“Another” Wave Of Commercial Defaults

In February 2007 Sam Zell sold Equity Office Properties to Blackstone for $39B, earning himself a place in real estate investing lore by cashing out 30 years of commercial property accumulation at the very peak of a delusionally white hot market that began its climb 15 years earlier.

That should have been a signal for other commercial real estate owners; the party’s over.

It is interesting reading the economic analysis in business publications circa 2007-8. A lot of story telling about how real estate always goes up in value, and the disingenuous bubble vs no bubble debate. Apparently the punch (i.e. credit) being passed around at the party was seriously spiked, and everyone there was under the influence enough to say “more punch”, instead of heeding the host’s announcement the party was over and it was time to go home.

Indeed, while Zell was casting around for suitors to EOP, other investors where refiing their properties to the max, pulling out cash for more acquisitions. With the wisdom of hindsight, the over-leveraging by investors looks careless, but hey, we’ve all done things at parties we shouldn’t have.

In March 2008, Bear Stearns collapsed, marking the beginning of the financial crisis. In a very short space of time commercial property owners were having trouble servicing their mortgages and the defaults began to increase.

In the face of the residential default tsunami and a collapsing economy, the servicing companies responsible for managing the loans for commercial mortgage backed securities (CMBS) didn’t want to be creamed by reo as well, so to minimize their non-performing commercial portfolios the servicing companies chose to allow loan modifications to avoid having to take the properties back.

In theory, a good solution. Push the problem out five years, give the market time to recover, and property owners can then refi again and cash us out at face value.

In practice, not so good. See, the properties still have the same owners. These are people whose thinking allowed them to be out of touch with market realities enough to overexpose themselves to risk at the very peak of the market, and when their day of reckoning arrived, the banks and servicers cut them a break.

In other words, a lot of investors who made a bad play in 2007-8 (by refiing when they should have sold) have yet to be “disciplined” by the market. If you have talked to any of these owners, they still think they’re smart guys.

Well, those five year loan mods are coming due over the coming year, and throughout 2013. The market is a different place today than it was a few years ago, reo is starting to be cleared out, “special servicers handling the defaults on commercial loans backed by bonds may not be so forgiving on defaulted notes this time around.

This article goes into more detail about the loan mods on commercial loans coming due in the coming year. I recommend you read it.

For apartment investors with their creative financing arrows sharpened and ready in their quiver, the coming 12 months (starting now) will be a great time to buy property. Both, from banks and receivers (for cash), and from sellers direct (with owner financing and master lease option).

It’s always a great time to buy real estate, but especially right now.