Goodbye For Now...

As of 9/1 I will be starting a very challenging new position, and between then and now we will be relocating from Seattle to Los Angeles. On the down side, I expect it will be many months before I will be able to make time for regular posting. On the plus side, I expect I will have a whole new set of topics to talk about when I resume posting.

Thanks to my regular readers - blogging is a lot more fun when you know someone is reading. I will be back when circumstances allow.

Now is a Great Time to be a Major Tenant: Part 2

A few weeks ago I posted about the opportunity for a major tenant to lease at 250 Montgomery Street. A major New York law firm did such a deal last week. From the Wall Street Journal article, Reduction in Rent for Law Firm Proves Patience Is a Virtue:

In 2007, when the law firm of Orrick, Herrington & Sutcliffe LLP began looking for a new location for its New York office, rents in a prestigious building that suited their tastes ranged from a pricey $120 to $140 a square foot.

What a difference two years and a massive global recession make.

Last week, in the largest Manhattan office lease so far this year, Orrick finalized a deal for 220,000 square feet in "Black Rock," headquarters of CBS Corp. at 51 W. 52nd St. The deal provided the law firm with a huge bargain over 2007 prices. Sources familiar with the deal said Orrick will pay monthly rent in the low- to mid-$70-a-square-foot range.

But it gets better. The landlord, CBS, agreed to spend $150 a square foot to renovate the space, leaving Orrick with little to no out-of-pocket costs to set up the new office.

That’s $33 million for tenant improvements the landlord is eating, and capping the rent reduction at 7% trims more that $133 million off the value of the building.

Knowing When to Stop

When you think about bad CRE loans, most people picture homes being demolished in Victorville, unsold high rise condos in Miami, or vacant office buildings in Orange County. But how about Minnesota? From a Minneapolis Star Tribune story (hat tip Calculated Risk):

Minnesota ranks fifth nationally, with 50, or 12 percent, of its banks carrying particularly high levels of dead real estate loans, according to an analysis done for the Star Tribune by Foresight Analytics, a financial research firm in Oakland, Calif. Only Florida, Georgia, Illinois and California have more banks at such levels.

A key quote:

Bank consultant Robert Viering, principal of River Point Group Inc. in Monticello, had that lesson drilled into him when he was a regional credit officer at the former Norwest Bank. A credit manual, circa 1990, warned him and his colleagues: "The pivotal issue in CRE lending is knowing when to stop. Restraint must be initiated by bankers because historically borrowers have been unable to recognize the warning signs. Commercial real estate lending should not be viewed as the cornerstone of a loan portfolio."

Stopping, of course, involves saying no before the problem is evident. This is something people are very bad at doing (for more on that, see my post Rising Markets Create Lender Losses).

More on Fractured Condos

Fractured condos are condo projects where only a portion of the project is sold to individual owners, and the remaining units are rented to tenants. A couple of recent examples:

The Millworks at Novato (from the Marin Independent Journal):

Millworks, a 420,882-square-foot residential/commercial project at De Long and Reichert avenues, had a grand opening in May but has only sold two of 124 condominiums situated above a Whole Foods grocery store slated to open next spring.

"Because of the mortgage market, it's really hard to get condo loans right now," said Mike Ghielmetti, president of Pleasanton developer Signature Properties. "A lot of the folks who are interested in buying there have homes to sell, and it's just a slow market. This is what we have to do for an interim period to make this viable."

Unit financing is a huge issue – Fannie and Freddie won’t buy unit mortgages until the project is at least 50% sold out, so these days the only available financing for unit purchases tends to be the construction lender on the project. It seems likely the construction lender on this deal refused to do that (construction lenders are not keen on holding long term fixed rate mortgages in portfolio). I suspect the other problem with this project is it’s pretty big for the size and niche it fills – how many people are there who want to live in downtown Novato?

Siena in Corona Hills (from GlobeSt.com):

 

A buyer from Fontana has acquired 189 units of a broken 296-unit condominium conversion project from its lenders for $14.25 million in a deal that says much about the state of the multifamily market in the Inland Empire today, according to Paul Runkle of the Inland Empire office of Hendricks & Partners in Temecula, who brokered the sale. The property is the Siena in Corona Hills at 2125 Highpointe Dr., formerly an apartment complex known as the Crossing…"This comp says that a quality, broken condo deal that was leased up with rentals, that was not readily financable, and was widely exposed, eventually sold at at 8.93% cap on an all-cash basis," Runkle says.

There are enough numbers in the story to piece together the before and after on this deal:

The moral to the story on this one is, don’t buy an apartment project on a 3.55% cap rate.

See previous post “Are Fractured Condos a Good Investment Opportunity” for a discussion of some of the hazards of doing these deals.

Borrower Risk, Net Worth, and Liquidity

You are considering making a $10,000,000 loan to one of two borrowers. Both borrowers have a $10,000,000 net worth and $1,000,000 in cash. Your astrologer has told you one borrower will default and the other won’t, but she can’t tell you which one. You are allowed to ask each borrower three questions. What do you ask?

Here are my questions:

What are your total liabilities (contingent and non-contingent)? A borrower with $10,000,000 in net worth with $20,000,000 in assets, $10,000,000 in liabilities and $1,000,000 in cash is a great risk. A borrower with the same net worth and liquidity comprised of $100,000,000 in assets and $90,000,000 in liabilities is toast in a significant downturn.

How did you make your money? If the answer is investing in the same market and kind of real estate as the loan you are considering (for example, multifamily in Dallas), the borrower is a good risk. Any other answer (selling a software company, dentistry, UPS driver, playing poker, aerospace engineer) is a problem. I know this from personal experience because I’ve approved and subsequently regretted making loans to borrowers with these former occupations. Each time I thought we had mitigated the risk – I now believe you can’t mitigate inexperience.

What was the value of CRE assets you owned in 2001? The answer should be at least $2,000,000 – enough to tell you they had some holdings in the last downturn. If the answer is less than that it means they made all their money in easy times. Ideally, a borrower would have been through the 1989-1994 trough, but those guys all have a net worth a lot bigger than $10,000,000.

I believe the answer to these three questions tells you pretty much everything you need to know about a borrower.

Commercial Real Estate Market Stability and Government Centers

Last week I posted on the merits of college town markets (although I glossed over the reasons – Chris Rodriguez goes into more detail in his post “Commercial Real Estate in College Towns – Recession Proof”). Markets with heavy concentrations of government employees also weather the storm better.

The charts below show the 12 month percent change in employment for the largest market in the state, and that state’s capitol. Starting with the state that’s always the worst:

Employment losses in Lansing are half those of Detroit. Next, Washington:

Employment loss in Olympia is a quarter of that in Seattle. On to Texas:

Austin is one of the few places that hasn’t lost jobs at all.

No discussion of government centers is complete without looking at Washington DC. Job losses there are half what they are in the nearest major market (Baltimore):

Government centers don’t always outperform; Sacramento and Albany performance is about the same as Los Angeles and New York respectively. But, as a general rule the relative stability of government jobs provides a safety net for their markets.

All data from this BLS site.

Retail CRE: Which Deals Get Renegotiated?

One answer: new, incremental deals in outlying areas. Calculated Risk put up this post a few days ago:

“We’re dumbfounded. We’ve been working on this deal for four-and-a-half years. I don’t know how, all of a sudden, the numbers don’t work.” JMW Development Principal Mark Johnson

From the Minneapolis / St. Paul Business Journal: SuperTarget planned for Woodbury now on hold (ht Arnold)

“Target recently informed JMW that it would not proceed with the project unless it receives “a pretty significant discount” from its previously negotiated deal, JMW Principal Mark Johnson said.
“We’re dumbfounded,” Johnson said, noting that Target officials had told him as recently as June 24 that the project was on track.”

Maybe Target has lowered their retail sales estimates for the store? Just saying ...

Woodbury is an outlying Minneapolis-St. Paul suburb, and already has a Target (“B” on the map below) which is eight minutes from the site of the proposed new store (“A”).

When it negotiated the deal for the new store Target was anticipating new residential growth in Woodbury which is now not going to happen. Without growth the new store won’t hit its numbers, and will cannibalize sales from the older store.