Using the Web and social media to sell real estate

Banks today aren’t lending based on the value of the real estate any more, but they base their decision on the “existing relationship2 which means the potential global income of the sponsor asking the loan. If you want a loan from a bank, it’s relationship driven, that means they want you to be local and to have all of your checking accounts with them. Basically, they want to have your money at hand before they lend any of theirs.

Restructuring commercial loans often now requires that the bank fails in the first place.

The majority of the commercial real estate developers are in dire straights, trying to hang on with their nails, to restructure their debt on anything they built from 2005 and 2007, but many local banks won’t even talk to them. So how does the relationship play in this case? Many banks know very well that the minute they begin a short sale or loan restructuring process, which means discounting the amount owed and negotiating new terms, their own balance sheet will start to suffer greatly and they will see a domino effect of a number of their commercial borrowers doing the same. They don’t want to foreclose because they can’t take the capital hit.
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Therefore they sit tight, insisting that developers and owners in general continue paying a loan that they can’t pay and hoping the problem will go away without actively tackling it. When this happens, the best thing that the developer or the owner of commercial real estate can hope for is that their bank goes under. Once the bank fails, it goes to the FDIC (Federal Deposit Insurance Corporation) and then the FDIC reduces the value of the asset and brokers it off to another bank which will be in the position now to negotiate.

Listen from an expert in the field about some real life stories that are happening right now.

Roberto Mazzoni

There has always been a second market for securing loans on real estate and it has been managed by insurance companies that have been providing long term funding for both residential and commercial properties. After the bubble burst a couple of years ago, all these companies suspended their activities in this area waiting to see how the situation was going to evolve and now they literally loaded with money and aching to lend it out on worthwhile projects.

Insurance companies can provide alternatives to commercial foreclosures.

Now they are offering loans at rates as low as 5.5% but the loan to value percentage is much tighter, namely they are willing to fund only 65% of the value of the property, while the borrower needs to come up with the remaining 35%, pretty much in line with what is currently being done by many banks.
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But they become a solution for those trying to avoid foreclosure and willing to put some cash to restructure the loan, which means using the insurance companies as a vehicle to bring the bank to terms and getting a discount on the current loan and then move it to the insurance companies putting in some cash to make it balance again.

A typical real life example given is a property originally worth 12 million where the owner now has to bring 5 millions to the table in order to avoid foreclosure and start with a new loan which could be transferred to an insurance company with the bank forfeiting 3 millions on the outstanding balance and the owner adding 2 millions of his own cash to secure a new long term loan that will allow him to weather the storm.

Listen to the video by Del GoForth that gives you a totally new view at how insurance companies can play a key role in the resolution of the upcoming commercial real estate foreclosure tsunami.

Roberto Mazzoni

Where is the commercial real estate market going? And is it going anywhere in the first place? George Hurst, experienced commercial broker with Coldwell Banker Commercial, tells us that we are at a dead stop right now: increasing vacancy rates, falling rents, unemployment, the resulting decreasing cash flow will reduce the borrower’s capability to repay her loan, bringing forth a surge in foreclosures.

The commercial building market is coming to a stop.

Additionally, the now reduced values of the commercial properties bring about a very high loan to value ratio when the time comes for refinancing, making it impossible to renew the current loan, but requiring the owner (borrower) to come up with a substantial amount of cash just to keep the financing in place for a property that is already under water.

Today when you go to a bank to get a commercial loan you cannot use “performing income” any more as a basis for your financing. As the properties are less and less performing and therefore you need to reduce your evaluation. Sales of commercial properties have decreased of over 80% and the recent reduction in unemployment in some areas is mainly due to temporary jobs.

The health of commercial real estate depends mostly on the overall condition of the economy and it will likely stay weak for the foreseeable future. Some estimates say that by the end of 2012 we might see a slow change, but that is still a matter of opinion since many changes could come about in the economy by that time. The effects will be felt anyway up to the end of 2020, which is ten years from now. There are definitely factors that could help stimulate a faster recovery, but that is scenario that we are looking at right now.

The economic growth has returned slightly, there is a 3% increase in the first quarter of 2010 of the USA GDP (Gross Domestic Product – a measure of an economy that adds the total market value of all finals goods and services produced in a country in any given year at the current prices).

Yet that is tempered by unemployment which is increasing the vacancy rates constantly, and such increase has been slowed down so far by long term leases held by major corporations, granted back in 2005, 2006 or 2007 for class A properties (the highest quality) but when those will start to fall out, the rate of space available will increase dramatically, particularly in class A properties, and the lower classes (B and C) will fall right behind in succession.

The commercial loans that will go in default are estimated between 1.4 and 2 trillion dollars. There is an estimate of about 40% of current loans that are upside down, but Deutsche Bank has estimated that over 75% of the existing commercial loans will be difficult to roll over (renew). So the key opportunity is for investors to start a buying campaign on these properties that are ready to go in default, but the challenge is to establish a correct value for those properties, knowing that the market is still on a slide and that economic conditions are still unstable.

Roberto Mazzoni

In the 1980′s there was a real estate boom, commercial loans had gone from 7% to 12% of banks total assets in the US. The market went up and then it came down again following its typical cycle and the government had to bail things out. They had to spend over 157 billion dollars to protect borrowers and bank’s assets at that time.

Over two thousand banks and savings and loan associations disappeared between 1986 and 1994. More precisely, 1,043 savings and loan associations and 1,248 banks failed with assets of 726 billion dollars which equates to 1,19 trillion dollars in today’s houses. At that particular time, Congress came up with the idea of creating the Resolution Trust Corporation, a united States Government-owned asset management company charged with liquidating mostly real-estate assets that belonged to savings and loan associations declared insolvent by the Office of Thrift Supervision.

The following video is taken from an event I have just helped organize and the first speaker of the event, George Hurst, of Coldwell Banker Commercial, mentions a particular property out of his memory that was about a 200,000 sq ft regional mall that had been built in 1987 in Hudson Florida, very close to US 19 highway.

It was the size of a Super-Walmart and had been never occupied, sitting on 30 acres of commercial property. RTC disposed of it and sold it to GE Capital Corporation for 650,000 dollars, and there was an investor at that time in Saint Petersburg Florida that was willing to pay 2,6 million dollar for it and that was already a steeply discounted price.

From 1990 onward, commercial real estate became again the popular vehicle of investment for several reasons:

1. the economy was growing and therefore there was an upswing demand for office and retail space
2. regulatory problems in the government had been resolved
3. the restructuring of investment in REIT‘s (Real Estate Investment Trust – a corporation investing in real estate in a way that reduces or eliminates income taxes) increased from 10 billion dollars to 176 billion
4. Wall Street investors and banks found it easy to get into these investment projects with low capital
5. the tax reform of 1986 had dropped taxes from 50% to 28% and brought in low income tax credits, a lot of tax deductions for rental properties
6. the technology bubble exploded in 2001 drove investors back to commercial real estate.

During the real estate boom of mid 2000′s we see the same things happening again: interest-only loans, very lax underwriting standards (it was very easy to get a loan), banks being caught up in the dream that the market prices would rise forever. In 2003 large banks had commercial real estate portfolios equal to 156% of their risk based capital (the amount of capital based on an assessment of risks that a bank should hold to protect customers against adverse developments).

By 2006 that figure was 318%, it had more than doubled in three years in commercial real estate alone. In 2007 we had the crisis of the sub-prime residential mortgages, the bubble began to burst and although the FDIC (Federal Depository Insurance Corporation – it guarantees the safety of deposits in member banks) had already identified commercial real estate as a problem, the main focus was on residential.

Congress created in 2008 the Emergency Economic Stabilization Act and the Trouble Asset Relief Program known as TARP.

Now it is time to tackle the commercial real estate crisis and in the next post we will take a deeper look at it.

Roberto Mazzoni

Commercial Real Estate sales in Florida are down about 80% and in general the commercial investment market is off completely, this is the summary given to us by George Hurst a real estate broker with Coldwell Banker that is specialized in troubled assets during and that delivered the opening speech at seminar we organized recently.

Massive amount of commercial foreclosure coming up.

Transactions of commercial properties that are still occurring are mostly owner occupied or REO’s (bank owned), rents are falling and vacancy rates are increasing considerably; therefore we are going to be suffering from the explosion of bubble that took place in 2005, 2006 and 2007, primarily in 2006.

We are getting into a six year term of increasing foreclosures due to the peculiarities of commercial lending which is usually just for five years, and then you need to renegotiate based on the current performance. Therefore if we simply project from 2006 we see that in 2011 many properties will go in default because unemployment and the consequent decrease of rental income will not allow them to renegotiate their loan effectively.

There are two types of risk that get into play in a situation like the one we are going to experience: credit risk, which means that the reduction of cash flow makes it difficult to service the debt (make the loan payments) and credit contraction associated to an economic downturn which is what we are in right now.

Up to about four years ago, both bankers and developers where caught up in a dream a nobody believed there was going to be an end to the continued increase in prices, but it was just all artificial inflation and it reached an end due to a number of things:

Very lax underwriting standards by banks. In 2007 almost 60% of commercial loans granted were interest-only, so you paid only the interest without repaying the principal.

Faulty appraisals just like in residential.

Now these loans are coming for review in a few months and it is very likely that the bank will refinance only 60% of the new value which means much less than the currently outstanding balance. Do you think that the owners will bring cash to the table just to keep the loan going on a property that continues to devaluate: very unlikely.

So a major wave of foreclosures is likely to happen, but it will follow patterns that will be quite different from the residential world and will find out more about that in the next articles inspired by this special seminar.

Roberto Mazzoni