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Monthly Archives: March 2012
Posted on the blog of the Real Estate Center at Texas A&M on March 29, 2012 by Mark Dotzour
Recently I served on a panel of speakers at the Information Management Network’s Bank and Financial Institutions Special Asset Executive Conference on Real Estate Workouts in New York City. The topics of the event were related to the disposal of troubled real estate assets that are owned by banks or are in the process of becoming owned by banks. A wealth of information was provided by the presenters, and what follows are some of the themes that were discussed.
The good news is that it is clear that troubled commercial real estate is starting to be sold by banks to private investors. It’s too early to say that the era of “extend and pretend” is over, but some product is beginning to flow. Banks are starting to sell properties in secondary and tertiary markets, and investor money is starting to move into those markets as well. For the past two years, most investor focus has been on the “gateway cities” of Boston, New York, Washington D.C., and San Francisco. Prices have risen dramatically in these cities, and returns have gotten low. This is the impetus for investor interest increasing in the rest of America.
There is still concern about the large volume of CMBS loans that were made in 2007 that will mature this year and need to be refinanced. The vast majority of these loans were made in the first half of 2007, so the refinancing pressure will be strongest in the first half of 2012 as these loans mature.
This worry about refinancing maturing debt has been around since 2009. But so far, there have been few examples of big failures to refinance or extend these maturing loans. Many are being extended for another two or three years. Often the borrower is asked to add more cash by paying down the loan. Some borrowers that are unable to come up with extra cash are “marrying up” with private equity firms who supply the funds. These funds have a high required rate of return.
The yield requirements for rescue capital has become more reasonable in the past year, down from 20-25 percent to more like 15-19 percent. This is why private equity is starting to play a role.
Some owners commented that when you take on a private equity partner, you feel like you really don’t own the property anymore. But the alternative is to lose the property to the lender. Private equity is available, but the cost is high.
Some banks still are in the extend-and-pretend mode because many don’t have the budget to write off the real estate losses when a foreclosure occurs. The banker must decide whether it is better for the bank to foreclose and take an immediate loss or to extend the loans and hope the market prices rebound and reduce any expected loss.
The capital markets were completely dead a few years ago; now there is some liquidity in secondary markets. Hopefully, it will bring more deal volume in 2012. As the general financial markets improve, the number of deals coming out of banks will increase. Private equity is stepping in to rescue these deals.
The consensus of the speakers at the event is that extend and pretend has been a success for the banking system. As prices stabilized and increased in some cities, the expected losses on real estate loans has also stabilized or gone down.
Stabilized asset workouts are treated very differently compared to loans on “half-built” properties. Extension is probably a good policy for the stabilized properties that generate cash flow. Prices are firming, and expected losses are diminishing. But half-built properties are another matter. These properties are not generating income, only costs. Banks are much more likely to be willing to sell these properties and get them off their books. Commercial real estate investors should view these broken properties as an immediate investment opportunity. If you are waiting for quality buildings with quality tenants to be sold by banks, you may be waiting for several years.
The investor panels at the conference expressed a common theme that I’ve heard for the past two years: “I can’t buy anything because of all the irrational bidders out there.” There is a lot of money trying to buy troubled commercial real estate from banks and CMBS special servicers. Prices are high, and yields are lower than expected.
Some of the bankers reported that extend and pretend is getting harder to do because of recent changes in accounting regarding troubled debt restructuring (TDR). If a real estate loan is identified as a TDR, then it’s classified as a nonperforming loan. If they extend a loan and it gets classified TDR, then they have to write down a loss.
Property values have increased substantially in gateway cities. In all other markets, appraisals are still flat or declining.
Restructuring a troubled commercial real estate loan usually means extending the duration, collecting a fee and requiring the borrower to put up more equity cash investment. The initial borrower often doesn’t have the cash so they have to marry up with rescue capital.
Another topic of interest among the panelists was the concept of the discounted payoff (DPO). Suppose a borrower has a $1 million loan that is maturing, and the bank doesn’t want to refinance it. The borrower may make an offer to completely pay off the loan at a discount. Some banks have a real aversion to offering a DPO to a borrower because it sends a bad signal to all its loan customers that you can pay off at a discount. However, banks may not have an aversion to accepting a DPO from a third party. In this case, the bank will actually sell the note rather than foreclose on the property. Some banks will allow the borrower a DPO in conjunction with a note sale. If the borrower is the highest bidder for their note, then they can buy it from the bank at a discount.
Some real estate loans are buried deep in the banking system under a loss-share agreement with the FDIC. Typically, this happens when a “good” bank acquires a “bad” bank. The good bank didn’t really want the bad loans, so the FDIC offers to protect them from losses when they ultimately foreclose on these troubled loans. But the FDIC is in no hurry to foreclose and sell these troubled properties now. Panelists noted it’s difficult for banks to sell notes where they are under a loss-share agreement. Banks with loss-share agreements don’t really want to sell notes. The FDIC has not signaled the all clear yet to flush the real estate assets.
One panelist offered an extensive overview of the CRE market. The $20 billion in private equity funds raised in 2011 is looking for U.S. real estate deals in all land uses. Transaction volume picked up in 2011. While prices increased substantially in gateway cities, prices are still on average 40 percent less than the 2007 peak elsewhere. Distressed sales were 25 percent of all 2011 CRE transactions.
Smaller banks are hiring consultants to evaluate their CRE portfolios and estimate their expected losses. There is a lot of thinking and planning but not much execution in moving troubled real estate loans off the books. There is pressure coming from the FDIC to recapitalize and get bad loans off the books. Banks that are struggling with capital ratios still are hesitant to sell, but healthy banks have taken write-downs (and charge-offs) for several years and are now in a position to sell troubled loans.
Dear George: I’m about to close on the sale of my home and want to see the results of the appraisal. But I was told that only the buyer can see the appraisal because he is paying for it. Is that correct?
Answer: Yes. You’ll know if the home appraised at or above the sales price when the lender approves the loan. It’s up to the buyer if he wants you to see the full appraisal report.
Architecture Center Houston hosts walking tours on Saturdays in the Spring and Fall showcasing some of Houston’s most distinct areas and highlighting it’s remarkable history and architecture. The tours offer a great way to learn about some of Houston’s most significant and cherished treasures—all within comfortable walking distance of each other.
Walking tours take place Saturday mornings 10 AM to noon and reservations are recommended but not required. See below for the different available tours and click here for dates, meeting places, and more information.
Explore the city from the waterway that gave Houston life and has been its backbone for 175 years. Architecture Center Houston (ArCH), with the cooperation of Buffalo Bayou Partnership, hosts this walk on Bayou Parkway for an overview of downtown Houston’s history and architecture from its beginnings in 1836 to the efforts to revitalize the central city today.
Quads, Courts, & Axis Rice University
Rice University and Rice School of Architecture both celebrate their Centennial in 2012. A treasure trove of great architecture, the campus features designs by great architects and large scale art works. This tour will look at some of the more unique, hidden, important and historical features of Rice University’s Campus and it will explore the context surrounding each building, the quads, courts and axes, and how these elements work together to shape collegiate space.
Towers and Trees Downtown
“Towers and Trees” is the newest downtown tour. On this tour explore the magnificent architecture between Hermann Square and Discovery Green as well as the changing dynamics of downtown Houston. Take a look at the partially realized civic center plan surrounding Hermann Square, the historic backbone of Main Street, the ambitious 1970 proposal that would become Houston Center, the internationally recognized icons from the skyscraper boom of the 70’s and 80’s, and Discovery Green, the newest catalyst for downtown development in Houston.
Montrose Walking Tour
Montrose is one of the most diverse and interesting neighborhoods in Houston with some of the city’s best architecture including spectacular mansions, charming bungalows, the campus of the University of St. Thomas, Rothko Chapel, and the Menil Collection. ArCH tour guides will present an overview of the architectural and social history of the area.
Museum District Walking Tour
The Houston Museum District is one of the few areas in the country with such a dense population of museums, public art, contemporary architecture, and landscape design. On this walking tour you will explore world class examples of design with ArCH tour guides and trace the chronology of significant cultural shifts from the early twentieth century through today. Spring 2012 we will have the opportunity to view Chinese Artist Ai Weiwei’s Circle of Animals/Zodiac Heads installed in Hermann Park by Houston Arts Alliance.
Texas Medical Center
The Texas Medical Center is the largest medical center in the world. Equivalent to the 12th largest business district in the United States, TMC has 33.8 million square feet of patient care, education, and research space. 160,000 individuals visit the Texas Medical Center each day with 6 million patients treated annually. The 1000+ acres is approximately the size of Chicago inside the “Loop” with 162 buildings on the main campus alone. Join our ArCH docents on this introductory architectural tour of Houston’s own modern marvel of medicine. Sites on our tour will include Baylor College of Medicine, the new Texas Children’s Hospital Maternity Center, MD Anderson Cancer Center, Methodist Research Center, and a short ride on Houston’s Metro Rail.
Editor’s note: Originally published in 2006, “Ground Control” is one of the most popular articles in CIRE’s archive. Author Philip “Fred” Himovitz updated the article for republication.
Commercial real estate developers and investors often favor total fee ownership of income property. The propensity to own — and the emotions attached to it — sometimes can result in misguided decisions and strategies and lost opportunities. Relinquishing ownership of income property is really a question of when, not if.
Once developers move beyond the notion of ownership as an investment goal, new opportunities that may not have been visible before, such as ground leases, become apparent. In its most basic form, a ground lease, or land lease, separates the ownership of land from the ownership of the improvements on the land, such as an office building or a shopping center. The landowner leases the land to the developer of the improvements, who pays rent for use of the land.
Typically ground leases are long-term and include set rent escalations, eviction rights should the lessee default, and a reversionary right, which means improvements on the property revert to the landowner at the end of the lease term. While such lease terms do not particularly favor developers, ground leases offer some distinct advantages to them.
The two most prevalent types of ground leases are subordinated and unsubordinated. Each provides benefits that can enhance the developer’s yield and turn dismal or modest returns into more attractive and risk-mitigated ventures. They also give developers the opportunity to involve multiple partners without negotiating formal partnership agreements.
Ground leases transfer control — not ownership — of a property and, for the landowners, they are considered one of the most secure forms of real estate investment. But landowners may be considered preferred investors and may be open to developers who offer them a stake in the improvements erected on their land, in exchange for other considerations such as rent abatement for vacancy. Such a quid pro quo can substantially reduce risk to a lender.
In a subordinated ground lease, the landowner offers the land as collateral for the developer’s mortgage, giving the landowner a significant stake in the development risk. The subordinated ground lessor is considered a secondary lender with junior rights behind the primary lender, usually a bank or other financial institution.
Normally the ground lessor has a future claim on the improvements, as most ground leases require improvements to the land to revert to la
ndowners at the end of the lease. As such, ground lessors usually consider the downstream value of the improvements in establishing a rental rate. On the other hand, a ground lease that provides for the removal of any improvements at the end of the lease, such as relocatable metal buildings, modulars, portable plants, or parking lot appurtenances, would factor that eventuality into the rate as well.
The subordinated ground lease rental rate is usually a few percentage points above long-term permanent loan rates applied to the land value, which would correctly calibrate the risk-reward equation, including the risk of foreclosure, for the ground lessor.
The unsubordinated ground lease offers the landowner a more desirable role, comparable to that of the primary lender. This makes long-term permanent conventional financing more challenging for the developer, since the lender must assume the risk of lease termination and default. However, due to the senior position of the unsubordinated ground lessor, the ground lease rate can be lower and therefore much more attractive for the developer. The permanent lender recognizes the ground lease payments as an annual expense that will be factored into its loan underwriting. In total, the cash required in the deal by the developer is reduced while his yield is increased.
In both cases, the developer’s requirement for cash in the deal is reduced because of the value that the landowner brings to the deal. The reduction in cash usually required causes the investment yield to increase when the income stream is extended into the future. The value of the future cash stream will be determined by a threshold discount rate, resource availability, and underlying assumptions — the same general market and economic model assumptions that apply to fee-simple land ownership deals.
Other considerations include the length of the remaining lease term, reversion covenants, and extension and renewal rights and options. Occasionally the ground lessor will participate in the cash flows by applying a lease rate as a percentage of the income that the rental property produces. This strategy can have the positive effect of averting a monetary default in the event of a “dark” project. It also has the positive effect of mitigating the risk that a first mortgage lender perceives if the lease is unsubordinated. For example, if prevailing long-term interest rates are 6 percent, a comparable subordinated ground rental rate might be 8 percent, whereas an unsubordinated lease might be priced at par or 6 percent.
Ground Lease Benefits
The potential to form a joint venture with a building developer can be attractive to the primary ground lessor. The yield values are enhanced by the security of the future improvements. Provisions against wasting the property, requirements to maintain the improvements, cure and notice rights, certain reasonable approval conditions, and the ubiquitous hazardous materials covenants are standard.
Clearly, an unsubordinated lease presents possibilities that offer an alternative investment vehicle that provides security to patient investors and can be traded, sold, or transferred in creative ways. For example, tax-deferred 1031 strategies are possible by trading into an income investment as a sandwich ground lessee-ground sublessor. The usual threshold is that the lease term be greater than 25 years. Since these instruments can take on the color of a security, real estate professionals who enter into these deals should carefully document all aspects of the transaction and seek advice from qualified securities professionals.
In addition, opportunities exist in some municipal ground lease situations wherein, under certain conditions, property taxes are completely or virtually eliminated. Likewise other tax benefits accrue to these sanctuaries because of the reversionary character of building improvements and the incentive-rewarding jobs creation. These areas of investment can offer a spectacular advantage over neighboring competing properties in pricing and yield.
Lease term and length influence the acceptability of ground lease deals. The current climate is cautionary because of the parochial need to own; however, institutional managers realize that it is all factored into the risk and yield and accept the challenge with appropriate lease drafting and terms that are favorable to the asset managers’ objectives. The environment is changing as the pressure for yield performance and risk mitigation goes begging. The challenge is pioneering in an area where heretofore only the creative and adventurous have explored.
The National Association of Realtors® annually surveys recent home buyers and sellers to gather detailed information about their experiences buying and selling a home. This report provides real estate professionals (and sellers) with insights into the needs and expectations of their clients (and buyers.)
Characteristics of Home Buyers
- Thirty-four percent of recent home buyers in Texas were first-time buyers, compared to a national level of 37 percent – a drop from 50 percent in 2010.
- The typical buyer in Texas was 46 years old, while nationally the typical buyer was 45-years- old, a jump from 39-years-old in 2010.
- The 2010 median household income of buyers was $92,300 in Texas and $80,900 nationally. The median income was $65,000 among first-time buyers and $108,700 among repeat buyers, compared to $62,400 among first-time buyers and $96,600 among repeat buyers nationally.
- Nationally, 64 percent of recent home buyers were married couples—the highest share since 2001. In Texas, the figure was 67 percent. Eighteen percent of recent home buyers were single females nationally—the lowest share since 2004; 15 percent were single females in Texas.
Characteristics of Homes Purchased
- Only 16 percent of all recent home purchases on a national level were new home purchases. This is not-reflective of conditions in Texas, where 31 percent of homes were new.
- Nationally, the typical home purchased was 1,900 square feet in size, was built in 1993, and had three bedrooms and two bathrooms. In Texas, the typical home purchased was 1,800 square feet, built in 2001 and had 3 bedrooms and 2 baths.
- The quality of the neighborhood, convenience to job, and overall affordability of homes are the top three factors influencing neighborhood choice; however, neighborhood choice varies considerably among household compositions.
- When considering the purchase of a home, heating and cooling costs were at least somewhat important to 86 percent of buyers and commuting costs were considered at least somewhat important by 73 percent of buyers nationally, compared to 91 percent and 78 percent of buyers in Texas respectively.
- The typical home buyer in Texas searched for 10 weeks and viewed 10 homes, compared to 12 weeks and 12 homes on a national level.
Financing the Home Purchase
- On a national level, 87 percent of home buyers financed their recent home purchase. Among those who financed their home purchase, the buyers typically financed 89 percent. In Texas, 88 percent of buyers financed their recent purchase and 91 percent of the purchase was financed.
- The share of first-time buyers who financed their home purchase was 95 percent compared to 82 percent of repeat buyers, nationally. In Texas, that share was 92 percent of first-time buyers and 85 percent of repeat buyers.
- Nearly half (46 percent) of home buyers nationally reported they have made some sacrifices such as reducing spending on luxury items, entertainment or clothing. This also holds true in Texas.
- Nationally, 23 percent of buyers reported the mortgage application and approval process was somewhat more difficult than expected and 16 percent reported it was much more difficult than expected. These numbers are equivalent to the Texas numbers, where 23 percent of buyers reported the process was somewhat more difficult than expected and 16 percent reported it was much more difficult than expected. Home Sellers and Their Selling
- Nationally, recent sellers typically sold their homes for 95 percent of the listing price, and 61 percent reported they reduced the asking price at least once. In Texas, recent sellers sold their homes for 96 percent of the listing price and 60 percent reduced the asking price at least once.
- Forty-one percent of sellers offered incentives to attract buyers nationally, most often assistance with home warranty policies and closing costs. In Texas, 48 percent of sellers offered incentives.
Article via Culturemap
The downtown Houston Post Office and Processing Center opened in 1962 with a well-publicized ceremony that included the reading of a letter from President John F. Kennedy.
The Urban Land Institute (ULI), a national non-profit dedicated to promoting responsible development projects, recently selected the downtown USPS lot near the intersection of I-10 and I-45 as the focus of its 10th annual Gerald D. Hines Student Urban Design Competition.
From almost 140 participating groups across the nation, four final teams — from the University of Michigan, University of California–Berkley, Columbia University and a joint team from Harvard and the University of Colorado — were chosen in February.
Each group is required to have at least one non-designer in its mix, leaving room for ideas from students working in fields like real estate, finance and even psychology.
“There are two juries who select the winner,” said ULI communications manager Robert Krueger, noting the first place award of $50,000 and the $10,000 cash prizes for the remaining three finalists. “One looks at the financials and another at the actual design. In the end, we want cities to be able to look at these projects and ideas as possibly viable solutions.”
See below for the finalists. Which one is your favorite?
“The Hill” plan by students of the University of Michigan
“Downtown BaYOU,” University of Colorado/Harvard University
“The Grand” by students from the University of California, Berkeley
All renderings are courtesy of ULI/Gerald D. Hines Student Urban Design Competition.
Below is a summary of RERC/CCIM Investment Trends Quarterly for the fourth quarter of 2011, of which Amy Silvey, CCIM and Kevin Dalrymple, CCIM, both of Clay & Company, were contributors. Click here for the full report.
CCIM members seem to be slightly more optimistic as they look to the future. Despite the very real headwinds our economy still faces, there are strong signs that the eco- nomic recovery in the U.S. will contin
ue in 2012, given that GDP grew 2.8 percent in fourth quarter 2011, the unemploy- ment rate declined to 8.5 percent in December, and manu- facturing activity is increasing. In addition, CCIM members increased their performance and return ratings for the com- mercial real estate.
- The overall picture for the economy and for investment in general is a little better, although risks remain, including the European debt crisis, the housing market, and the growing federal debt and deficit. Watch for positive eco- nomic growth to continue, but to remain modest in 2012.
- Expect the Federal Reserve’s monetary policy to remain very accommodative and for short-term interest rates to remain low until late 2014.
- Do not expect to see much improvement in the housing market for the near term, and for foreclosures and dis- tressed sales to continue.
- Watch for government spending to continue to decline or to remain flat during this election year.
- Watch for investment capital to increase, and the playing field for investments to start to level off.
- Due to the stability and safety commercial real estate of- fers, CCIM members continued to give commercial real estate the highest rating among investment alternatives.
- The apartment sector remains the strongest property sector overall from a risk versus return perspective, al- though the investment appeal for all of the property sec- tors improved significantly.
- From a value versus price perspective, the industrial sector received the highest rating from CCIM members, followed closely by the ratings for the apartment and office sectors.
- On a 12-month trailing basis, total transaction volume for the retail and apartment sectors increased during fourth quarter 2011. Volume decreased for the office and ho- tel sectors, and remained mostly stable for the industrial sector.
- On a quarter-to-quarter basis, the total transaction vol- ume for the office and hotel sectors fell during fourth quarter 2011, while the volume for the industrial, retail, and apartment sectors increased. In contrast, the aver- age prices for the office, apartment, and hotel property sectors declined, remained stable for the industrial sec- tor, and increased slightly for the retail sector.