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Distressed RE Market: Why it never materialized
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Distressed RE Market: Why it never materialized


Presentation of key trends & factors in the RE market landscape over the next 3 years

Presentation of key trends & factors in the RE market landscape over the next 3 years

Published in Economy & Finance , Business
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  • 1. Where was the Big “Kaboom”? Why the Distressed REO Opportunity Failed to Launch Michael White Principal, Pacific Cascade Group June 25, 2010
  • 2. The Capital Markets Fuse
  • 3. The Capital Markets Fuse Heyyyy Abbott! Who’s on First?
  • 4. The Big Picture becomes Bigger In 20 years, outstanding RE debt increased by 300%
  • 5. Capital Markets Fuse The Fingerprints of Froth
  • 6. Capital Markets 2007-2008 The Amazing Met the Unexpected! Credit Swaps 10 Year CMBS Spreads to Swaps & Treasuries, 1997-2009 Bank Lending Volume 7600 Total Bank Lending Y/Y % Change As of 12/17/09: 7200 AAA: 487 bps 20% 6800 AA: 2962 bps A: 3598 bps 6400 BBB: 5169 bps 6000 15% 5600 5200 4800 10% 4400 Basis Points 4000 5% 3600 3200 2800 0% 2400 2000 1600 -5% 1200 800 -10% 400 0 1995 1996 1997 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1/97 7/97 1/98 7/98 1/99 7/99 1/00 7/00 1/01 7/01 1/02 7/02 1/03 7/03 1/04 7/04 1/05 7/05 1/06 7/06 1/07 7/07 1/08 7/08 1/09 7/09 Source: Federal Reserve, Stifel Nicolaus Source: Bloomberg, Morgan Stanley, Stifel Research AAA AA A BBB Property Values
  • 7. The Capital Markets Fuse Banks picked up CMBS biz in 2008, then they too fell into… the Underworld
  • 8. Vulture Culture [2007-2008]
  • 9. Vulture Culture Anticipation Phase By 2007 distressed asset fundraising was already up by 207% By 2009, 35% of ALL RE fundraising focused on distressed assets! In 3 years, “Vulture Funds” raised $75B Source: Prequin – Private Equity Real Estate Distressed and Debt Market Report: April 2010
  • 10. Vulture Culture “Concentration of Risk in a Small Space” 79% of these funds targeted North America As of April 2010, $61B additional was still being actively marketing for deployment in …North America Currently, 74% of currently marketing funds target distressed investment. The Vulture perch is crowded! Source: Prequin – Private Equity Real Estate Distressed and Debt Market Report: April 2010
  • 11. Vulture Culture “Inexperience compelled by Fees” Source: Prequin 4/2010 Distressed RE Report 70% of Vulture Fund sponsors were First-Time Managers of distressed and debt vehicles. Hedge fund fees in distressed sector among highest in the industry! Source: Prequin – Private Equity Real Estate Distressed and Debt Market Report: April 2010
  • 12. Vulture Culture Why Didn’t the REITS get Hit? $25 1,800 1,600 Reason #1 $20 1,400 Proceeds (in billions) Shares (in millions) 1,200 $15 $10 1,000 Wall Street’s 2009 “Recapitalization Rally!” 800 600 $5 400 REITs issued over 1.5B shares [worth $18.7B] of new stock $0 200 2004 2005 2006 2007 2008 2009 equity in 2009! Equity REITs only. Consists of follow -on offerings and private placements only. Proceeds Shares Issued Sources: NAREIT, SNL Financial, Stifel Nicolaus REIT issued more shares in 2009 than in any of the previous 10 years! What did REITs want to buy with all this money? DISTRESSED ASSETS!
  • 13. Vulture Culture Why didn’t the REITs get hit? Reason #2 REITS were NET SELLERS into the Valuation Peak! Effectively, they were “re-calibrating” their balance sheets.
  • 14. The Government Bootstrap
  • 15. The Government Boostrap Why isn’t this woman smiling? Possible Answers: – “Sheila’s on First” – She is looking at the next charts – Her Boss puts her on “hold” every time she calls Sheila Bair: Head of the FDIC
  • 16. The Government Bootstrap “Exactly where does it hurt, Sheila?” 87% of CRE risk is concentrated in local and regional banks with <$1B in assets. Average commercial loan held by those banks is only $8M* US Money-Money Center banks are NOT at Tier-1 risk (thanks to TARP)! What size deals are Vulture Funds targeting with $120B? *Mortgage Bankers Association, Press Release 2/5/2010
  • 17. The Govt Bootstrap The “4 Horsemen” Charts
  • 18. The Government Bootstrap Disturbing Facts vs. Disturbing Realities As of May 2010, the Deposit In the next 12 months, the FDIC Insurance Fund, or DIF, had is expecting to spend “$40 a negative balance of billion” closing troubled banks. $20.7 billion. Commercial banks hold $1.5T of The FDIC has $46 billion in CRE mortgage debt outstanding three years of prepaid deposit insurance CRE Loan Losses at banks alone premiums and $17 billion in could be $200-$300B* cash for a grand total of $63 billion in “liquid resources” to close insolvent banks. Potential CRE bank loss exposure is 697% of current “net” FDIC Deducting the $20B DIF resources available today. deficit, there’s $43B in “net” liquid assets. * Source: Congressional Oversight Panel, February Oversight Report: “Commercial Real Estate Losses and the Risk to Financial Stability” Feb 10, 2010
  • 19. Government Bootstrap The Trend is NOT the FDIC’s Friend 2008: – $14.9B – 25 banks – $596M/bank 2009: – $36.4B loss – 140 banks – $260M/bank June 2010: – $17B loss (first 6 months!) – 81 banks – $321M/bank Annualized 2010 Projection – 162 failures – $277M/bank (avg) (avg) – $45B estimate total liability for 2010 Current Trend: Chart on the lower left – the ORANGE line
  • 20. The Government Bootstrap
  • 21. The Government Bootstrap Politics trumps Economics What’s Washington’s political motivation to accelerate Tier-1 loss defaults into bank failures prior to November? ZERO!
  • 22. The Government Bootstrap Sticky issue: FDIC Funding in 2011?? November Elections “Bail-Out” Political Backlash State Budget Meltdowns (CA) Record-setting Federal deficits “Hello Sheila? No… it’s not a good time to talk about this… can I put you on hold?”
  • 23. Government Bootstrap What “HOLD” looks like to the FDIC
  • 24. Government Bootstrap Why “Hold” is better than “Fold” for FDIC
  • 25. The Government Bootstrap “If you only remember one thing…” The US Government controls the distressed asset market because they regulate the key player: the banks.
  • 26. Atlas Shrugged [2010] Distressed Asset Investors: All dressed up with nowhere to go…
  • 27. Disappointment in 2010 “Today I’m sitting with $125M in cash that I can’t find investment for” Stephen Richter, CFO – Weingarten Realty Investors “The volume of properties that are truly distressed and will be sold in a distressed fashion will be significantly less than had initially been thought” Bob Steers, Co-Chief Executive Cohen & Steers, Inc. “Funds are fighting over a slim group of available deals” Mark Edelstein, Real Estate Group Head, Morrison & Foerster, LLP
  • 28. What Happened and Why Only 17.5% actually transacted 59% of investors targeted un-levered IRRs north of 16% 49% sought leverage of 50% or greater. (ie, levered IRRs >30%) Resulting Bid-Ask spreads too wide for sellers (banks) FDIC handed the banks an option: refusal of low-ball offers. Charts: Ernst & Young, US Distressed Real Estate Loans Invstor Survey, April 2010
  • 29. Throwing in the Towel? A total of 19 private- equity real-estate funds have either returned or plan to return more than $6 billion of capital to investors. WSJ, “Dearth of Properties Spurs Fund Givebacks” May 26th, 2010
  • 30. Where Are We, Watson? [2011-2017] Sleuthing for Clues At the Scene of the Crime
  • 31. Mysterious Footprints Bank Maturities peak in 2010- 2013? Not quite - 3 year workouts suggest our villain will return in 2013-2016. But Holmes – look at CMBS!!
  • 32. Another set of Footprints leading to…. Right you are, Watson! A second set of footprints – CMBS – leads to the same exact destination: 2014-2017! But that’s preposterous, Holmes! What then…? Source: Goldman Sachs and Trepp
  • 33. Death by Blunt Instrument [the Re-fi Gap!] 100 90 80 70 60 Others lenders ($ Billions) Banks (Construction Loans) 50 Banks (Income producing CRE) 40 CMBS 30 20 Source: Morgan Stanley, MBA, FDIC, FFIEC, Intex, PPR, and 10 Jones Lang LaSalle - 2010 2011 2012 2013 2014 Difference between debt outstanding upon maturity and debt that is sustainable today based on normalized LTVs (~65%) Bank extensions are shifting these maturities three years forward! 2010 shifts to 2013 ! CMBS maturities peak in 2015-2017
  • 34. Critical Impact: Re-fi Rates in 2013? A 3.3% 10-year treasury rate is way below our 30 year average! (why?)
  • 35. An Extraordinary Puzzle! INVERSE correlation between debt and interest rates. More debt = lower rates! Counter-intuitive? Convenient? Conspiracy? We borrow more when rates are low, why shouldn’t Uncle Sam? Excludes Public debt (Soc Security, et. al.)
  • 36. But …what about Public debt? Public debt is off- balance sheet liability. Guarantied (but not serviced) by US Govt. Bad trend in net foreign purchases of US Treasuries!
  • 37. Foreign Buyers frame dynamic float for US debt
  • 38. But EVENTS (not rates) are defining demand [The most interesting chart of the morning!
  • 39. Clues to watch in the next 12 months! Higher rate indicators – Net drop in Treasury purchases by central banks – More bail-outs/guarantees by US Government – Stock market drop below 9600 on DOW (Fibonnaci 38.2% retracement support. – Increase in residential foreclosures after November (perceived loss of economic virility devalues fiat-based $ resultingMBA, increasing interest Source: Morgan Stanley, in rates to lure investment back into T-bills.Intex, PPR, and FDIC, FFIEC, Jones Lang LaSalle Lower rate indicators – Environment of political or economic crisis (Euro PIIGS, Iran, N. Korea, Mexico) – Dow regains 11,136 (unlikely – 61.8% Fibonnaci) THANK YOU!