Priel's Perspective - “The Light at the End of the Tunnel”

The Peak Corporate Network Newsletter

I want to start by saying it is clear to me that there are some buying opportunities in today’s uncertain market.

Many real estate investors, myself included, have been saying that commercial real estate is the next shoe to drop, our next crisis. However, the collapse is actually being held up by a “slow-motion” release of inventory. It is clear that values have declined significantly and many in the industry have serious problems holding on to their investments. The emerging reality is that the idea that an investor can sit idle waiting to buy “Class A” malls or apartments for 9 to 10 caps will not happen during this downturn.

The reasons for this are the “Slow-Motion” release of distressed assets by lenders, the willingness to work with borrowers without regulator pressure, and the fact that there is a huge amount of capital waiting to jump in on any opportunity put out to market.

Now that I made my point clear, I do need to make it equally clear that we are not in a “Boom” market or that I expect values to quickly recover to our 2006 peaks. The “Slow-Motion” idea also applies to any recovery. It will be drawn out as hard times will continue for the short to medium term – buyers beware!!

Many lenders are continuing to play the “extend and pretend” game with their loans and over time will need to take action by disposing of their bad debt and assets. This, in turn, means that these will sell at distressed values and further delay the rebound of investments.

The experts at Strategic Asset Solutions, one of the Peak Corporate Network affiliates, act on behalf of borrowers in debt restructuring on commercial properties. We have seen a significant shift in lender willingness to work with a borrower to reach a new realistic basis for their loans and creating a solid value for both lender and borrower/owner. This is accomplished with principal reductions, rate reduction (temporary and permanent), extended maturity date, funding reserve for property repairs, etc. The bottom line is giving the borrower a reason to stick with the program.

These types of negotiations will increase over the coming years as loans are nearing maturity. Deutsche Bank estimates that more than 65% of the loans that have been packaged in commercial mortgage backed securities (CMBS) will not qualify for refinancing when they become due. Some will be restructured while others will turn into distressed asset sales over time.

Another reason why the commercial real estate market will not collapse is that a bulk of mortgages are held by a single lender (not securitized) that is not under the strict scrutiny of Federal Bank Regulators. This gives that lender ample time to attempt to work out a problem loan in a smooth and orderly manner. The downside, again, is that it drags out any correction for years and of course is a delay for any real rebound is values. A 40% decline in values is not uncommon and it takes a robust rebound to bring it back.

In a recent real estate investor magazine survey, 65% of the responding investors indicated that they plan to boost their investment in real estate over the next 12 months. This is an increase of 30% from last year.

For anyone contemplating making an acquisition there of course remain many concerns that are very real, they include:

- Vacancies continue to increase
- Rental rates continue to fall
- 100’s of properties are in default in most markets
- Sales have plunged
- Appraisals and values are falling
- More equity required by lenders
- Still a disconnect between seller and buyers

These concerns will continue to dominate every due diligence model and challenge decision making by prospective investors over the next few years.

The analysis should be made under an extremely conservative perspective as is required in this very volatile market. This strategy is in the face of what we see as very stiff competition for a very limited supply of distressed properties.

At Peak, we continue to make bids for some of these assets and in many cases competing with as many as fifty “all-cash, quick –close” bidders. We recently purchased a non-performing note secured by two office buildings, in Southern California, with a firm belief that we would ultimately own the underlying assets. In a clear example of money being available, we were overbid at our foreclosure sale by aggressive buyers paying all-cash with little or no due diligence.

I do believe the next 12 months will provide a better flow of deals although many will likely be sold in an auction environment. This requires costly due diligence with a low likelihood of success making it more palatable to the large institutional players who will be the winning bidders with adequate staffing and resources.

As an explanation of the low flow of deals, it seems that the institutions that acquired banks assets during the crisis have had no real reason to sell and no pressure to do so. Now that it is clear that there is a lot of liquidity we feel that change is coming. Currently, Wells Fargo, LNR, and others, are taking billions in loans and assets to market. The capital is available and I would expect an even larger flow of capital looking for safety in the U.S. as economies like Greece and other European countries have their own crisis. Many believe the worst of our crisis is over and the U.S. is a safe haven once again.

In conclusion, the factors I have discussed make me believe that the light visible ahead in the tunnel is not an imminent train wreck, but rather it is the light of optimism.

Gil Priel

Founder and Managing Partner

Peak Corporate Network