An Attitude Adjustment
On the first Monday in January, one segment of the real estate world began to return to normal. The phones started ringing again. For all of 2009, may it rest in peace, the real estate transaction market was almost totally dysfunctional. Owners and developers with cash couldn’t put it to work; first mortgage lenders couldn’t deploy their allocations; and investment funds chose to let huge sums of committed capital remain idle. The most frequent topic of conversation was the total lack of interesting deals that virtually anyone was seeing. Yes, there were a few very high-profile large sales in New York-mostly flowing out of the Macklowe defaults-but the massive size of those deals limited the potential buyers to a very select few.
Since that Monday morning, however, the conversation has shifted. Many developers, owners and entrepreneurs who have been tracking and pursuing deals for months now seem to have a greater sense that these deals will likely get consummated in the near term. This optimism is due unquestionably to a change in the attitude of sellers-not all of whom are distressed.
Sellers fall into a few classes. Most interesting are the opportunistic investors who bought smartly in the early part of the downturn, worked their investments in ways like foreclosing/wiping out/restructuring the junior debt or equity partners, or negotiating deed-in-lieu transactions with the original developer/borrower, and who now have the ability to sell a consolidated capital stack at a price that is not only profitable for the seller but also low enough to allow true value creation by a new developer who is willing to take on the risk of completing the project.
With big money flowing so freely from 2003 to 2007, many operators got in over their heads, buying substantially larger or more complicated properties than they had dealt with previously. Those with short-term debt are already mired in problems they may not survive, but many others have long-term debt that is locked in at very low interest rates and with no amortization, allowing them to stay out of current distress/default so far. However, this latter group is going to need to accomplish major income appreciation at their properties to avoid maturity defaults when the debts finally come due (possibly in a higher-interest-rate, higher-cap-rate environment). Recognition of their difficult position in this uphill battle has set in among some in this situation, and they are reaching out to more established/experienced/liquid operators and seeking to form joint ventures.
Flight (and non-flight) capital from around the world is seeking entry into high-end Manhattan properties, and is willing to accept yields that are low enough to make even multigenerational family owners consider the possibility of selling or at least partially recapitalizing some of their high-profile assets, although it is likely that most of these transactions will be accomplished very quietly.
For those owner/developers finding purchase opportunities that are attractive based on today’s market fundamentals, or any owners holding cash-flowing properties with low to moderate existing leverage, low-rate financing abounds. Despite the common and frequently stated conviction that there is a dearth of mortgage money available today, the real state of the finance world is exactly the opposite-and has been since early 2009. A multitude of lenders remain eager to originate fixed-rate loans, and virtually all of them missed their target allocations last year.
There has been a tendency in the real estate media to blame the 2009 transaction drought on a short, or nonexistent, supply of mortgage money, but the truth is that what really occurred was an almost total lack of demand. While this was understandable with regard to acquisitions (given sellers’ unrealistic asking prices), it was very surprising with regard to existing loan maturities and refinancings. Only a tiny portion of the existing stock of commercial mortgage loans carries an initial term of greater than 10 years, and many are written for five years or less. Assuming an average term of five to seven years, one would assume that 15 to 20 percent of all commercial loans would mature in any given year, and that 25 to 35 percent of all loans would have an impending maturity date within less than two years.
Clearly nowhere near that amount of property was financed or refinanced in the past 15 months, leaving a backlog of both healthy and unhealthy loan maturities on the horizon. With the demise of many of the previously more aggressive lenders, many borrowers are likely to find that their former “go-to” lenders are no longer viable sources.
Demand for money is now coming from many competing directions, and it appears that 2010 will finally bring the opportunity for investors and lenders to step up to the plate.
Scott A. Singer is principal of the Singer & Bassuk Organization and a member of REBNY’s Finance Committee. He writes monthly about real estate finance for The Commercial Observer.