December 22nd, 2009
2010 is almost here! I pride myself on being an optimist and always looking for the good in life. Therefore, I am heading into the new year with hope that even though 2009 was a difficult year for everyone, I think 2010 will be an improvement. I am not suggesting that the economy will come out of this crisis overnight, but I do think that we have bottomed and that in 2010 will see the start of a recovery.
This is the first in a series on what to expect in 2010. The post below was written by Joel Levy. Joel is the Vice Chairman and former President of the Adler Group. He has worked with my family for over 25 years and has been a significant mentor to me. Having managed dozens of commercial real estate acquisitions and dispositions over three decades, Joel is uniquely qualified to offer thoughts for the new year. I intend on posting my thoughts and other guest posts over the coming weeks.
Some Thoughts on 2010 — Part 1
By Joel Levy
There are no lack of issues to discuss about commercial real estate and countless opinions as what to expect in 2010. In Matthew’s previous blogs, there has been a lot written about “Distress”, whether it be distressed assets, debt, owners, lenders, etc. etc. I however want to focus on one of the areas Adler Group intends to emphasize in the year ahead.
In 2009 we attempted to acquire properties from certain sellers who we did not believe were distressed, but who appeared ready to shed assets for various strategic reasons. It could have been a need to raise cash, a desire to sell an asset not core to their business or a desire to exit from a particular market. Let me report that as of now we have not been successful in this pursuit. Why you ask? It is really simple, an insurmountable spread between bid and ask. However, we now think that a narrowing of this spread is on the horizon. Are we being too optimistic or naïve? I hope not.
We have heard many opinions from various real estate professionals, and based on their and our own opinions we look to the new year with some optimism as to the narrowing of the pricing differential. Some of the issues are as follows:
- There is a very large amount of capital that has been on the sidelines or is currently being raised. We are believe that buyers will lower their return expectations and be more active acquirers.
- All signs are pointing to their being more available debt at better rates and slightly increased loan to value ratios.
- Sellers will be under more pressure to dispose of assets to fulfill their strategic goals as noted above. Many of the assets have recently been marked to market, making it easier to justify disposing of assets at lower prices.
- Although gradual in its impact, economic signs are improving and there will be an ability to underwrite a bit more positively.
While we intend to continue to pursue this path, we will also be in a pack of investors looking at distressed assets and debt.
Stay tuned for another interesting ride in the year ahead and more posts about the new year.
Tags: 2009, 2010, acquire, Acquisitions, Adler Group, assets, bid and ask, capital, commercial, Commercial Real Estate, crisis, debt, dispositions, distressed, hope, improvement, lenders, loan to value, marked to market, market, new year, optimist, owners, predictions, Properties, recover, return, sellers, spread, thoughts, year
Posted in Commercial Real Estate | 1 Comment »
November 24th, 2009
I am out of town for Thanksgiving so I am thrilled to have a guest blog post from Adam Lubkin. Adam has gained some notoriety in the commercial real estate world for facilitating some prominent note sales. We are proud to be one of Adam’s approved developer partners. I hope you all enjoy his unique insight into the distressed acquisitions world.
How to Acquire Distressed Real Estate Assets
By Adam Lubkin
First, I would like to thank my good friend Matt Adler for allowing me to write a short blog on his site. I enjoy Matt as a friend, as a real estate professional, and I always appreciate his insight and views on real estate.
My company, Ibis Development Group, was created three years ago specifically as an outsource acquisition arm to approximately 30 developers throughout the United States. We locate, analyze, bid and hopefully close on all types of assets, primarily commercial real estate. Although we look at assets throughout the United States, recently we have had success within our home state of Florida with note and mortgage sales. The primary sources of these note sales are local and regional banks, large real estate funds, special servicers and attorneys.
Here are the top 5 frequently asked questions by our developer/owner-operator partners and our responses:
1) Do you analyze the note’s asset or just the discount from the note’s face value? We always analyze the underlying value of the real estate asset. In fact, we rarely ask about the mortgage’s face value. Obviously, we will eventually find out the asset value, but we want to first focus on the asset itself, not necessarily the discount being offered. Frankly, the discount offered is a secondary consideration. We prefer REO’s or deed in lieu scenarios. Most developers shy away from litigation, but that’s a real risk when playing in this arena and everybody has a certain level of risk tolerance.
2) What the best advice you can give when talking with the banks? Be considerate. Most of these bankers run into “tire kickers,” people who need to raise money in order to close, and inexperienced wannabe developers who talk a big game and just want to take advantage of a distressed situation. Remember, most of these bankers are also the same people who originated the loan so this process is very uncomfortable for them. Also, don’t assume that you are the only developer in town or the only company with cash. Its a very competitive marketplace, and there is incredible wealth out there and plenty of people who can close a deal. My advice is to show credibility through recent closings; be completely transparent and honest by showing your analysis, assumptions and ROE (Return on Equity); and be prepared to show proof of available funds. Lastly, act like you are the great wide receiver Jerry Rice - If you score a touchdown, just give the ball to the ref, don’t showboat and run quietly to the sidelines!
3) Are transactions happening? Absolutely. Deals ARE getting done quietly. Banks aren’t going to publicize the fact that they are selling bad loans, but they are. Furthermore, if you expect to buy more loans in the future, don’t brag about your most recent acquisition - It’s bad business. There is no upside for developers to spam e-mail the world or advertise about their conquests.
Read the rest of this entry »
Tags: analyze, asset class, asset value, assets, attorney, banks, broken condos, buyer, capital expenditures, Class A, Commercial Real Estate, cycle, deed in lieu, developer, distressed acquisitions, due diligence, face value, Florida, hospitality, hotels, industrial, JV partner, loans, multi-family, note sales, office, purchases, real estate funds, REO, replacement value, retail, seller, special servicers, stabilized asset
Posted in Commercial Real Estate | 2 Comments »
November 19th, 2009
The historical norm in office investment is a flight to quality. Typically, a premium has been paid for brochure quality assets with “credit” tenants. At the top of the last cycle, I would estimate a minimum of a 150 basis point cap rate premium was paid for Class A assets over B.
Adler Group’s core competencies are the acquisition and operation of multi-tenant, management intensive Class B office and flex space. For decades we have been on the front lines, working with investors to optimize the value of these assets. We have always believed that focusing on smaller, entrepreneurial tenants, allows us to more consistently maintain higher occupancies and raise rents. In addition, we believe our credit risk is mitigated by the size and diversity of these tenants. In our properties, typically there is not a single tenant whose default or non-renewal would cripple our occupancy and therefore inhibit our ability to pay debt service. In addition, we believe that in this current economic climate, tenants will gravitate to Class B space as a cost saving measure.
Smaller entrepreneurial tenants tend to be more rooted to their location. Often, large national companies make decisions having little to do with local operations. For example, in difficult times, national companies are more likely to merge their Orlando and Tampa offices into one. Smaller tenants tend to live within a few miles of their office and employ multiple family members. Their size makes it harder to downsize their space. Large companies can have layoffs and shrink from 20,000 to 10,000 square feet. It is hard to downsize when you only lease 2,000 feet and your employees are relatives.
I am not saying that we are without defaults or downsizing in our portfolio but generally we have seen our entrepreneurial tenants fight on because they have limited options. Their business is literally what puts food on their family’s table.
Today, there is growing awareness of the advantages of Class B office within the investment community. Inherently, new office buildings are Class A. In Downtown Miami and Brickell there is over 1.5 million square feet of new office towers set for completion in the coming months. New buildings, typically do not encourage smaller tenancies and therefore have less effect on Class B buildings. In addition, there is less allure to large “credit tenants”. Some of the largest and most prestigious companies in the Country have gone into bankruptcy’s causing additional Class A vacancy.
Finally, the amount of money one needs to invest in Class A leasing is discouraging investors, who are currently more focused on immediate cash flow than they have in the past. Class A office tenants generally demand significant tenant improvement allowances to build out their space, while Class B tenants require far less improvement allowance. In our space we often just provide new paint and carpet. This makes the recurring annual reinvestment in the space far less on a percentage basis.
There will always be an investment market for Class A office. However, I believe the premium many were willing to pay for Class A is diminishing and there is starting to be a recognition to the benefits of Class B. The one challenge with Class B office space is it remains management intensive, but strong operators with expertise can provide an attractive return.
Tags: acquisition, Adler Group, assets, basis points, Brickell, cap rate, Class A, Class B, core competencies, credit, cycle, defaults, downsize, entrepenurial, flex space, investment, investors, management intensive, Miami, mulit-tenant, occupancies, office, operation, Orlando, return, Tampa, tenant improvement, tenants
Posted in Commercial Real Estate | No Comments »
October 28th, 2009
I just read the excerpt of Andrew Ross Sorkin’s new book Too Big to Fail in this month’s Vanity Fair. I can’t wait to read the entire book. Sorkin seems to have written one of the great works of investigative journalism. While reading, I had to keep reminding myself that this isn’t historical fiction and these events actually took place. It was fascinating to read the inside story of how giants such as Goldman Sachs and Morgan Stanley were led to the brink only to be pulled back primarily by government intervention.
The panic and potential domino effect that many believed was happening during the week following the collapse of Lehman Brothers was perfectly encapsulated by Sorkin. A perfect example of this fear is seen in a section about then Treasury Secretary Hank Paulson; “The entire economy, he said, was on the verge of collapsing. Paulson was no longer worried about just investment banks; he was worried about General Electric, the world’s largest company and an icon of American innovation. Jeffrey Immelt, G.E.’s C.E.O., had told him that the conglomerate’s commercial paper, used to fund its day-to-day operations, could stop rolling. Paulson had also heard murmurs that JPMorgan Chase had stopped lending to Citigroup; that Bank of America had stopped making loans to McDonald’s franchisees; that Treasury bills were trading for less than 1 percent interest, as if they were no better than cash, as if the full faith of the government had suddenly become meaningless.”
I was immediately drawn to this book because I am fascinated by the proposterous notion of “too big to fail” and I oppose the entire concept. As a capitalist, I believe companies should succeed (or fail) based on their own merits. Yet as a progressive, I understand the need for regulation to protect the entire society from a company either gaining a monopoly or becoming so expansive that their failure would cause irreparable harm to the entire society.
Ironically, the same people who demanded banking reform with little regulation were forced to ask for government handouts. Striking the balance between oversight and an independent private sector isn’t easy. Clearly, the balance got out of control in the last decade. Hopefully, we have not lost momentum on banking reform with the Dow hovering around 10,000 and over a year removed from the height of the crisis. We have to find a new balance, one where we encourage innovation and incentivize success, but we also demand oversight, transparency and protection from any one company becoming so large that their failure would begin a ripple effect that could bring down our entire economy.
Tags: Bank of America, banking, capitalist, economy, General Electric, Goldman Sachs, government, Hank Paulson, innovation, intervention, JPMorgan Chase, Morgan Stanley, oversight, progressive, progressive capitalist, reform, too big to fail, transparency, Vanity Fair
Posted in Finance | 3 Comments »
October 7th, 2009
The FDIC announced yesterday the winner of an extensive bidding process for the assets of now defunct Corus Bank which included some of the largest names in private equity. The portfolio comprises mostly construction loans for residential condominiums. The winner was a group led by Starwood Capital Group. The most fascinating part of the deal was the incredibly innovative structure created by the FDIC. The structure detailed in this Wall Street Journal Article allowed Starwood to invest equity of only $554 million for a portfolio that is estimated to have an original face value of over $5 billion. Although Starwood purchased controlling interest in the portfolio their ownership will only be 40%. It is estimated that Starwood valued the portfolio at $2.77 billion and the remained funds were part of a series of equity and debt provided by the FDIC which is maintaining a 60% stake in the portfolio.
The structure of this deal is very compelling as it incentivized a company such as Starwood and their partners to enter into a long term strategy to workout these loans but still allows the FDIC the opportunity for significant upside participation. I suspect, as the FDIC continues to close banks and control pools of loans that we will see more transactions of this kind. It is pretty interesting that the FDIC in this transaction essentially became the seller, the buyer, the lender and equity partner all at the same time.
Tags: assets, buyer, condominiums, debt, equity, FDIC, residential, seller
Posted in Commercial Real Estate | 2 Comments »
September 29th, 2009
On September 15th the IRS issued new guidance on the modification of commercial Mortgage backed securities (CMBS) loans. Though, largely unnoticed outside of real estate circles, this was an important first step in addressing the pending maturity of hundreds of millions of dollars of CMBS debt in the coming years. I wanted to post something on this topic but before I got a chance an attorney of ours, Wythe Michael with Hirschler Fleischer in Richmond, Virginia offered an article he wrote as a guest blog. I hope this is the first of many guest posts.
Modifying Securitized Real Estate Loans - New Guidance Provides Flexibility
By G. Wythe Michael
Over the past decade, many commercial real estate owners financed the purchase of commercial real estate with loans that were securitized by the original lenders as commercial mortgage backed securities (CMBS). Although these loans offered advantages such as lower interest rates, limited recourse and limited guarantees, the tax regulations governing the associated conduits severely limit the ability to modify the terms of such mortgages. In general, the tax regulations prohibit loan modifications unless the modification is due to a default or a reasonably foreseeable default. The tax regulations can impose still penalties - including the possible loss of favorable tax status - on the conduits (but not the borrowers) if the regulations are violated. Because there was little guidance from the IRS concerning what constituted a “reasonably foreseeable default,” loan servicers have been reluctant to discuss loan modifications until an actual default occurs.
With the collapse of the CMBS market and the lack of other financing options, borrowers attempting to negotiate with loan servicers prior to the maturity date of their loan have been ignored by the servicers or told that nothing can be done until loan maturity - when the loan defaults. The servicers generally blame their unwillingness to negotiate on the tax regulations. Given that approximately $150 billion of CMBS loans are scheduled to mature between now and 2012, numerous industry participants asked the IRS to ease the regulations.
The IRS responded to this situation by issuing guidance on September 15, 2009 concerning modifications to CMBS loans. In general, the guidance allows servicers to modify loan terms if the servicer “reasonably believes that there is a significant risk of default of the loan at maturity or at an earlier date.” A servicer must document this belief by written facts provided by the borrower. In such a case, the servicer may modify the loan if the servicer reasonably believes that the modified loan will substantially reduce the risk of default.
Read the rest of this entry »
Tags: bondholders, CMBS, commercial, default, foreclosure, IRS, loan, maturity, modifications, real-estate, servicer
Posted in Commercial Real Estate | 1 Comment »
September 18th, 2009
I may have published my last post a few days too early. I spent this week at the Young President Organization’s (YPO) Real Estate Round Table. It was a gathering of members of YPO who are in the real estate business. After being around people from all sectors of the industry for three days, my take away is there are two clear distinct camps.
A fair amount of people are convinced that great opportunity in the distressed real estate market is right around the corner. Others believe that the opportunity is years away, if ever. I am trying to reconcile these seemingly divergent opinions.
Most of the confusion is being caused by the great unknown, what happens to the trillions of dollars of commercial loans that need to be replaced in the coming years. Obviously, we are experiencing a significant de-leveraging of assets. The loss of leverage will need to be replaced with a combination of equity and/or loss in asset value.
The big question is: How does de-leveraging impact property values now and into the future? The lack of an answer to this question, I believe, is largely the cause for the present lack of transaction volume. The spread between the bid and ask price is still wide because buyers must project this future distress into their pricing. In addition, lenders are not yet prepared to realize significant losses. To date, banks and special servicers who control CMBS debt are not selling distressed assets or loans in any significant way. Property owners who purchased assets from 2005 - 2007 either have lost most of their equity or are holding off hoping things will improve.
So will transaction volume increase in 2010? I think we will see activity and more assets and notes trade. I am not expecting the RTC 2 frenzy that some have been expecting but there will be deal flow. The only way to participate is to be conservative and stay in the market. Only while in the market can one ever hope to participate at the bottom.
Tags: 2010, assets, CMBS, commercial, de-leveraging, distressed, equity, leverage, loans, opportunity, real-estate, value
Posted in Commercial Real Estate | 3 Comments »
September 15th, 2009
Today, real estate companies fall more or less into two categories: ones crippled with distressed assets and those trying to purchase those assets at steep discounts. We are fortunate to be in the latter.
Every day we hear of a new company forming a distressed real estate fund. Just last week Sam Zell announced the latest of these ventures. We are also in the process of raising our own commercial real estate investment fund. However, while we plan on having a distressed allocation, our acquisition strategy will primarily focus on performing assets in the core plus and value add category.
At the Adler Group, we have a saying about this market: “we don’t want to buy distressed assets. We want to buy high quality assets, from distressed sellers”. Today at the Adler Group, we are focused on performing assets for a number of reasons. Our primary rationale for adopting this investment strategy is our experience. We have been successful in developing, acquiring, managing and leasing multi-tenant, management intensive commercial real estate for generations. Distress in the market place isn’t a reason to depart from our core competency.
Our other reason is risk. The investment management business is primarily about diversity and asset allocation. We believe that all the money raised targeting “opportunistic” returns will compete for many of the same deals. The competition for distressed deals may lead some to overpay for properties, thus over estimating the potential “risk adjusted return”.
On the other hand, with many focused on distressed properties and other historic buyers having left the market, few are focused on performing assets. We project the targeted return on core plus and value add acquisitions to be 400 to 600 basis points higher than these same categories in 2007. These higher targeted returns are theoretically intended for the same corresponding risk category. However, there is no question that with less leverage and more conservative underwriting there is actually less risk. So in this cycle, we hope to make acquisitions taking less risk than years ago while targeting a significantly higher return.
Our company culture has always been to focus on singles and doubles rather than the home run. We believe that the potential return on the acquisition of performing assets in the coming years will be attractive, particularly when compared to other investment alternatives. We would be very happy to make relatively conservative acquisitions and achieve a return above sixteen percent. If that turns out to be a single, I’m happy to be Ichiro and hit for average and leave the home runs (and the strike outs that inevitably accompany them) to others.
Tags: Acquisitions, asset allocation, assets, commercial, core plus, distressed, fund, opportunistic, real-estate, value add
Posted in Commercial Real Estate | 2 Comments »
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