During the first half of the year the REITs were able to raise substantial sums at a low cost of capital, and to out bid private investors. The CMBS 2.0 market was ramping up and as many as twenty five firms entered the market and began to staff up. Money was flowing and values were beginning to rise rapidly, especially in the usual major markets where cap rates were getting to silly levels for office and even for larger hotels. Money literally poured into Manhattan properties as though it was 2007 all over again, and CMBS lenders were even starting to go to covenant lite. It began to look like amnesia had set in and the same old mistakes were starting to be made. Some of us who are older and who had seen the huge irresponsible behavior a few years ago, and had called the collapse in 2007-2008, began to talk about here we go again, doesn’t anyone remember anything. Then it happened right on schedule-August. Just like in 2007.
This August it is Europe and its lack of leadership with Angela Merkel, adding on top of the sheer disgust everyone feels with both the president and Congress over the debt talks. Once again they showed there is nobody with the slightest leadership skills and the president, instead of leading a compromise, moved left and started to rehash his class warfare and attacks on all of us who work hard to make money. Why would any businessman invest and hire when we are attacked for success and then told those of us who pay almost all of the tax don’t pay our fair share?
The result of this is most people with investable funds have pulled in their horns and are sitting on their cash. Private banking groups have seen a disinterest by major clients to invest in funds or other vehicles that private banks use offer their clients. There seems to be a substantial view that there is no way to know where all of this is going until the election. Uncertainty is the word of the day. The stock and commodity markets are so volatile for the past several months that one does not know from day to day if being short or long is the right strategy. Some of the market timing geniuses of the last cycle are now losing their shirt.
The good news based on my own investment banking practice is that there is still a good interest to invest in cash-flowing real estate, whether it be hotels, office or multifamily. With good real estate, there is a hard asset you can walk up to and physically touch. There is a measurable cash flow which may get temporarily reduced through more vacancy, but after the past three years, most tenants are restructured in terms of cost cutting and cash accumulation, and the weak tenants have mostly been washed out. It is unlikely that we will see wholesale lease cancelations and corporate bankruptcies in the next two years they way we did in 2009. US banks are all in good to very strong shape, as are the finance companies. CIT, I Star and others have restructured. Hotels are doing much better, and while travel and events will slow next year, revpar is more likely to be stable or not down much. There is not going to be the complete collapse of revpar that we saw in 2009 and 2010. In short, real estate offers one of the few solid places to invest and generally hold principal value even if there are some declines in rents or slowdown or delay in increasing rents. Values are not affected by high speed traders or speculators like in the stock and commodity markets. We got rid of the real estate flippers pretty much in the big wash out of the 2008-2010 period. It is now much more an investor willing to hold for as long as five years who is buying the asset.
Cash is king. There will be many more defaults on commercial mortgages in 2012 -2013 as five year loans mature and the extend pretend loans also mature. Hotels will be hard pressed by the brands to finally do their long delayed PIPs. However, the lenders and servicers are now far stronger and much more willing to say pay or give me the keys. Servicer staffs are likely to try to modify so they can keep the fees rolling in and keep their jobs, but banks are more likely than they have been to just foreclose. It is likely that transaction activity will increase the next two years.
I believe CMBS will be very slow to ramp back up. There is no expectation that Obama even understands the damage he is doing to the economy and the capital markets. Merkel seems more interested in the next election than in solving problems. The Tea Party and Pelosi and Reid are more interested to hold their extreme positions than getting the country back on the right track. The result is nothing good will happen in Washington for the next 18 months until a new president has had time to start to undo the severe damage Obama and Pelosi have burdened us with. As a result the capital markets and risk pricing will remain unsettled and pricing will be choppy. It will be hard for major lenders to commit very large sums to CMBS. While the senior tranches of the pools that priced over the past three weeks have sold well, subordination levels are materially higher and the sub tranches had a hard time pricing. The issuers have said they “did not lose money on these pools”, whatever that means. That suggests CMBS 2.0 is not going to come roaring back. Then there is always the Dodd Frank issues which could kill it altogether. Cash is king for investors, and the non CMBS balance sheet lenders will have a good number of deals to look at. Buy now and hold for five years and you will make a lot of money. Just be patient.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
