant.
n Restructure: Recapitalize could be the fourth R. The best opportunities for access to the best deals are going to be joining forces with existing sponsors. Injecting new capital, finishing out stalled construction or providing expertise with workouts will be key and will help to avoid the feeding frenzy when the deal hits the trustee’s sale or the open market.
n Resolve: Investors that can get creative and align themselves with capital and, as mentioned, provide expertise to resolve workouts and recapitalize existing companies will reap great benefits.
Krall is a managing director at Cohen Financial in Newport Beach.