The long road to clarity and price discovery may seem a little shorter than it was in the darker days of the recession, as momentum in loan sales and modifications is building. This activity also proves the old adage that one person’s distress is another’s opportunity.
CMBS delinquency rates – loans that are 30 or more days delinquent, in foreclosure or REO -- for office (6.93 percent) and industrial (8.97 percent) in December 2010 were lower than the overall rate of 9.2 percent, according to Trepp, LLC, a provider of CMBS and commercial mortgage information, analytics and technology. It calculated the value of delinquent loans at more than $61.5 billion. At the same time, what’s now referred to as “CMBS 2.0” is growing and special servicers are becoming more adept at resolving troubled loans.
Paul Mancuso, vice president of Trepp, said that the rate of increase in defaults moderated in 2010, versus 2009, but that this could be partly attributed to special servicers being overwhelmed by volume. Now the servicers are becoming more proactive in managing their portfolios, either by instituting loan modifications, seeing payments become current or conducting distress sales. Loan modifications may involve extending maturities, interest rate reductions and “a host of other conditions,” he said.
According to Standard & Poor’s, 354 CMBS loans with a balance of $15.6 billion were modified through November 2010 – more than double the amount for all of 2009. According to the credit rating agency Realpoint, a Morningstar company, the volume of CMBS loans in special servicing remained flat in December, at $89.4 billion, from the previous month. According to Trepp, 2010 was the most active year ever for CMBS loans being liquidated; it represented 38 percent of all CMBS liquidated loans.
These loan sales were discounted significantly, Mancuso reported: “In 2010, the loss severity was 45 percent on U.S. conduit deals -- up from 43 percent in 2009 and typically, 40 percent,” he said. Who’s buying these loans? Opportunity funds, opportunistic investors and overseas investors.
One way special servicers are becoming more adept and market-savvy is that instead of foreclosing on assets, they are putting more properties in receivership, giving the receiver the right to sell an asset directly. That was the case in Orange County, Calif., in which a judge authorized what the Wall Street Journal reported as the $213 million sale of a four-building office complex owned by MPG Office Trust Inc., which had defaulted on its securitized mortgage loan, to Irvine Co. (For its part, Irvine has begun to reinvest in the complex, with improvement of on-site amenities, floor common-area enhancements, upgrades to operating systems and a unification of exterior landscape design and outdoor workspaces.)
Bill Hoffman, CEO of Trigild, a non-performing commercial loan specialist active in 24 states, said that if special servicers can restructure debt and offer an asset to a buyer, the sale price will be higher – about 20 to 25 percent above an all-cash purchase. The special servicer cannot be involved in a sale directly; it has to be sold by a receiver. Hoffman noted that Trigild might have had 20 to 25 properties for sale in 2006-2007; now it has about 150.
Unfinished developments are difficult, though they represent the best bargains. “There’s always a buyer; the issue is, what’s the price?” he said, noting that he has not seen sales equaling the original full loan amounts. “There’s still a substantial discount,” he commented. Hoffman expects a slow recovery, with maturity defaults, not payment defaults, in the next few years as loans mature.
“We’re at a crossroads, but it comes at a good time,” Trepp’s Mancuso said, noting that values are perceived to be at bottom, market conditions are improving, spreads are narrowing and new CMBS issuance is growing.
Comparing the five commercial real estate sectors that Trepp tracks, Manuso observed that “industrial is not a sexy industry. It didn’t grow as much as other sectors. It’s one of the five prime property types, but the smallest.” Office has experienced a different dynamic. It may have been insulated at the beginning of the downturn because leases are long-term in nature, and only now may be starting to deal with lease renewals and occupancy issues.
Plenty of Capital on the Buy Side
Earlier this year, Starwood Capital Group announced that it completed the acquisition of a $157 million non-performing commercial loan portfolio from a major Midwest regional bank. The portfolio of loans was purchased for 40 cents on the dollar, representing a price of approximately 32 percent of the initial capitalization. The portfolio consists of 137 commercial loans with concentrations in Fla., Ind., Mich., N.C. and Ohio.
But this should not necessarily be read as a benchmark, according to Stuart Salins, senior managing director and head of Holliday Fenoglio Fowler’s (HFF) Loan Sales Group, who called it a “very opportunistic price” and not typical of the transactions HFF has been involved with. “We’ve even seen some defaulted loans selling substantially higher than that. The delta between bid and ask has narrowed dramatically,” he said. Moreover, Salins said that assets are being kept up and generally, “we haven’t heard of too many deals where management has let the property go. Lenders want properties managed properly.”
HFF’s Loan Sales Group, which Salins said had posted sales of more than $1 billion last year, continues to enjoy robust business volume; Salins said that before the end of January, volume has already exceeded first quarter 2010 volume and he expects this to continue through 2011 and into 2012. Loans involve all commercial property types and all geographic areas. Growth of this business prompted the company to hire two additional producers and an analyst in 2010; it teams with HFF’s investment sales producers as well as loan sale experts.
Sellers are banks, special servicers, insurance companies and funds of various types. Last year, he pointed out, the FDIC was a substantial seller, but it slowed its pace down in the second half of 2010 and Salins does not expect it to rush into the market this year.
There is plenty of capital seeking the right opportunities and buyers have included various types of funds: private equity, hedge funds and opportunity funds, as well as some banks and insurance companies. For many, returns on investments in loans are a bit better than they would be on acquiring the real estate.
“The values are generally close to each other,” he remarked, adding that it is not unusual to find that sellers can be buyers, and vice versa, though buyers are “not looking for the same types of loans as they’re selling.” Recently, HFF took on a major assignment involving something he said the market hadn’t yet seen: a portfolio of high-quality, low-leverage, performing loans.
“You can’t be surprised at much of anything these days,” he said.
That portfolio may generate considerable attention. As CBRE Econometric Advisors outlined in its podcast, “Many Happy Returns: U.S. Commercial Real Estate Opportunities in 2011,” commercial real estate investments made in 2009 and 2010 are already delivering positive returns. That is in keeping with principal and director of investment strategy Jim Costello’s analysis of five-year quarterly returns on investments made in the post-recessionary periods of 1998-1999 (three percent quarterly) and 2003 (four to five percent). Although returns on investments made in 2007 are likely to continue to be negative, Costello maintains that “investing in commercial real estate, after recession – assuming no double dip – is the best time.”