Yet the practice of extending and pretending may be falling by
the wayside for other reasons, depending on the lender’s finan-
cial health. “Banks that are marginally capitalized are still sticking
their heads in the sand with regard to the value of their real
estate,” says Neil Aaronson, Chicago-based CEO of Hilco Real
Estate. “We’re frequently seeing banks make what I would call
fundamental financial mistakes. Rather than taking a markdown
now and recapitalizing, they’re holding assets in the hope that
one day three to five years from now, the real estate will return to
the values the banks have on their books.” The well-capitalized
institutions, by contrast, are “taking their hits and marking their
balance sheets more appropriately.”
Grillo sees the practice becoming less prevalent as sellers and
buyers agree more on pricing. “One of the reasons for extend-and-
pretend was that there was such disconnect between lenders and
potential buyers for assets that it was impossible to get deals done,”
he says. “When assets continued to under-perform in 2009 and
2010, values became completely depressed. As the economy and
asset performance improve, you’ve got buyers who are willing to
pay a little more and lenders who have sat with assets for longer
periods of time” that now want to dispose of them.
“The good news is that the capital
markets are improving. The bad
news is that there’s probably 20
times as much product as there
are transactions.”
EDWARD INDVIK
Lee & Associates
Lenders in 2011 may also be willing to foreclose, although Grillo
says some are open to recapitalizing “so long as somebody is willing
to put in new money.” To the extent that buyers or borrowers can
raise the capital and thus wipe out some of the senior leverage, “the
senior lenders will typically be willing to stay in the deal. Whereas
before they were extending, now they’ll give you essentially a new
deal if you can show that you’ve got enough cash to bring to the
table.” He adds that Goodwin Procter has done a couple of deals
lately along these lines.
A poll among audience members during a recent Deloitte webcast illustrates how diffuse the outlook is for financing. Asked
which factor would have the greatest influence on commercial
real estate lending as the year progresses, the 1,200 audience
members for the Deloitte webcast were pretty evenly divided
among new CMBS issuance, relaxation of banks’ underwriting
standards and the emergence of new sources; each garnered
slightly more than 20% of the vote. A reduced role for Fannie
Mae and Freddie Mac was preferred by slightly fewer respondents,
while only 8% thought insurance companies would be making
more loans.
To Deloitte principal Guy Langford, who moderated the hourlong discussion, titled “Real Estate Markets 2011: What Factors Will
Influence Your Decisions?,” the audience’s response tied in with
what his firm is seeing. “It will take many levers” to refinance all of
the approximately $1.7 trillion in commercial mortgage debt
maturing between 2010 and 2015, said Langford, leader of Deloitte’s
distressed debt and asset practice.
52 REAL ESTATE FORUM APRIL 2011
10 TO KNOW…
RISKS AND PITFALLS IN DISTRESS INVESTMENT
Investing in distressed assets, whether via the debt or the underlying properties, is not like playing hide-and-go-seek. The object
of the game is to have both eyes open at all times. Here are 10
watchwords to keep in mind:
• Choppy pricing recovery. Commenting on the uneven results in
the most recent Moody’s/REAL Commercial Property Price Indices,
Nick Levidy of Moody’s Investors Service says, “A clear positive
trend is unlikely to develop until markets become convinced that the
recovery of the broader global economy has real staying power.”
• Rapid pricing recovery. “More than anything else, people worry
about being outbid on deals,” says Emanuel Grillo with Goodwin
Procter. “That’s driving up pricing and values. We haven’t seen too
much crazy money yet, but we’re seeing strength and pressure
building on pricing.”
• Spotty fundamentals. “To the extent that properties are seen as
income-producing, while market rents have stabilized somewhat in
certain areas, they certainly have not shown any sign of meaningful
bounce-back and the credit quality of many tenants is still uncertain,” says Neil Aaronson with Hilco Real Estate.
• Drags on values. “State retirement systems are now looking at
selling assets to fund pension shortfalls,” says K.C. Conway of
Colliers International. “If they begin to dump assets as well, a whole
new supply of CRE assets will come to market that could suppress
values.”
• Lender caution. “New lenders coming into a deal are still not willing to go as far as old lenders would in a restructuring,” Grillo says.
• Getting rid of it. For banks and others holding distressed assets,
there’s the question of whether to dispose of an asset on an as-is
basis or on an as-stabilized basis. Since stabilizing the property is
likely to take some time, says Conrad Andersen of Grubb & Ellis,
service providers who recommend that approach need to be sure
that it can be accomplished in a reasonable period of time and that
the lender will receive an appropriate return on whatever is spent.
• Take note of bubbles. “Right now, there absolutely is a pricing
bubble in note sales,” says Grubb & Ellis’ Craig Sherman.
• Junior debt, senior complexity. While buying at a junior level in
the capital stack has its advantages, “Given the amount of due diligence, it’s even more complicated than buying the building because
if you’re going to buy the debt, you don’t know whether you’re going
to be able to get the deed,” says David Eyzenberg of NewOak Capital.
“You’re a little bit removed from the asset itself.”
• The waiting game. “The time from getting the note to actually
working out the troubled debt restructure or foreclosure can drag
well on past projected periods,” says Aaronson.
• Return expectations. For anything other than core, institutional-quality assets, Aaronson says, “It’s still a very volatile, uncertain
time, and return expectations need to reflect those risks.”—Paul
Bubny and Bob Howard
