To say that there is an air of pessimism in the commercial real estate (CRE) market would be something of an understatement. With ominous terms like "tranche warfare" and "debt stack" being tossed around, and fears mounting over the health of U.S. commercial mortgage lenders and China's growing real estate bubble, real estate lawyers can be forgiven for feeling as if they're under siege.
To discuss the CRE crisis, The Am Law Daily caught up with Dewey & LeBoeuf real estate chair Stuart Saft.
Hello Stu, thanks for taking the time. So what's the current state of play?
It's soft and it's getting softer. The problem is multifaceted. It stems from the fact that for the last five years there was a great deal of construction going on, so it brought space onto the market. At the same time, we're really still in a two-year recession. So forgetting about residential real estate, which is already in default, we have $1.3 trillion in CRE that needs to be refinanced between now and 2013.
Where is that money coming from?
About $260 billion of it was originally financed by the securitization market, which of course doesn't exist anymore. And if that's not bad enough, the recession has pushed rents 40 to 60 percent below what they were when these loans were made. So even if the credit market was available to refinance the debt, the owners wouldn't be able to refinance because of the [diminished] rental stream.
Sounds like quite the conundrum.
It is. There's going to be a huge change in the values of real estate and probably a great many foreclosures, which lenders have been attempting to not do.
Why are lenders resisting?
Because they're concerned about being taken over by the FDIC or other regulators. It's better for them to 'kick the can down the road' where they have extended loans as they become due, rather than requiring that the loans be repaid. The last thing they want are regulators to come in and see loans that are passed their maturity and then require the lenders to create loan-loss reserves, which would necessitate them getting more regulatory capital in an environment where there is no capital.
What about regulatory reforms?
We're getting to a point where regulators will say, 'Enough is enough, it's time to recognize that the real estate is worth less than the amount of your debt, and you're going to have to write down the property on your books.' Once that happens, there's no longer an incentive for the lenders not to foreclose. And then everything begins to collapse at one time.
Washington likes to fight the last war. By tightening lending rather than creating an environment where there can be more liquidity, the seeds are being sown for a further real estate collapse, which will undermine the economies of a lot of countries and the portfolios of some of our largest institutions.
You've been a real estate lawyer for more than 30 years. Haven't we seen bad times before in this cyclical industry?
This is the fourth one of these cycles that I've been through, and to a large extent it's mirroring what we saw during the S&L crisis in the late eighties and early nineties. But I think we're in for something much worse. The problem is during the last crisis we basically dealt with properties that had a single mortgage lender and the debt was rather straightforward. You could have the lender and borrower sit down and negotiate some form of a workout.
I take it that's no longer the case?
Yes. In part because of the disappearance of S&L's in the early nineties and the credit markets creating the securitization of real estate. Then mezzanine loans became more available and so now workouts are extremely difficult, because there are so many people with different interests at the table. And the availability of all of this financing meant that more and more money could be lent against the properties, so the numbers are significantly bigger than where they were 20 years ago.
What are the complicating factors in arranging workouts?
You've got different people on the A and B notes of a senior debt position, ten levels of mezzanine debt, and the debt stack now is just incredibly complex. That's going to make the fall even greater because you can't just get a lender and borrower in the same room and negotiate a deal.
What does this mean for lawyers?
Well, we invented the system, and so far we've benefited from it.
How are you staying busy?
Fortunately we have a diverse real estate group here and our practice includes a lot of public transactions. We represent the Lower Manhattan Development Corporation on rebuilding Ground Zero, Lincoln Center on its redevelopment, the proposed Moynihan Station, the New York Public Library, and Mount Sinai Medical Center.
So that keeps us busy, along with a strong residential practice that's one of the best representing condominiums, which doesn't stop just because a project is partially completed or sold. And we've begun doing a tremendous number of workouts directed to us from abroad--where the debt is being held--by clients wanting insight into the nuances of the U.S. legal system and someone to step in and workout the debt difficulties themselves.
We've all heard that real estate is an important driver of economic growth. Has that been your experience?
I had an amazing assignment last winter where I took a group of associates to Detroit to analyze General Motors's 380 million square feet of real estate around the world. That kept us busy for a good chunk of the winter and helped us recognize that everything has changed. GM is essentially a real estate business that makes cars. Corporate America really doesn't appreciate the real estate asset--they're focusing on how to produce income for their shareholders.
Do you get the sense that the role of real estate lawyers is changing?
Real estate lawyers are going to have to be more than the guys you call in to cut a deal. We started a new subspecialty in our practice for the strategic utilization of real estate--how clients can make money from the real estate that they have. One not particularly palatable alternative is to sell the real estate at a depressed value. But in five years they'll likely need that property back and will end up paying far more for it. So the question becomes: how do you come up with a way to assist them while maintaining an ownership interest until the market improves?
You just took over the firm's real estate practice. Talk about timing.
I guess it speaks to the amount of aggravation that I'm willing toaccept!
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