The great commercial property value writedowns of the '2007-?? Recession' have begun and early indications are that the damage to values could be substantial and, in some cases, ruinous. The re-valuation of properties already has one major U.S. office property owner on the ropes and its survival in doubt.
Numerous triggers are forcing the re-valuation of assets, including the burn off of interest-only periods on loans that became increasingly popular in 2005-'06, other loan maturities, rising cap rates, rising vacancies due to falling space demand and falling loan-to-value ratios.
The writedowns in property values are all over the board, ranging from about 10% to more than 60%. And they are impacting both performing and troubled assets, with performing assets at the lower end of the scale and nonperforming at the higher end. Where properties in between fall is anybody's guess.
"The challenge is that appraisers are shooting in the dark - in a market with virtually no sale or lease activity, the only intellectually honest answer to the question, 'What are cap rates and lease rates?' is 'I don't know,'" said Steven K. Lindley, senior vice president of the Capital Markets Group of Grubb & Ellis|BRE Commercial in Phoenix, AZ. "Of course the appraisers can't say this, so they are forced to guess at what cap rates or lease rates might be if anything was moving - not the most reliable approach."
"This creates an appraisal conundrum," Lindley continued. "Lenders are required to get a reliable appraisal to resolve their non-performing assets but when they get the appraisal they don't trust it. We are aware of assets that have been appraised three times to try to agree on value for loan extensions. The range in values was so big that the negotiations to extend the loan got stuck and the borrower and lender ended in a major dispute."
"I hear that there are many owners receiving requests for re-evaluation of credit risk on performing loans I assume that could translate into a higher cap rate being applied which would revalue the asset," said Mike Flynn, a partner in Beacon Commercial Real Estate in Conshohocken, PA. "There haven't been many new appraisals. There are not currently enough sale comparables to re-appraise, although market rental rates are falling and concessions are increasing, which could be used in the credit risk analysis."
The need for risk evaluation cannot be ignored, Flynn said. The reality is that properties are not worth what they were two years ago. So when properties are re-valued for refinancing purposes, the owner could be faced with needing "massive amounts of equity, which in most cases is not available."
Hence, just as there is a conundrum of where property values are right now, there is also confusion as to what property owners should do in regards to assessing their property values, agreed Gabriel Silverstein, president of Angelic Real Estate in Chicago, because property values are in a period of disequilibrium and confusion.
"Many assets not being re-valued are being carried at inflated values, and those that are being re-valued are being re-valued by scared appraisers afraid of lawsuits, who are consequentially being grossly over-conservative," Silverstein said. "Therefore two identical buildings next door to each other may now carry values that differ by 50%. That is creating complete confusion and uncertainty, only further hurting investor appetite, and therefore values."
"There is a lot of 'hold' and 'wait and see' going on now because absent real transaction volume, many owners have the attitude that until trades start clearing the market, they don't know what the real values are," Silverstein added.
"I am not convinced those that are required to mark asset values to market have truly done so yet, using the lack of transaction volume as an excuse," he said. "Historically in economic dips, there was an incentive -- once the world acknowledged things were going down -- to over-adjust and take as much of a hit as possible when it was already expected, making future earnings or asset pricing adjustments unexpectedly positive (and therefore stock price / investor attitude benefiting). Today I think many companies are so beleaguered they can't take any more hit to their asset bases and are under-reporting the real value drops in their portfolios."
For one firm, the hit to property values appears to be critical. Sydney, Australia-based real estate investment trust Rubicon America Trust (RAT) voluntarily asked for suspension from trading on the Australian Securities Exchange.
Rubicon Asset Management Ltd., the responsible entity for the REIT, said it received "additional information in relation to the possible impact of the continued dislocation of global credit and real estate markets on the financial statements of RAT and the ability for RAT to continue as a going concern."
At year-end 2008, RAT owned a portfolio of 18 U.S. office properties valued at $641.9 million. That value was already down 10.7% from RAT's valuation at the end of June 2008.
Late last month, Rubicon Asset Management said it had commissioned another independent valuation of the all the properties in portfolio. There has been no indication of what information Rubicon Asset Management received since commissioning the re-evaluation.
However, it should be noted that also last month, RAT had defaulted on its warehouse facility with lender, Credit Suisse, and is in continuing negotiations with them. In addition, RAT has a commercial real estate loan portfolio that is also being re-valuated.
RAT also has entered into a conditional deal with Kaufman & Jacobs LLC to sell four of its GSA II real estate properties (Robert Duncan Plaza in Portland, OR; Beacon Station in Miami; 1970 E. Parham Road in Richmond, VA; and 2600 Lord Baltimore Drive in Baltimore, MD) covering 680,000 square feet for $175 million. The sale is conditional upon the completion of due diligence and assumption of the $113.1 million of senior debt. The due diligence period ends Feb. 17.
According to Rubicon Asset Management, the resolution of the warehouse loan default and re-valuations "are likely to have a significantly negative impact on the financial position of RAT."
Rubicon Asset Management said the result could end up amounting to a $164 million loss for RAT for the year ended 2008.
Macquarie Office Trust, another Australian-based REIT, also reported on a re-valuation of its 15 U.S. office properties this week. The REIT reported an 11.6% decline in value as of Dec. 31, compared to its June 30, 2008, value.
"Given the changes in the economic and real estate landscape over the past six months, we believed it prudent to conduct independent valuations on all 42 properties [globally] in the Macquarie Office portfolio," said Adrian Taylor, Macquarie Office Trust's CEO. "This valuation movement was driven by a range of factors, including a downturn in economic activity, a tightening credit market, which has weakened investment demand for property globally, and more conservative assumptions adopted by valuers which was particularly evident on properties with vacancy and upcoming [expirations]."
Unlike RAT, Macquarie Office Trust remains in compliance with all its remaining debt and derivative covenants.
Nonperforming properties are getting hit even harder. Servicers, which pay bondholders of commercial mortgaged-backed securities, undertake re-appraisal of troubled loans in their portfolio as an assurance that they are not overpaying the bondholders.
Declining commercial real estate values, along with higher loan default rates and delinquencies, are placing more focus on servicer advancing and appraisal reductions in the U.S. CMBS sector. CoStar Group is beginning to see more such appraisal reductions showing up in monthly CMBS bondholder reports.
CoStar pulled the information on a random sample of appraisal reductions done in the last three months. On average, the appraisal reductions we examined averaged a 52% decline in the re-appraised value of the property vs. the outstanding debt on the loan on the property.
Particularly noteworthy was an $85 million (62%) appraisal reduction on the Macon Mall issued on Jan. 12.
Macon Mall, which is rolled up in Wachovia 2005-C20, is a $137.5 million loan secured by two cross-collateralized regional malls in Macon, GA and Burlington, NC, owned by the Lightstone Group. Macon Mall is a 1.4 million-square-foot two-level enclosed super regional mall and the Burlington Mall is a 419,194-square-foot one-level enclosed mall.
The loans transferred to special servicing (CW Capital Asset Management) in February 2008 due to imminent default.
Both properties have had declines in occupancy as a result of new competition in their markets and tenants vacating over the past year.
The borrower had been funding the shortfall and then indicated it would stop doing so and will not contest a trust foreclosure.
It is clear that the consequential impact of re-valuations is enormous, not just for associated deals and properties but for the immediate localized economy. It has the effect of sucking capital and risk-taking investment out of the system, said Lawrence Schnurmacher, executive director investments for Oppenheimer & Co. in Boca Raton, FL.
Steven Sandler, CEO of Crosswind Capital LLC in Rye, NY, argues that the situation has been made worse because lenders have been and are still reluctant to re-value properties.
"For the most part, lenders remain surprisingly resistant to asset re-valuations that would mirror market realities," Sandler explained. "We are not seeing true 'mark to market' if you will, but a strange intermediate phenomenon of 'mark to appraisal,' which allows institutions to value assets somewhere on that bridge between fantasyland and tomorrowland.
"The trigger for contrition will be some forced action on the part of a regulatory entity such as the FDIC, SEC, TARP, etc.," Sandler continued. "This process is starting to resemble what we observed in the very early 1990s, with the creation of the Resolution Trust Corp. (RTC), albeit on a much larger relative and nominal scale. Ultimately, it required a massive and aggressive disposition of impaired assets to clear the system. At that time, the federal government was less concerned about maximizing value and more focused on protecting its downside exposure. It's unclear how the current iteration will work, if at all."
"Surprisingly, our observation is that there is little pressure from lenders to re-assess property values to the extent those assets are collateral for performing loans, and the loan is not due in the short term, say within 12 months," he said. "Even if the borrower is notably under water, from the perspective of most institutions, that is 'next quarter's problem.'"
"We have migrated, and quickly, from a mere credit crunch, to a full blown insolvency crisis," Sandler said. "Our conclusion is that if you tested the capital of most regional depository institutions in the U.S., (and a few large ones), based on the true current value of their loan portfolios and real estate collateral, a frighteningly disproportionate number would be insolvent."
"With respect to lenders and property values, keep in mind that this has been a slow process for one very important reason: confidence has been lost in the financial sector because investors feel that banks have hidden their problem assets to sustain their valuations," said one executive with a private real estate investment and development firm in New York. "Banks on the other hand have been so inundated with problem loans that they have been unrealistic as to the true valuations. By holding the line on their portfolios and selling and/or working out these problem loans, the hope had been to contain losses and allow them to slowly redistribute equity on their balance sheets and hopefully return to profitability once they can lend on sound assets."
"Add to this a high concentration of residential development on the part of a number of banks in areas like Southern California, South Florida, Arizona and Nevada and these markets having negative demand from consumers, the result is asset values declining faster than anyone expected," he added.
Part II of The Great Property Writedown will appear in next week's issue of CoStar Advisor. The article will look at what impact leasing activity is having on property valuations and consequently what that is having on financing arrangements and also will address some of the strategies owners are using to maintain higher property values.