As Europe and Washington bumble and stumble on with political bickering and no real resolutions of the sovereign debt and banking crises, and no agreement anywhere other than the UK as to how to deal with the massive deficits now burdening most counties, the prospect for a robust CMBS market next year dims further. Instead of the $50 billion of CMBS issuance in 20011 that many projected, it is likely to end under $30 billion. In 2012 it is likely to be around $30-$35 billion maybe. It is really impossible to predict, but there is no reason to think that it will be anymore. With all European sovereign debt in question and on credit watch, the failure of a recent German bond issue, and a potential crisis looming with Chinese banks, there is little prospect that investors will be rushing to believe AAA ratings on CMBS and to buy large quantities of these issues. In fact, there is now talk of eliminating rating agency ratings as the metric for certain institutional investors. Whether that happens or not, there is a clear message that ratings are very suspect. Everyone should have clearly learned that after 2008, but even that complete demonstration of the invalidity of ratings did not seem to end the reliance on the major rating agencies. The downgrade of US Treasuries again demonstrated the invalidity of rating agency work. Now we have major questions about the ratings to European sovereign debt. Given all of this, why should anyone think that a AAA rating of a CMBS issue has any more validity than the sovereign ratings. If the US is not AAA, then how can you say a tranche of CMBS is.

The ramifications are that to revive CMBS bond sales will take a reset of the belief of investors, especially institutional investors, that CMBS mortgages and therefore, bonds, are being well underwritten and that the monetary and fiscal crisis of the western world is really being dealt with by political leaders who have even a rudimentary understanding of banking and economics, which it seems is not the case in the White House or Europe. The only hope we had that anyone in the White House understood anything about banking or finance, was Daly, and they quickly demoted him and shoved him aside. It is clear they have no interest to hear what he has to say. My own personal dealings with the White House on mortgages and how banks and mortgage lending really work, just reinforced their complete lack of any understanding. Congress is so divided that even the members who do understand the subject have no real influence on the outcome of legislation.

There is low expectation that Washington is going to accomplish anything useful before January 2013, and if Obama is reelected there is no hope at all. It will just be more of the same attack the banks and solve none of the major problems. Europe may stumble into some sort of fix which is unlikely to fully solve their problems and will most likely shove partial solutions onto the IMF, to take the heat off of the politicians who are up for reelection next year who will then try to blame the IMF for austerity and higher taxes.

Given all of this and the continued showing that the rating agencies are not really well qualified to assess the quality of a loan portfolio, it is reasonable to assume that CMBS issuance in 2012 is not going to be robust. It would seem unlikely that investment officers at pension funds and insurance companies will be able to make a strong case to put very large sums of their institutional funds at risk purely on the say so of S&P or Moodys. A few billion of the most senior tranches, maybe, but who is going to buy the middle tranches? How much capacity is there for B pieces? There will simply not be the issuance to deal with all of the maturities coming due in the next two years. Given that the economy will not suddenly make some huge leap forward, but will grow slowly, it is also unlikely that new loan underwriting is going to get any looser next year, and it is unlikely that commercial rents or hotel rates, or values are going up materially next year. Therefore cash flow is not likely to rise much over this year, and is not likely to be sufficient, given the tougher underwriting, to allow many properties to be fully refinanced. Maturity defaults will rise.

The other major unknown is Iran. There is no way that Israel can allow that situation to continue past another year. They have said so publicly. Maybe the imminent collapse of the Assad regime, and the clearly more aggressive covert war against Iran by Israel and the US will bring a change of regime without Israel attacking, but don’t count on it. If there is a military attack on Iran, which is highly likely, then there is no way to know what the ramifications will be, but owning solid, cash flowing US assets will surely be a better bet than almost anything outside the US. China is facing a banking crisis and real estate value collapse. In the event that Iran and China play out in the worst case scenarios, a lot of foreign capital will come here.

The implications for all of this is that for those who are good fundamental investors with a lot of cash, and a long term horizon, the opportunities will increase. The pressure on the banks to raise capital ratios will mean more loan sales. Servicers will be selling more loans. More assets will be turned over to lenders and resold over the next two years. This is the time we have all been waiting for. The next two years is a buying opportunity if you know what you are doing and you underwrite carefully. By late 2013 it is likely to be too late. If Obama is reelected and the Democrats get back control of Congress, then I retract all of this and suggest stay liquid as you can in Treasuries and gold and hide out for two more years.

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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.