Reality Therapy (for commercial real estate)

Reality: The state of the world as it really is rather than as you might want it to be

by Joseph Forman, CEO of Bond Street Capital in News & Views

The commercial real estate business is in uncharted territory. It feels as if we are actors in a slasher movie where the teenager is about to be beheaded. We know it’s coming and perhaps we avert our eyes when the power saw is revved up but the result is the same. Lots of gore and mayhem and in the end perhaps one survivor. And……..we are all trying to be that survivor. To be that survivor, you can’t simply cover your eyes and wish it all away. You have to see things for what they are and act within the realities of the climate we are in.

The most challenging part of my job these days is trying to help borrowers see the commercial real estate business with clarity in 2009. How do we properly value an asset in this market? This is of course a challenging question in normal times but today, it’s particularly critical that folks have a realistic view of what their assets are worth.

So in the spirit of finding truth and reality, Bond Street is sponsoring our own mental health initiative. To see if you are in the real world or are a candidate for a straight jacket, please take the following reality check: If you say……..

My property is worth the same as it was three years ago because I bought it right! REALITY CHECK: Property values have declined significantly – perhaps as much as 60% for some properties from the peak values of early 2007. For 99% of the folks that purchased performing assets between 2004 and 2007, your value is way down. You are in “dreams-ville” if you think that your property has not declined in value.
My loan comes due this year but I have never had a problem securing financing, and I doubt that this time will be any different. REALITY CHECK: If you secured a maximum leverage loan after 2005, you probably have no remaining equity in your property. Even if you are not over-leveraged, it can be very challenging to finance certain asset types such as hotels or construction loans. No matter how confident you are about finding financing, you need to start the process early to give yourself time to deal with the hiccups that are sure to come.
I need financing but I will not guarantee a loan! REALITY CHECK: Yes, there are non-recourse loans out there, but those are limited to agency and low leverage insurance company loans. If you need higher leverage or a typical bank financing, you will need to provide a guarantee. If you are unwilling to do that you can expect to pay bridge rates.
We have hit the bottom! Everything will be significantly better in 2010. REALITY CHECK: While certainly no one can predict an end to the recession, most of institutional asset managers and lenders are talking about 2011 as the year that we see stabilization in our industry.

The Bottom Line: Our industry is caught in a vise between sellers and borrowers who will not accept what their properties are really worth and buyers and lenders that are sitting on the sideline waiting for reality to set in. Until sellers and borrowers get real, there will be no increase in the number of transactions.

War Stories:

FROM 11 TO 6 IN EIGHTEEN MONTHS: The borrower owns a “C” quality apartment building in Las Vegas. The property generated a 2007 NOI of about $800,000 with a consistent occupancy of 91% plus. At a 7.25% cap (C quality borrower and tenants), the property was worth in 2007 about $11,000,000. The property was primarily occupied by construction and casino workers coming up from Mexico. Jobs have dried up and many of these folks have fled the market. Occupancy is down to 76%. The NOI is down to the low $600,000 level. Cap rates have risen to what some folks might argue are double digits. Using a 9.5% cap on current income, the property is worth $6,400,000. That’s a 40% drop from peak value. Before I went through the numbers with the borrower I asked him what he thought the property was worth. He told me he wouldn’t sell it for less than $10,000,000. Reality Check: The borrower needs to replace a $6,500,000 loan. He has no equity in this property yet he is still operating as though it’s 2005 and buyers are throwing money at sellers. There is no rational basis for him to value his property at $10,000,000 plus. By not dealing with reality, he is not on the way to a solution.

KILLED BY TIME: Time is the killer of all deals. A developer client is delayed by the city from constructing his “Recovery Center” facility. Started in 2005, he finally nears completion in late 2008. He master leases the property to a weak operator on a triple net basis for $1,500,000 a year. He has nearly $14,500,000 of debt on the property and it is still not open and the loans are due. He thinks the property is worth $18,000,000 and is looking for an 82% loan to value. The borrower has bad credit. Reality Check: The borrower missed the market on this deal. Given the special purpose asset type, the weak tenant, the bad credit and the fact that the property is not finished puts this deal in the disaster zone.

THE COMMON THREAD: In both cases the borrowers see reality as what they want it to be and not what it is. Folks, its time for tough love. It’s time for a hard look at the real world, Its time that borrowers get “real” as to the value of their properties and the terms and conditions that the market has to offer. If you have to finance or sell your property, you need to be realistic about the value. Being realistic is the first step towards a resolution of your problem.

No one is helped by the overly optimistic broker or advisor that will not realistically underwrite the borrower and the deal. The first step to a solution starts with seeing the deal as it really is! Reality, its a good thing!

Perhaps we need a twelve step program for commercial real estate owners to help them overcome delusions of value?