Over 250 small and midsized banks have been closed and it ispossible another 300-500 could get closed or merged over the nexttwo years. Some of the big aggressive banks like Wachovia,Countrywide, Colonial, Freemont and Corus are gone. Capmark isgone, I Star is still stabilizing, and CIT and others areessentially gone. CMBS may be slowly returning, but it will be along time before the old style conduit lending returns for theaverage small to medium sized project refinancing. It may be oneyear, but more likely it will be two or more years as the economyfalters and the recovery remains muted. The lending infrastructureis obliterated with entire lending groups at major firms havingbeen wiped out. That has to be rebuilt and there will need to besome changes to how it operates under Finreg. The rating agenciesare still trying to figure out how they will rate the everydayconduit pool of properties.

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Although many talk of all the capital looking for a place toinvest, reality is that there is a total of roughly $3.4 trillionof real estate debt outstanding from all sources and which will bematuring over the next 7-10 years. There is supposedly around $800billion of just CMBS which will be maturing that has to berefinanced. 2010 CMBS issuance will just be $6-$10 billion mostlikely. Not even a rounding error, and it was almost all to just afew top borrowers. There will not be capital for the averageborrower with a property in a secondary city for a long time.

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On top of all of this there is all the refinancing and newfinancing required for companies, municipalities and states. Thatis another very large sum. Then we have to fund the Obama-Pelosispending binge and massive federal deficits. I don’t know what theoverall demand for capital will be over the next 5 years, butclearly it is massive. While that demand is growing, the Fed isgoing to be reducing the money supply and raising rates. Consumersare also going to hopefully be increasing borrowing for homes andautos. All of this ignores the demand for capital from foreigngovernments and businesses.

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The providers of capital have been reduced in quantity and inability to create that capital. It is not just the banks which arereduced in number, but we also do not have Bear, Merrill,Lehman-huge originators of loans and equity investments. The restof the Street and commercial banking will be tightly restricted forat least a few years and the rating agencies will be much tighteron subordination levels than they had been in 2007.

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So the question for the average borrower whose loan may havebeen extended for 2 years or even 3 years, and whose asset is nowworth 40% less than his total capital basis, is, where will therefi dollars come from. Even if values rise by 20% from where theynow are, that will mean on average the asset is still only worth72% of original cost, and that is a very overly aggressiveassumption of value increase over the next two years. Even at 72%it means the original loan is likely as much as, or more than, thevalue will be in two years. Under what will surely be much tighterunderwriting, the refi loan is likely to be no more than say 75% ofthe new 72% of original value so it is 54% of original value in2007. That is a very large equity gap to fill for most ordinaryowners whose net worth and cash reserves have been devastated overthe past two years. His original equity is gone now, and probablyhe infused more to get the extend and pretend. There may be nothingleft for him to cover the difference.

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It is for these reasons that I predict we are yet to see thereal downward revaluation of assets which is coming over the nextthree years. Unless the fairy godmother of capital sprinkles fairydust on us all, there is simply a massive capital shortage tosustain the pretend values still carried on the books of CMBSbondholders, mezz investors, banks, private equity firms, pensionfunds and other investors. The reset has to happen. The refinancerequirements are simply not going to get extended long enough forinflation to solve the problem. One of the biggest hotel appraisersis claiming that hotel values in 2015 will be 140% of 2007 frothvalues. That is utter nonsense. Anyone who thinks that, or similarsorts of projected values for other food groups, is either on drugsor has an agenda. It is not happening. Values have to get back tofundamental real estate underwriting. Be patient- the buyingopportunities are coming.

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Joel Ross

Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.