[IMGCAP(1)]When a real estate market starts to turn, the perception of changing market conditions may depend on the beholder. More to the point, observers in different disciplines will offer differing perspectives on the changes. A broker might see a downturn in terms of fewer or smaller transactions, or in terms of more sublease space to work with. A lender might describe a period of watchful waiting for the capital markets to start shaking off the doldrums. A real estate attorney might tell you his or her practice is as busy as ever—just not with the same types of work the firm was doing a year ago. Marc S. Shapiro and Jill Block, partners in the firm of Orrick, Herrington and Sutcliffe LLP, tell Real Estate New York that the real estate practice’s emphasis lately has been on restructurings and workouts, a shift they began seeing during last summer’s subprime meltdown.

RENY: This recent demand for restructuring- and workout-related counsel—will it intensify as we go forward into 2008?

Shapiro: The lack of liquidity in the marketplace creates certain inevitable consequences. You have loans that are maturing and cannot be refinanced, and there’s no other source of capital to repay those loans. You necessarily find yourself in a restructuring scenario. The only alternative to refinancing is foreclosure, and most financial institutions know that the last thing they want to do is to go into a business that is not their core business—real estate.

[IMGCAP(2)]Block: Even with respect to property owners who would be willing to sell a project or who intended at the outset to sell the project after a certain amount of time, it’s not just their inability to refinance and retain that project as an existing financing matures. If a buyer is unable to obtain financing, then there is no buyer. It’s not just refinancing work that has dried up; it has impacted the buying and selling of real estate, too.

RENY: How is this affecting financial institutions’ behavior? Since lenders hope to avoid inadvertently getting into the real estate business, are they becoming more flexible?

Shapiro: Yes, the people whom we represent have generally been through this before. They understand today that their best solution lies in a consensual, cooperative agreement with the borrowers. By contrast, the last time we saw any kind of sustained stress in the real estate market, the people who controlled the restructurings were generally not as experienced as the people we have today. There was a much more aggressive and inflexible approach to restructuring real estate debt in the early 1990s. We’re approaching the world today with the benefit of what we learned the last time around.

Block: Also, the loans today are different than they were in the down cycle of the early ‘90s. The debt tends to be non-recourse or limited recourse. The borrowers tend to be single-purpose entities with certain bankruptcy remoteness features built into the loans. So the lenders are less aggressive, probably because the documents have already addressed much of what was not in place during the last down cycle. Therefore, there’s likely to be less bankruptcy and more consensual deals.

RENY: So it would be fair to say that the current down cycle differs in some ways from the previous one, but primarily because the financial institutions are building on their experience from last time.

Shapiro: If you look all the way down into each of the situations that we’re confronting today, what you will find in common is a much higher level of sophistication. The real estate is more sophisticated and more involved, and the financing, bankers, owners and lawyers and documents are all more sophisticated. So what we’re seeing today is not just the benefit of the experience that we had 15 to 18 years ago, but also that we’re reacting to a much more complex set of facts.

You’ve probably heard people say that during the last cycle it was possible to get all of your lenders in a room or on the phone. For the most part, that is no longer possible. The debt has been securitized and bonds have been sold to multiple groups. Sometimes we don’t even know who holds these bonds at any given time. So it’s harder to accomplish the same objective today because of the complexity and sophistication of the overall transaction.

RENY: What are some ways in which transactions are more complicated now?

Block: One thing that’s different in ’08 from 1990 or 1992 is that the bulk of the real estate financing these days comes from capital markets. In commercial real estate, there is much less financing provided by savings and loan institutions, or balance sheet lenders. So conversing with your lenders is more difficult these days because they’re institutions that own a bond representing a very small piece of a portion of a pool of loans in which a particular loan may be one of 10 or 100.

In recent years, we had been seeing very large loans that were originated by a lender or a group of lenders, and immediately after closing, the loan was cut up by the lenders. The ownership of the paper evidencing the loan was so broadly diffused that it made the transactions very complicated and sophisticated simply because there was the loan itself and then there were the subsequent transactions in connection with the sale, transference and securitization of the paper after the fact.

Shapiro: The real estate capital markets can be viewed as a super-efficient capital highway. If you compare it to the Interstate highway system and how it moves an enormous number of people and cars simultaneously, you can easily understand the efficiency of the capital markets. By the same token, when there’s an accident on these four- and five-lane superhighways, everybody crawls. As efficient as the system is when it works, it becomes grossly inefficient when it doesn’t work. You’re even less efficient with a four-lane highway when it doesn’t work than you are with a single-lane highway with a stoplight. What we’re seeing now in the capital markets is a multi-car pileup. We have to figure out how to clear the traffic jam.

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