Thursday, May 7, 2009

Successful, Until You Aren’t

Lansner on Real Estate reports Pacific Property Assets has defaulted on the interest payment due on $90,000,000 in notes held by its investors. PPA has a 2,400 unit multifamily portfolio in Southern California and Arizona. Some excerpts:

Company CEO Michael Stewart said interest payments on about $90 million in notes would be suspended for an undetermined period, adding that he’s hoping investors will bear with the firm to give it “breathing room…”

“We’ve never missed a payment in over 10 years. It’s probably the toughest decision (we’ve made),” Stewart told the Register.

The fact that no payments were missed for ten years doesn’t mean much. I was Chief Credit Officer at ARCS Commercial Mortgage from 1997 to 2006, during which time we originated about $2B a year in multifamily loans with virtually no delinquencies, foreclosures, or losses. I would love to believe that was a result of my stellar judgment, and maybe it was. But, I’ll never know for sure, because during the time I was there any bad decisions I made were bailed out by declining interest and cap rates. Periodically, someone would complain we should do a risky deal I had turned down, because the fact we had no defaults indicated we weren’t taking enough risk. My response was that if the average CRE default rate was 2%, that was arrived at by 9 years of no defaults and one year of 20% defaults.

Commercial real estate performance, to paraphrase the quotes about airline travel and war, is years of boredom punctuated by periods of terror. If you’re a CRE investor who never missed a payment between 1995 and 2008, that puts you in the same class as 99% of all CRE investors. If you never missed a payment between 1979 and 1982 or between 1990 and 1994, I’m impressed. I expect 2009 to 2012 will be another period where never missing a payment will be something to brag about.

One of my grandmother’s sayings was “You don’t know if your roof leaks until it rains.” It hasn’t rained hard in the CRE world since the early 1990’s, and many lenders and owners (like Mr. Stewart) have assumed that, because they weren’t getting wet, they had a good roof.

Here’s a link to another story about Mr. Stewart during happier days just 8 months ago, in which he explains PPA’s decision to diversify into the Phoenix market (oops!), and how risks were lower in October 2008 than when he started PPA in 1999.