I've thought the market was overvalued, and that a wave of foreclosures was coming, for several years. I was wrong in 2005 and 2006; by 2007 a fair number of folks thought the CRE market was overvalued, but we did not see many defaults, at least here in Southern California. In 2008, the CRE market seemed to be generally stuck. This felt very similar to 1991 -- everyone knew values of CRE had fallen, but no one wanted to take action -- as if denying reality might make it go away. But many of us, including me, have been surprised by how long it has taken for the weakness in the overall economy to affect the CRE market this time, and how long it has taken before an uptick in defaults, workouts and foreclosures. In some parts of the country, like Michigan and Florida, the wave of foreclosures brought on by falling values has already hit. But in California, where we have generally seen only limited CRE foreclosures in 2009 (but a lot of modifications), it looks like we're in the trough of activity looking up at the crest of the wave now.Just today, in connection with a discussion of a consensual workout of some prominent San Francisco real estate, Bloomberg reports: "Commercial mortgage defaults more than doubled in the third quarter from a year earlier as occupancies fell, according to Real Estate Econometrics LLC. . . Property sales financed with commercial mortgage-backed securities plunged 95 percent from a record $237 billion in 2007, according to JPMorgan Chase & Co. "Bloomberg goes on to quote Moodys, as saying that values "may fall 55 percent from their peak" due to a lack of securitized debt. Third quarter 2008 was bad enough: double that default rate is ugly. A drop of CRE values anything like 55% obviously will be even worse news for highly leveraged projects --- and could gouge the LTV ratios for even the most conservative lenders.Probably we'll see a greater number of underwater owners giving back their properties to lenders, either by deeds in lieu, agreements to not fight foreclosure, or the like. Often these graceful surrenders are made in exchange for limiting guaranty exposures. In the case of CMBS loans, we're starting to see lots of resales of the property made consensually through a receiver to a willing buyer/new borrower who is willing and able to assume the existing loan, as modified. These can be fairly simple and effective workout deals, if documented correctly to avoid the traps presented by California law. We're also seeing some lenders who don't want to battle through foreclosures quietly moving to sell their loans to buyers willing to undertake those legal fights in exchange for a discount on the note price.True to 1991 form, we don't seem see borrowers or lenders completely capitulating to reality yet: there's still a persistent gap (though a diminishing one) between what lenders are willing to sell distressed debt or foreclosed property for, and what buyers are willing to pay.That's what we seem to be seeing now, as we go into the holidays. I'd be interested in hearing whether you are seeing that too -- or seeing something different. Please let us know by posting a comment.

Instant Insights /

Happy Holidays, 2009: CRE is Scrooged

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