So far in this bust the pain has been concentrated in single family homes and their associated mortgages and mortgage backed securities. But that’s not the only kind of debt that got out of hand during the boom. There were similar debt orgies in commercial real estate and private equity. Two recent Barron’s features articles by Andrew Bary suggest the pain still to come in those two areas.
For example, the biggest one, Stuyvesant Town and Peter Cooper Village, a giant complex with 56 buildings and more than 11,000 apartments that was bought by Tishman Speyer and Blackrock Realty Advisors for $5.4 billion in 2006, has annual interest costs of $300 million but rental income - rent minus expenses - of only $108 million in 2007. The deal was financed by a $3 billion first mortgage and $1.4 billion in junior debt. The $3 billion first mortgage was chopped into pieces and securitized to investors by Wall Street investment banks.
A lot of commercial mortgage backed securities are held on the books of Wall Street investment banks: Investment Bank Commercial Real Estate Holdings Chart. Pretty soon the writedowns on these things could start mounting if the deals Barry talks about are representative of the overall market.
First we need to segment to commercial owners into categories. The owner who holds mortgages on a single strip mall in Des Moines vs. the REIT that hold 100 or more properties. The little guys who gets in trouble? Sorry bud but you are cooked. There will be no help for you from either the banks or the Feds. But, you big boys out there are going to be spared OR at least kept on life support.
Why? Scale. Let's say we have three property owners in a town. One guy holds 20 properties and the others each own one or two. All three are currently delinquent. Who does the bank care the most about? Of course, the big guy. If he is forced into bankruptcy, the entire town's property values are destroyed. The chance of the bank recovering anywhere near their investment is virtually nothing. Now if they refinance his loans (extend maturity to lowers payments so they are covered by current rents) and let the other two go into bankruptcy, the market takes a small hit while it waits for the economy to come back. As the economy comes back rents rise and, property values rise with it and the bank gets made whole on its loans. The key point here is that the market survives.
But, with banks already strapped, how can we be sure there will be funds available to refinance?
From the WSJ:
Commercial real-estate debt is potentially more dangerous to the financial system than debt classes such as credit cards and student loans because of its size. The Real Estate Roundtable, a trade group, estimates that commercial real estate in the U.S. is worth $6.5 trillion and financed by about $3.1 trillion in debt. Partly because the commercial real-estate debt market is nearly three times as big now as in the early 1990s, potential losses in dollar terms loom larger.
According to an analysis of bank financial reports by The Wall Street Journal, the broad shift to real-estate lending can be seen by comparing commercial real-estate loans -- including both mortgages and construction loans -- with banks' so-called Tier 1 capital, a key indicator of a bank's ability to absorb losses. In 1993, less than 2% of the nation's banks and savings institutions had commercial real-estate exposure exceeding five times their Tier 1 capital. By the end of 2008, that had risen to about 12%, or about 800 financial institutions. A higher ratio means a thinner cushion for loans that go sour.
The Federal Reserve and the Treasury are moving to adapt a funding program to make it attractive for investors to buy debt backed by office buildings, hotels, stores and other income-producing property. The program, called the Term Asset-Backed Securities Loan Facility, or TALF, was begun to finance purchases of debt backed by consumer credit, and officials will expand its use to include commercial-property debt.
See, if CRE goes bust, all the aid to banks that has been doled out up to this point gets flush away. It is in both the banks AND the government's best interest to assure that does not happen. Keeping it from happening in CRE is also FAR easier than the mortgage market. Rather than dealing with millions of individual homeowners, only a dozen or so REIT's must be helped.
So, this all leads us to General Growth Properties (GGP). It looks increasingly like two or three debt holder are going to force (or allow) it to file Chapter 11 reorganization today (this weekend) after the 5pm deadline. If (when) that happens, what is in the best interest of all? You see GGP is the largest mall owner in the US. That means that whatever happens to it, effects the entire CRE market in the US.
Because of that, a liquidation cannot happen. There are not buyers that can purchase enough of the properties with credit markets in their current state to avoid a total collapse of the CRE market. With $3.1 TRILLION of loans out there for it, it sort of makes the $50 billion given to Citi (C) look like change found in the sofa and gives us some proportion of the potential damage. With mark-to-market accounting rules, the destruction of GGP debtors would cascade to all lenders and make what homeowners did to banks look like "the good 'ole days".