Distressed RE Market: Why it never materialized

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

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Distressed RE Market: Why it never materialized

  1. 1. Where was the Big “Kaboom”? Why the Distressed REO Opportunity Failed to Launch Michael White Principal, Pacific Cascade Group June 25, 2010
  2. 2. The Capital Markets Fuse
  3. 3. The Capital Markets Fuse Heyyyy Abbott! Who’s on First?
  4. 4. The Big Picture becomes Bigger In 20 years, outstanding RE debt increased by 300%
  5. 5. Capital Markets Fuse The Fingerprints of Froth
  6. 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. 7. The Capital Markets Fuse Banks picked up CMBS biz in 2008, then they too fell into… the Underworld
  8. 8. Vulture Culture [2007-2008]
  9. 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. 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. 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. 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. 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. 14. The Government Bootstrap
  15. 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. 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. 17. The Govt Bootstrap The “4 Horsemen” Charts
  18. 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. 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. 20. The Government Bootstrap
  21. 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. 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. 23. Government Bootstrap What “HOLD” looks like to the FDIC
  24. 24. Government Bootstrap Why “Hold” is better than “Fold” for FDIC
  25. 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. 26. Atlas Shrugged [2010] Distressed Asset Investors: All dressed up with nowhere to go…
  27. 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. 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. 29. Throwing in the Towel? A total of 19 private- equity real-estate funds have either returned or plan to return more than $6 billion of capital to investors. WSJ, “Dearth of Properties Spurs Fund Givebacks” May 26th, 2010
  30. 30. Where Are We, Watson? [2011-2017] Sleuthing for Clues At the Scene of the Crime
  31. 31. Mysterious Footprints Bank Maturities peak in 2010- 2013? Not quite - 3 year workouts suggest our villain will return in 2013-2016. But Holmes – look at CMBS!!
  32. 32. Another set of Footprints leading to…. Right you are, Watson! A second set of footprints – CMBS – leads to the same exact destination: 2014-2017! But that’s preposterous, Holmes! What then…? Source: Goldman Sachs and Trepp
  33. 33. Death by Blunt Instrument [the Re-fi Gap!] 100 90 80 70 60 Others lenders ($ 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. 34. Critical Impact: Re-fi Rates in 2013? A 3.3% 10-year treasury rate is way below our 30 year average! (why?)
  35. 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. 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. 37. Foreign Buyers frame dynamic float for US debt
  38. 38. But EVENTS (not rates) are defining demand [The most interesting chart of the morning!
  39. 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!

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