A Weekly Report of Property and Credit Market Conditions and Real Estate Investment Opportunities
In this week's issue:
- You know there is a problem when...
- Another blow to the faltering 1031 real estate business.
- S&P pulls the 'trigger on YRC Worldwide.
- Shrinking GE Capital.
- Plus, we give you the latest properties on the Watch List in: Sheffield, AL; Petaluma and Woodland, CA; Boulder, CO; Pensacola, Tallahassee and Winter Haven, FL; Macon and Newnan, GA; Cedar Rapids, IA; Metairie and New Orleans, LA; Pembroke, MA; Grand Blanc Township and Lansing, MI; Durham, NC; Lawrenceville, NJ; Newburgh, NY; Maple Heights, OH; Lancaster, Pittsburgh and York, PA; Charleston, SC; and Richmond and Vienna, VA.
You Know There Is a Problem When…
When companies preemptively announce that there is nothing to worry about, it's a good bet that there is a lot of worrying going on.
Take last week, when major insurance companies were coming clean about their CMBS holdings. MetLife Inc., The Hartford Financial Services Group Inc. and PMA Capital Corp. without any prompting all issued statements saying essentially that their CMBS portfolios were clean of any toxic holdings.
What would prompt such a need to reassure investors that there was nothing to worry about?
Perhaps it was all the worry that was stirred up by the pronouncements from Wall Street that commercial real estate and thus, CMBS deals, were heading for a big fall. And where up to this point in time, forecasters were pushing any prospects for a turnaround into next year, every report coming out in the past couple of weeks has pushed those prospects further out until 2011.
Moody's Investors Service first stirred up anxiety levels when it issued reports that said conditions across all markets and property types are under pressure. The balance in supply and demand that has been currently helping support U.S. commercial real estate prices is now expected to give way to decreasing demand over the next several months, leading to lower rents and higher vacancies.
Moody's said it expects commercial property values to decline from 20% to 30% from their peak in late 2007, with the market reaching a bottom in 2010-2011.
"We believe that commercial property prices will soon start to decline again. As pressure continues to build in the sector, owners will begin selling into a deteriorating market at lower prices," said Nick Levidy, Moody's managing director of Moody's.
"The headwinds faced by the retail sector in particular appear to be strengthening, the hotel sector has been re-pricing for months, demand for office space appears to be on the decline in many markets, and multifamily properties are buffeted by cross currents relating to unemployment, shadow rentals of unsold homes and condominiums and home affordability," Levidy said. "Meanwhile industrial properties have been impacted by slower trade and retail sales."
As such, aggregate defaults in commercial real estate loans are also expected to increase several fold over the next few quarters from the current historically low rate of less than 1%, the rating agency said.
The weakened conditions are likely to put downward rating pressure on the ratings of some commercial real estate mortgage-backed securities, the rating agency said.
"We do expect that the 2006 through 2008 vintages will experience more downward pressure on ratings than earlier vintages," Levidy said. "In particular we are concerned about fixed-rate deals with concentrations of pro forma loans - loans that were underwritten assuming continued strong macroeconomic tailwinds."
Fitch Ratings followed with its own commercial real estate and CMBS outlook. Fitch was particularly glum about the retail sector predicting that consumer spending would fall by 1.6% next year, gross domestic product would decline by 1.2% in 2009 and unemployment would rise to 8.3%. None of which bodes well for retailers.
Poor labor market prospects would also hurt the office markets. Fitch is predicting that business investment would fall 6% next year in line with previous recessions.
On the CMBS front, Fitch said it expected to see loan delinquencies increase 1.5% to 2% by the end of next year. In addition, because of the lack of liquidity in the markets, CMBS losses would increases and they would be forced to hold onto properties longer than has been the norm.
Alan Todd, head of commercial mortgage bond research at JPMorgan Chase & Co. followed up the rating agency outlooks with an even bleaker assessment.
"It has become increasingly obvious that commercial real estate credit problems will finally materialize and intensify in 2009," Todd said in published research.
Commercial property prices may fall as much as 40% from peak-to-trough, Todd said.
Todd said he was most concerned about retail properties since a recession and a "severely weakened consumer" with limited access to credit would continue to curb retail sales.
Regarding CMBS deals, Todd said, commercial property loans originated in 2005 to 2007 that increasingly carried risky terms are likely to see a significant increase in defaults in 2009 due to lack of credit, falling property values and reduced cash flow.
Another Blow to the Faltering 1031 Real Estate Industry
Already stung by cases alleging massive embezzlements and a string of failures of 1031 exchange accommodators, now comes another major blow to the business of tax-free real estate exchanges. LandAmerica 1031 Exchange Services Company Inc., one of the stalwarts of the business and one to whom many investors turned to for stability has run out of money, closed up shop and filed for bankruptcy court protection.
LandAmerica Financial Group Inc., Fortune magazine’s number one Most Admired Company in the mortgage services industry in 2007, has shut down operations of its LandAmerica 1031 Exchange Services. In addition, the parent company is being forced to sell its primary title insurance subsidiaries Commonwealth Land Title Insurance Co. and Lawyers Title Insurance Corp.
The string of actions was touched off Friday Nov. 21 when Fidelity National Financial Inc., parent company of Chicago Title, cancelled a deal to buy LandAmerica Financial.
The following Monday, LandAmerica 1031 Exchange Services quit accepting new customers and terminated its operations.
That same day, the Nebraska Department of Insurance filed petitions for rehabilitation for Commonwealth and Lawyers Title under the Nebraska Insurance Code. That move likely would have meant turning over controlling of LandAmerica's title companies to Fidelity.
So two days later, LandAmerica Financial came to news terms on the sale of its title companies to Fidelity National, a deal that did not include LandAmerica 1031 Exchange Services. Thus the exchange accommodator and LandAmerica Financial the parent filed for bankruptcy to help facilitate the sale of the title businesses. The filing was made in under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of Virginia in Richmond, VA.
LandAmerica 1031 Exchange estimated that its assets and liabilities were between $100 million and $500 billion. LandAmerica Financial estimated both at more than $1 billion.
Separate from the title insurance drama, LandAmerica 1031 Exchange Services was having problems of its own.
In a typical 1031 exchange, an exchanger sells its real estate investment and then has 45 days from the date of sale of the property to identify a like kind replacement property and it has 180 days from the date of the sale to close on the purchase of that replacement property without suffering any tax consequence.
The money from the sale of the first property is held in escrow by an exchange accommodator and released for the purchase of the replacement property. LandAmerica 1031 was one such firm.
While it held those funds, LandAmerica was investing a portion of them in auction rate securities -- in this case in investment grade securities rated A or stronger, including auction rate securities backed by federally guaranteed student loans.
Despite their investment grade ratings, LandAmerica 1031 got caught up in the troubles for such securities when the market for them froze earlier this year.
Its inability to sell or borrow against these securities precipitated its decision to terminate operations, the company said in a letter to customers.
"We understand that this situation is detrimental to you, and we can only assure you that we have taken every reasonable step possible to avoid the problem, including pursuing numerous liquidity options to no avail," LandAmerica's letter to customers said.
Customers are finding out just how detrimental it is after the filing of Chapter 11.
In a real estate alert to its clients, the law firm of DLA Piper in Atlanta, GA, wrote, "For taxpayers who have exchange funds at LandAmerica 1031 Exchange, the automatic stay imposed by the Bankruptcy Court in connection with the Chapter 11 filing will require Court approval of the release of any funds. Accordingly, it is highly unlikely that those funds will be immediately available, and they may not be available in time for the scheduled exchange closings, if any."
"In addition to negatively affecting the contractual obligations of those taxpayers to close on the purchase of identified replacement properties, the unavailability of exchange funds may disqualify the transaction from favorable Section 1031 tax treatment or have other adverse tax consequences," DLA Piper wrote.
According to bankruptcy filings made by LandAmerica 1031, there are approximately 450 taxpayers with pending exchange transactions.
There have been at least two lawsuits filed on behalf of such clients on an emergency basis seeking the release of those funds in time to complete pending transactions.
"I am deeply disappointed over the need to file for bankruptcy protection for the LandAmerica holding company and the 1031 company," said Theodore L. Chandler, Jr., chairman and CEO of LandAmerica Financial. "However, this sale of our principal domestic title operations to Fidelity National in this coordinated Chapter 11 filing and Nebraska rehabilitation action offers our stakeholders the best result available in this brutal real estate, credit and capital market environment."
S&P Pulls the 'Trigger' on YRC Worldwide
Fortune 500 transportation services provider YRC Worldwide Inc. had its credit rating cut by Standard & Poor's late last month, a "trigger event" under its credit agreements that is going to force the Overland Park, KS-based firm to collateralize its remaining unencumbered assets. The assets to be turned into cash primarily include its real estate.
At year-end 2007, YRC operated 845 transportation service centers across North America, of which it owned more than 500 of them. The centers vary in size ranging from one to three doors at small local facilities, to more than 426 doors at the largest consolidation and distribution facility.
It owns substantially all of its larger facilities and office buildings in Overland Park; Akron, OH; Lebanon and Carlisle, PA; and Holland, MI.
The company estimates the market value of its assets to be around $1.5 billion.
"It is unfortunate that the economic environment and financial markets are causing these types of reactions," stated Bill Zollars, chairman, president and CEO of YRC Worldwide. "Yet it is important to understand these disappointing downgrades do not change our strategic plans to combine the national companies or improve our financial condition."
The collateralization of these assets could include entering into sale and leaseback transactions and/or the disposition of excess facilities including the expected 150 properties from the integration of Yellow Transportation and Roadway.
Shrinking GE Capital
GE is undertaking a major restructuring of its GE Capital finance arm, a move that will include the selling some highly leveraged assets and eliminating redundancies among its 75,000 employees and consolidating facilities.
The company has yet to identify how many positions will be eliminated.
GE's real estate holdings fall under the GE Capital group. GE's real estate portfolio is highly diversified with more than 8,600 properties in 2,600 cities in 28 countries at an average investment a little less than $15 million. Of that amount, about 3,200 investments are in properties in 150 markets -- about 70% of which is outside the U.S. The rest of the portfolio is made up of mortgage debt.
"We are taking a number of tough, but prudent actions to make GE Capital safer, stronger and more secure during this financial crisis. We are committed to being a triple-A company," said Keith Sherin, GE vice chairman and CFO. "These actions include a funding plan that reflects the current market, and we are lowering our leverage ratio and commercial paper balance. Our forecast anticipates a challenging loss environment. We are also reorganizing the business to reduce costs and allocate capital more efficiently."
Jeff Bornstein, CFO of GE, provided details of GE's economic outlook
GE is assuming unemployment will hit 8.5% by year-end 2009, which would drive approximately $4 billion of pre-tax losses for 2009. That would be about a 20% increase from where GE said 2008 would end. GE's worst-case scenario showed a 9% unemployment rate, which would add roughly $800 million in additional pre-tax losses.
GE is predicting an additional 20% decline home price next year, which in combination with the 2008 experience would mean 37% decline over that period of time.
Next year, GE expects average cap rates to increase 50 to 100 basis points resulting in approximately $500 million of losses and equity impairments. That would be up roughly $220 million from where it thinks 2008 will end. GE's worst-case scenario forecasts a 200 basis point increase in cap.
You can view the Watch List loans here.
Read Watch List First
The Watch List is a powerful one-two-combination of both top-down macro analysis and bottom up micro real estate news, as well as valuable leads about companies expanding and contracting and property and loan investment opportunities. It is available for free by e-mail, which is the quickest way to review all of the news in the column as soon as it is published and link directly to the news and features you want. Just e-mail me your name, title, company, company business, city, state, and e-mail address. You can reach me by clicking on the byline above or e-mailing me at Mark Heschmeyer
For news of companies with increasing space needs, see Expansions & Relocations
, a weekly column of major corporate headquarters expansions and relocations.
For news of companies shedding commercial space, see Closures & Layoffs
, a weekly listing of future corporate downsizings.
For news of property financing and a listing of loans nearing their maturity, see Property Finance
, a weekly column of commercial real estate finance news and loan leads.
For news of properties about to go through a change of ownership, see Under Contract
, a weekly listing of properties to be sold or acquired.
For development and construction news, see In the Pipeline
For retail news including expansions, closings and mergers and acquisitions, see CoStar's Retail News Roundup
For green building news from CoStar, see Green Lede.