Market Stumbles As Commercial Real Estate Crash Looms - By Joe Duarte
One of Hawaii's premium resorts, the Maui Prince, located in the pristine Makena-Wailea side of the island, is facing foreclosure as a joint venture between a local developer and Morgan Stanley missed a nearly 200 million payment to Wells Fargo in the last few days. This is a stunning situation, given the scope of the potential can of worms that's about to be opened if the foreclosure isn't forestalled.
The hotel was owned by Japan's Prince group since 1986, when it was built. Morgan Stanley and a local development group bought it for $575 million near the top of the market, and have struggled ever since. We were at the hotel earlier this year and filed a "Tales from the Road" report in this pace noting how the island's economy seemed to be very sedate compared to most other times we had visited.
Some 380 jobs are in danger, although a report from KMGB9.com says that the hotel will stay open and that the employees are being rehired for now. So who's on the hook for now? According to The Wall Street Journal: "Mortgage-holders led by Wells Fargo Bank sued last week to foreclose on the 310-room resort, following the owners' failure to pay the resort's $192.5 million mortgage when it came due in July. The foreclosure threatens to wipe out the $227.5 million in mezzanine debt held by a UBS fund and the $250 million in equity that Morgan Stanley and its partners put into the property."
Yet, the situation is Maui, sensational to be sure, is not isolated, as commercial real estate is likely to be the next trouble spot in the global economy's boom and bust cycle. On 8-31, the Wall Street Journal reported that "Federal Reserve and Treasury officials are scrambling to prevent the commercial-real-estate sector from delivering a roundhouse punch to the U.S. economy just as it struggles to get up off the mat."
The Fed is worried about "surge in foreclosures of commercial property carrying mortgages that were packaged and sold by Wall Street as bonds." In other words, the same thing that happened in residential mortgages could be about to develop in commercial real estate as mortgage holders miss payments and the buck gets passed onto the banks who get nothing and start foreclosure proceedings.
According to the Journal, there are about $700 billion of commercial mortages that may be at risk if the situation begins to cascade. That means that the "for rent" and "for lease" signs at your local strip mall may be replaced by something else, empty buildings that gather moss as tenants and landlords evacuate the premises under less than friendly circumstances.
There are two reasons for this. One is that lenders made bad loans, assuming that the boom would continue. The other is that "is coming from the inability of property owners to refinance loans bundled into CMBS when these loans mature. By the end of 2012, some $153 billion in loans that make up CMBS are coming due, and close to $100 billion of that will face difficulty getting refinanced, according to Deutsche Bank."
And here's where things get very sticky. According to The Journal: "Even though the cash flows of these properties are enough to pay interest and principal on the debt, their values have fallen so far that borrowers won't be able to extend existing mortgages or replace them with new debt. That means losses not only to the property owners but also to those who bought CMBS (commercial mortgage backed securities) -- including hedge funds, pension funds, mutual funds and other financial institutions -- thus exacerbating the economic downturn.
And if you add the differential is tax liabilities when these loans are not negotiated, or the property is sold at a loss, things get compounded even further. And things are starting to happen fairly fast. According to The Journal: "Realpoint found that 281 CMBS loans valued at $6.3 billion weren't able to refinance when they matured in the past three months, even though 173 such loans worth $5.1 billion were throwing off more than enough cash to service their debt."
So far, all we've talked about is what could happen, and how much money there is to lose in Commercial Mortgage Backed Securities. According to the Journal, the combination of property value declines and scarce credit could throw another trillion dollars into the loss pot. This would happen as defaults rise, triggering "losses (that) would be at least as large as those on loans originated and bundled into commercial-mortgage-backed securities, or CMBS, from 2005 and 2008."
Are you looking for a kicker? Try this. According to The Journal: "In contrast to home loans – the majority of which were made by only 10 or so giant institutions – thousands of small and regional banks loaded up on commercial property debt. As a result, commercial real estate troubles would be even more widespread among the financial system than the housing woes. At the present, more than 3,000 banks and savings institutions have more than 300% of their risk-based capital in commercial real-estate loans."
Conclusion
We started with a story about a plush resort held up by a bad deal that has imploded. But the real story is about the precarious state of commercial real estate where weird loans and bad securitization of crazy debt may be set to implode.
The residential market's implosion was bad enough. We're still recovering from it. But at least it hit a few very large banks which the government bailed out. These banks are now more solvent, and in many cases, such as JP Morgan, have made astute acquisitions and have grown to be even more dominant players.
The problem with commercial real estate, aside from the large amounts of money involved, and the repercussions for employment, local economies, and so on, is that small town and regional banks are big players in this segment. That means that the neighborhood banks that many of us use for daily transactions, home equity loans, and yes, even commercial real estate loans for small businesses, are now in danger.
The falls of Guaranty and Colonial in the last two weeks are likely the canaries in the coal mine for this next wave of problems.
In other words, the banking crisis in commercial real estate may well be about to give the term 'personal" a whole new meaning.
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