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G5 Some owners up the ante to hold on to distressed properties real estate from G1
and jeopardizing the stability of still-tottering banks is enough to keep analysts up at night. “It’s a very tricky time right
now,” said Geoffrey DiMeglio, di- rector of consulting at Market Outlook, a consulting firm. “Even in a weak recovery, I don’t see employment improving the fun- damentals in real estate fast enough to get these properties out of default.” Property owners and lenders
may well ride out this storm with lessons from the last major slump in the commercial real estate market. During the collapse of the early 1990s, bankswereunder pressure to secure a speedy fix for troubled properties. So instead of working with borrowers, they were quicker to process foreclo- sures and then sell off properties at auction. Lenders ended up losing billions on real estate port- folios that they didn’t want to hold and weren’t equipped to manage. The fallout rattled through theeconomy. Intime, the glut of cheap property on the market created a fast and vast run-up in wealth once the market took off again, fueling those heady days of consumer largesse. “Banks and other lenders were
forcing things onto the market whentherewasnorealmarket, so that things were going really cheap,” said Douglas J. Donatelli, chairman and chief executive of First Potomac Realty Trust in Bethesda. “And the losses that banks were taking were much, much greater than they should have been or could have been.” In those days, the Mayflower
may well have been foreclosed upon and sold at auction along- side luxury townhouses and exur- ban housing developments fund- ed by speculators.
The workout This time, another scenario
played out.RockwoodCapital sig- naled in November that it might not be able to make its next mortgage payment, according to Realpoint. Bank of America, the primary lender, and investors in theMayflower didn’t hit the pan- ic button. Instead they were will- ing to overlook a missed payment or two and wait out the down-
turn, absorbing some short-term losses, according to sources with knowledge of the deal who were not authorized to discuss it. In late July, a special servicer, a
company that manages dis- tressed loans for lenders, agreed to extend the due date on the loan. In return, Rockwood Capi- tal would put up $11 million of additional cash, according to Standard & Poor’s analysts. The servicer, Midland Loan
Services, a division of PNC Real Estate, extended the due date for the balance of the loan by a year, to 2013, in exchange for the capi- tal infusion. The deadline could be pushed out to 2014 if Rock- wood meets specific performance benchmarks. Rockwood and Bank of America declined to com- ment.
Cash works, too The wait-and-see attitude of
the Mayflower’s creditors signals a shift in thinking. While stretching out the pay-
ments on a loan may well save it, it could also delay the pain. “Even though it was a bloody situation in the early ’90s, at least it was mercifully quick,” Donatelli said. “Alot of people lost a lot ofmoney and a lot of jobs and a lot of projects changed hands that might not have had to change hands, but it was fast, reasonably fast. This is going to be pro- longed.” Where refinancing doesn’t pan
out, cash can save the day. Some investors have upped the ante when debt comes due, even on purchases made near the peak of themarket.NewYork-based Tish- man Speyer and a half-dozen partners defaultedona$600 mil- lion note for a portfolio of 28 Washington area office buildings that they’d agreed to buy for $2.8 billion in late 2006. In June, five days before Barclays had reportedly scheduled an auction on the debt, Tishman and its equity partners threw another $700 million into the deal, eras- ing the debt and hanging onto the properties. Even Lehman Brothers, still embroiled in bankruptcy pro- ceedings, has managed to scrape together money to save a deal. In 2007, Monday Properties of New York partnered with Lehman to buy 10 Rosslyn office buildings
for $1.1 billion — only to see Lehman go bankrupt 16 months later. This spring, Monday had $239 million of debt coming due on the properties, a situation that seemed ripe for distress. In June, Lehman secured bankruptcy court approval to join Monday in making an additional $263 million equity investment to erase the debt. Anthony Westreich, chief executive of Monday Properties, said the strength of Rosslyn’s office mar- ket, considered a top market in- ternationally, was a major factor in persuading Lehman to in- crease its equity stake. He said that he does not expect to see many otherWashington property owners with debt coming due lose their portfolios, either. “A lot of loans that matured
today or tomorrow are being ex- tended out, sort of pushing the problem down the road,”Westre- ich said. While “lending and extending”
is keeping some properties out of foreclosure, he said, other bor- rowers are surviving on savings or loans that are still locked into low interest rates. All that could change if interest rates rise, mak- ing loan payments more pricey, he said, which could push more properties onto the market and create opportunities for buyers. A large equity stake, Donatelli
said, is strong incentive for a borrower to salvage a deal. “There’s a lot more equity in
the real estate market as a whole than there was in the early ’90s,” he said. “Back in the early ’90s, there was very very little equity. Most projects were built with 100 percent debt. Today, it’s really rare to see a project built with 100 percent debt.”
A wave of trouble Without question, the stakes
are high. Commercial real estate accounts for 6 percent of gross domestic product and property values have fallen more than 40 percent since reaching a high in 2007. The default rate for commer-
cial mortgages held by banks has yet to peak; it hit 4.28 percent in the second quarter and is expect- ed to climb to 5.4 percent by the end of next year. Fitch Ratings predicts “significant increases in delinquencies on commercial
property loans.” Overall, the U.S. economy is balanced between a return to healthy lending and economic growth and continua- tion of the recession amid anemic capital markets. “The real flood of these matur-
ing loans hasn’t happened yet,” said Ben Thypin, senior market analyst at research firm Real Cap- ital Analytics. With banks still reeling from
the financial crisis and stingy with their lending, borrowers could fail to find lenders willing to refinance when their mortgag- es come due. Developers that have the mon-
ey to pay the debt coming due on an underwater property face the same decision that many home- owners do: Is it better to just walk away? In recent months, major commercial-property owners have defaulted on debts and sur- rendered buildings worth less than their loans. Companies such as Macerich,
Vornado Realty Trust and Simon Property Group stopped making mortgage payments to put pres- sure on lenders to restructure debts, according to a report in the Wall Street Journal. Insomecases they have simply walked away, notifying the lender of their deci- sion with “jingle mail”—sending back the keys. These companies may have piles of cash to make the payments, but a default ends up being a better business deci- sion. Even so, theMayflower experi-
ence offers a ray of hope that, despite the “wall” of maturities coming due before 2014, many commercial real estate markets will persevere. After all, a power- ful collection of actors have a stake in buoying the sector: inves- tors hunting for bargains, federal regulators who have papered over trouble in the past and lend- ers who would rather have some income than amass a collection of nonperforming real estate.
“To foreclose or liquidatemany
of these distressed assets in this market does not make sense,” said Frank A. Innaurato, manag- ing director at Realpoint. “There is a lot of optimism that. . . things might be turning around. We’re looking at some point in 2011 wherewemay hit a turning point, but it’s verymuchdependent on a willingness to lend.”
Washington fares better Standard & Poor’s ranks the
Washington area as one of the healthiest commercial mortgage- backed securities markets in the country, second only to Massa- chusetts, largely because of the federal government’s growing de- mand for office space. States that suffered the most in the housing bust and manufacturing down- turn are at the top of the list for delinquencies: Nevada, Arizona, Michigan, Florida and Ohio, said Larry Kay, a Standard & Poor’s director. But major cities in other states and, to some degree, the regions around them have weath- ered the storm. Other properties — even the
iconic — have been pushed onto the market by untenable financ- ing and less patient lenders. Case in point: the Watergate Hotel, a portion of the complex made infamous by the Nixon-era break- in. The hotel was purchased by developer Monument Realty in 2004 for $45 million.Monument planned to transform the 251- room hotel into high-end condo- miniums called Belles Rives at theWatergate. But last year,Monumentbegan
missing payments on a $40 mil- lion loan from PB Capital, a Ger- man bank, which foreclosed in July 2009. Monument principal Michael J. Darby said that he offered to replace the debt using $25million innewequityand$25 million in subsidies that hehoped to receive from the District of
Columbia, but PB Capital de- clined. After PB Capital failed to find a buyer at auction, a holding company of Euro Capital Proper- ties bought the property for $45 million inMay. PB Capital did not respond to requests for comment. “Youwould think that the lend-
er would be willing to work with us,” said Darby, whodoesn’t think many properties will go the way of theWatergate. “That happened in the recessionary part of the market because the lenders didn’t have anything else that they knew they could do with the property.” Unlike the residential mort-
gage market collapse, malaise in the commercial real estate sector is more a symptom of a sluggish economy than a looming threat to recovery. When housing prices plummet, household wealth evaporates and consumers cut spending, leading to economic contraction. But trouble in com- mercial real estate merely reflects the health of theeconomy,wheth- er slower retail sales, decreased tourism or corporate downsiz- ings. While the sector affects state and local tax revenues and eco- nomic growth — thereby touch- ing every taxpayerandresident in the country — it’s unlikely to single-handedly trigger a repeat of the 2008 financial crisis. Still, interest rates and the
overall economy are wild cards. A jump in interest rates would worsen the difficulties borrowers are currently experiencing and increase defaults. Similarly, if the U.S. economy moves into a defla- tionary cycle, all assets would lose value, including real estate. As Donatelli put it: “There’s an
inevitable day of reckoning com- ing. It might not be as bloody, it might not be as severe, but it’s gonna come, it just might be kicked down the road a couple years.”
oconnellj@washpost.com
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