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Watch List (Oct. 12-18): A Brutal September

A Weekly Report of Property and Credit Market Conditions and Real Estate Investment Opportunities
October 16, 2008
In this week’s issue:
  • Even apartments took a hit in the third quarter.

  • Hedge funds, pension plans see surpluses erode.

  • Third straight increase in CDO delinquencies.

  • Casino developer needs a good roll, or else ...

  • Plus, we give you the latest properties on the Watch List in: Oxford, AL; Victorville, CA; Ormond Beach, FL; Ormond Beach, FL; Tallahassee, FL; Dracut, MA; Wilmington, NC; Brooklyn, NY; Brooklyn, NY; Irwin, PA; Gaffney, SC; and Austin, TX.

Even Apartments Took a Hit in the Third Quarter

The U.S. apartment market had the smallest increase in annual effective rent in the third quarter in more than four years, according to Axiometrics Inc., a national apartment research company in Dallas.

"This is just one more indication that the U.S. economy has continued to weaken during the last several months and that the apartment market is being negatively affected as well, contrary to what some may have initially thought," said Ron Johnsey, Axiometrics president.

Johnsey said that the results for third quarter show not only that effective apartment rent growth had substantially slowed from one year ago-with an overall increase of only +0.8% in effective rent from a year earlier-but also that occupancy rates had dropped by -0.7% to 93.5%. (All measurements are based upon the same apartment communities in each time period.)

The third quarter annual growth rate in rents of +0.8% is the lowest of any quarter since the Internet Bubble burst in 2001.

The apartment market is expected to worsen into 2009 as the U.S. economy continues to lose more jobs. So far in 2008, the U.S. economy has lost more than 760,000 jobs and the unemployment rate has increased from 4.7% in September 2007 to 6.1% in September 2008.

The rate of quarterly rent growth in the third quarter of +0.2% was the second lowest rate of growth for a third quarter since 1996 and well below the long-term average growth rate for a third quarter of +1.3%.

The national vacancy rate increased by +0.7% from a year ago to 6.5% in the third quarter, which is the highest third quarter vacancy rate since +6.6% in five years.

The five markets with biggest declines in annual effective rent growth compared to a year ago were: Austin, TX; Charlotte, NC; Chicago, IL; Lake County, IL; and Los Angeles, CA.

The five markets showing the most improved annual effective rental rate growth compared to a year ago were: Boston, MA; Birmingham, AL; Durham, NC; San Diego, CA; and Washington, DC.

Hedge Funds, Pension Plans See Surpluses Erode

As the world watched in anticipation of a U.S. government bailout last month, the global financial markets roiled and pension plans and hedge funds took huge hits.

Hedge funds reported their worst losses since January 2003, when Morningstar Inc. created its Hedge Fund Index.

In September, the Morningstar 1000 Hedge Fund index dropped 7.87%, more than double August's losses. Hedge funds entered the third quarter virtually flat for the year, but the index's 13.17% third-quarter drop dragged year-to-date performance into the red.

"In September, the financial world as we know it turned upside down. We saw a shakeout in the hedge fund industry all around the globe. Hedge funds experienced poor borrowing, hedging, and trading conditions while liquidity dried up and volatility skyrocketed," said Morningstar hedge fund analyst Nadia Van Dalen.

Hedge funds were affected by extreme and unforeseen events during the month, including failures and takeovers of mortgage agencies, banks, insurers, and prime brokers.

The assets of the 100 largest corporate defined benefit pension plans dropped by more than $78 billion in value. This according to a index publicly released for the first time by Milliman Inc., a global consulting and actuarial firm.

Seattle-based Milliman will be releasing the results of the index monthly going forward.

"It should come as no surprise that pensions suffered during the sharp market downturn in September," said John Ehrhardt, co-author of the Milliman 100 Pension Funding Index. "Fortunately these losses were offset by gains in interest rates. We cannot predict where the market will close at the end of October, though Wednesday's [Oct. 8] worldwide reduction in interest rates seems to indicate that we may not have such an offset in October."

While the September results are the most dramatic of the year, they mirror the year-to-date trend. The Milliman 100 pensions opened the year with a healthy funding position of 104.9%, only to see the funding surplus erode during the first quarter.

The cumulative asset return for the past 12 months stands at -12.11%, a loss of $102 billion. Looking forward, the combination of a 0% return for the rest of the year and steady discount rates (7.63%) would result in a $22 billion funding loss and a funded ratio of 96.4% on December 31.

Third Straight Increase in CDO Delinquencies

Nine new delinquent loans led to the third straight monthly increase in the U.S. commercial real estate loan CDO delinquency rate to 2.39% for September 2008, according to Fitch Ratings.

"Although this delinquency rate remains relatively low and many CREL CDOs are adequately cushioned to absorb some credit deterioration, some CDOs are experiencing more distress than others," said Karen Trebach, Fitch senior director.

Commercial real estate loans found in CREL CDOs are generally highly leveraged and backed by transitional properties. In the current state of the economy, these properties often have stalled or failed business plans. As a result, sponsors have found it difficult to refinance and/or fund current loan obligations.

This negative outlook for CREL CDOs is somewhat mitigated by the asset managers' flexibility to change the terms of the underlying assets through continued extensions and modifications. In addition, some asset managers continue to exercise their right to repurchase credit impaired loans.

Another continuing and anticipated trend has been the increase in the number of matured balloon loans which comprise approximately 58% of all new delinquencies this month. While the majority of these loans continue to make monthly payments, approximately 30% are considered non-performing with inadequate cash flow to meet debt obligations. In these cases, sponsors have refused or are unable to infuse additional equity into the projects.

Asset managers report the continued use of loan extensions by borrowers and lenders, as refinancing to third parties remains difficult under current market conditions. In line with last month's total, asset managers reported 33 new loan extensions in September (3% by number of loans in the CREL CDO universe); roughly 90% were extensions that were contemplated in the original loan documents.

Casino Developer Needs a Good Roll, or Else

FX Real Estate and Entertainment Inc., which controls 17.72 contiguous acres on the southeast corner of Las Vegas Boulevard and Harmon Avenue in Las Vegas, NV, is out of compliance with the debt-to-loan value ratio covenants set forth in its $475 million mortgage loan on the properties, according to a company regulatory filing.

The land is currently occupied by a motel and several commercial and retail tenants, including the Harley Davidson Cafe. FX has been pursuing development of a hotel, casino, entertainment, retail, commercial and residential project.

The lenders most recent quarterly appraised value of the properties was $675 million.

Under the terms of the loan, FX has until Nov. 14 to regain compliance or prepay approximately $26 million of the loan's outstanding principal amount or obtain a waiver or modification of the loan's financial covenants.

FX has said that it does not have adequate capital to make a payment and would need to secure additional financing in order to prepay part of the principal.

Thus, the company has contacted the senior lenders to pursue a waiver or modification of the covenants.

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

Property Watch List

Property Property Type CMBS Special Servicer Notes
China Town Center, 10901 N. Lamar Blvd., Austin, TX Retail, 163,744 square feet JPM 2007-CIBC19 LNR Partners 60 to 89 days delinquent.
Gaffney Retail Center, 1100 Factory Shops Blvd. & Nancy Creek Road, Gaffney, SC Retail, 56,940 square feet JPM 2007-CIBC19 LNR Partners A court had ordered mediation between the parties to be concluded by late September. The loan remains current on monthly payments.
Oleander Plaza, 1925A-D & 1929A-G Oleander Drive, Wilmington, NC Retail, 50,450 square feet JPM 2007-CIBC18 LNR Partners 30 to 59 days delinquent.
Wickes Furniture, 12704 Amargosa Road, Victorville, CA Retail, 39,014 square feet JPM 2007-CIBC18 LNR Partners The loan was transferred to the special servicing in May due to imminent default. The loan is paid through March. The single tenant Wickes Furniture Co. filed bankruptcy in February 2008 and the Bankruptcy Court rejected lease in April. The property is 100% vacant no new leasing activity is reported. The special servicer is in the process of negotiating a deed in lieu with additional compensation from the borrower as an alternative to foreclosure.
Rockaway Avenue Retail, 830-842 Rockaway Ave., Brooklyn, NY Retail, 20,000 square feet JPM 2006-LDP6 LNR Partners The loan transferred to special servicing in June for being more than 60 days delinquent. It is due for the April payment. The borrower has reportedly refused to respond to calls and other correspondence. Local counsel has been retained and foreclosure was filed on Aug. 25.
Rocket Lofts, 98-106 S. 4th St., Brooklyn, NY Multifamily, 75 rooms JPM 2007-LDP11 CW Capital Asset Management Collections in progress.
Beaver Brook Village, 91-101 Mill St,, Dracut, MA Mixed Use, 73,285 square feet JPM 2007-CIBC19 LNR Partners The borrower has filed Chapter 11 bankruptcy. A hearing to approve debtor's reorganization statement was scheduled to occur in the past couple of weeks. The debtor is current on all post-petition payments -- including reserve impounds.
University Loft, 680 W. Virginia St., Tallahassee, FL Mixed Use, 49,040 square feet JPM 2006-LDP6 LNR Partners 30 to 59 days delinquent.
Baymont Inn, 1600 Highway 21 South, Oxford, AL Lodging, 129 units JPM 2007-LDP12 J.E. Robert Co. A court had given the borrower 20 days to respond to a motion for summary judgment that included a receiver provision. A hearing was to be scheduled for September.
Quality Inn & Suites on the Beach, 295 S. Atlantic Ave., Ormond Beach, FL Lodging, 54 rooms JPM 2007-LDP10 J.E. Robert Co. Collections in progress.
Comfort Inn on the Beach, 507 S. Atlantic Ave., Ormond Beach, FL Lodging, 47 rooms JPM 2007-LDP10 J.E. Robert Co. Collections in progress.
QXL Metals Inc., 381 Colonial Manor Road, Irwin, PA Industrial , 70,000 square feet JPM 2007-CIBC18 LNR Partners The loan transferred to special servicing in February due to payment default and Borrower's expressed desire to deed the property in lieu of foreclosure. The borrower claimed that the tenant had stopped paying rent. The special servicer is currently negotiating a deed in lieu of foreclosure.

CoStar Columns

For news of companies shedding commercial space, see Closures & Layoffs, a weekly listing of future corporate downsizings.

For news of companies with increasing space needs, see Expansions & Relocations, a weekly column of major corporate headquarters expansions and relocations.

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.

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