The peak of distressed properties has come and gone, according to Gregory Leisch, chief executive officer of Delta Associates. "Our conclusion is that we have reached a plateau in the volume of distress," Leisch said during a special address at the second annual Real Share Distressed Assets conference at the Adolphus Hotel in Dallas last month. More than 350 executives attended the conference, which was produced by ALM's Real Estate Media Group. Leisch's contrarian observation was just one of the highlights of the day-long conference.

"From March 2009 to March 2010, we saw distress increase about $10 billion per month," Leisch noted. "Since then, it's been flat. Therefore, it is our thesis that we have seen the peak." As more proof to back up his theory, he added that this month, for the first time, the industry has seen a decrease in construction-loan delinquencies.

Leisch said the most recent distressed cycle was shorter than the cycle in the early 1990s. For example, property values rebounded in second quarter 2010 after only eight quarters, according to NeREIF. During that period, values declined 33%. In contrast, during the 1990s downturn, the US experienced seven years of negative property trends for a total decline of 39%, he recalled.

Leisch admitted that he has a somewhat contrarian view on distress. "There are risks that I'm wrong and that we have not plateaued-that distress will exceed $160 billion," he said.

The biggest potential complication, according to Leisch, is interest-rate risk, which has yet to materialize. "So far so good, thanks to the debt crisis in Europe and our own slow-growing economy," he noted.

"Bank failures are the biggest wild card," Leisch explained. However, he pointed out the bank failure rate during this cycle, while concerning, is still well below the failure rate seen during the late 1980s and early 1990s. "So far, they've figured out how to kick the can down the road."

DISTRESS & VULTURES Investment vehicles focused on distressed assets, so-called vulture funds, are having a hard time deploying capital since the bulk of distressed deals are smaller than $5 million. Al Pontius, senior vice president and managing director of Marcus & Millichap, made that observation during a special address at the conference.

Pontius noted that both international and domestic funds have raised billions of dollars to take advantage of distressed assets in the United States. "These funds represent a tremendous amount of investment capital, yet their money is not earmarked for smaller properties," he pointed out. "They're looking for larger deals, which are hard to come by."

In fact, 82% of all distressed transactions trade for $5 million or less, according to Marcus & Millichap research. The average size for distressed property transactions is just $4.6 million.

During his presentation, Pontius noted that the number of asset trades has grown dramatically. Activity increased 80% during the first half of the year compared to the same period in 2009.

However, he emphasized that the pace of loans entering delinquency has diminished by about 72%. "We're way down from the peak," he pointed out. Although banks account

for 60% of maturing loan volume over the next three years and CMBS accounts for less than 20%, Pontius noted that CMBS loans have a higher proportion of delinquencies-nearly 9% of all CMBS loans are delinquent.

SERVICERS IN FOCUS

After several quarters where thousands of distressed assets went into servicing, the pace of transfers has moderated, and resolutions are catching up, according to experts in a presentation entitled, "Meet the Special Servicers,"

"If you look at the pace of transfers and the level of distress in 2010, it would be a record year if not for 2009," said Kevin Donahue, senior vice president of Midland Loan Services Inc. "That seems to have moderated a bit, and the pace of resolutions seems to be catching up to the pace of transfers. The ratio used to be 4:1."

On the panel with Donahue were Michael Carp, EVP of asset management for Berkadia Commercial Mortgage LLC, John Maute, managing director of Helios AMC LLC, Timothy Mazzetti, partner and EVP of Cohen Financial, Matt Stewart, VP of TriMont Real Estate Advisors, and moderator Steve Pumper, executive managing director of Transwestern.

Carp also noticed a shift in the number of distressed properties that have been transferred to special servicing. "Our sales of REO have picked up dramatically, as well, over the past six to nine months."

It's important to note that all loans in special servicing (currently about $90 billion) are not there because they are in default. "You've got to make a distinction between loans in default and loans in special servicing," Maute asserted during the discussion. "Of the total, maybe 40% is there for reasons other than default."

Stewart said CMBS resolutions have outpaced bank resolutions, primarily because of issues related to recourse. "Any bank under the FDIC umbrella has to deal with recourse," he explained. "Banks are not likely to forgive recourse provisions, and those will hinder the pace of resolutions among the banks."

Despite the slowdown in transfers and the increased pace of resolutions, the panelists believe even more properties will end up in special servicing. "There is a lot of opportunity to move loans into special servicing," Carp said, acknowledging that more properties will likely fall into the distressed category as more loans mature and are unable to be refinanced.

Mazzetti offered this final thought: "There's not a lot out there that provides us hope that tomorrow will be a better day. Once we work though some of the property-level distress related to occupancy, we walk right into refinancing again."

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Delta's Contrarian CEO: Distress Has Peaked

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