Given the increase lately in the number of firms now offering advisory services for distressed commercial properties and the mortgages attached to them, it appears the sector is in for some trying times. Will the federal government's rescue plans help? How much will loan delinquencies permeate the various property types? For answers to these and other pressing questions, MortgageOrb spoke with Dan Greenstein, an attorney at Bernick, Lifson, Greenstein, Greene & Liszt PA.
Q: What sort of foreclosure trends are you seeing for commercial properties? Delinquency/default rates are still statistically low, but has there been a noticeable uptick? What are the most common causes of foreclosure right now?
Dan Greenstein: This year, there has been a noticeable rise in vacancy rates for office, retail and industrial properties in the U.S. Office vacancies alone increased in the third quarter of 2008 to 13.5%.
Falling retail sales, store closures, a rapidly weakening manufacturing sector and a decrease in global demand for U.S. manufactured goods have all contributed to the increase in the industrial vacancy rate. Retail vacancies have increased as well, partially due to the decrease in activity for mom-and-pop stores and small chains.
Prices have not yet fallen off, because the lack of sales has made it tough for the market to price properties, and default rates are low. However, all of this will change when the large amount of debt created in 2006 and 2007 starts rolling over in 2009, 2010 and 2011.
The credit squeeze, economic turbulence and capital market volatility are causes of the current condition of the commercial real estate market. As a result of these factors, vacancy rates continue to rise. If the vacancy rates continue to rise in retail, office or industrial buildings, building owners will have difficulty generating enough income to pay mortgage loans, which will increase the number of foreclosures.
Additionally, investors who bought at the top of the market with short-term debt will have difficulty refinancing due to the credit crisis. A lot of the debt will not be refinanced next year, and as a result, delinquencies and foreclosures will increase.
In 2009, retail properties and office buildings will suffer more than apartment buildings and industrial real estate. In past years, most debt could be refinanced, but we cannot count on that during our current recessionary times. Economists expect commercial real estate delinquencies and foreclosures to surge next year when landlords cannot refinance.
As a result, a turnaround in the commercial real estate market is not expected until at least 2010.
Q: What role do you see the government's Troubled Asset Relief Program (TARP) playing on the commercial mortgage side?
Greenstein: Answering this question is like attempting to hit a moving target! It appears that the final plan may not have been conceived yet.
After a month of looking to purchase troubled assets, the Treasury has now reversed positions and will not focus on the purchase of troubled assets. Instead, it will instead infuse capital into banks through buying shares of banks. Although the Treasury secretary recently noted that purchasing troubled assets may still occur in the future, that focus is now gone.
Therefore, the effect of TARP on the commercial mortgage market is irrelevant. The better question now is whether injecting capital into the markets will help commercial mortgages. The challenge with that is that all of the same complexities exist with regard to ownership of commercial mortgage-backed securities and mortgages themselves, and nobody is likely to invest any capital that they may have in commercial mortgages.
So far, actual commercial lending has yet to feel the real strain of the credit crisis. Instead, it has been the secondary market for commercial loans that has seen the slowdown. It is likely that this lack of investing will trickle down and make credit more difficult to obtain for commercial borrowers in the near future, but that has yet to be fully seen by borrowers.
Q: How are condos doing these days, especially in Minnesota? How much different is that market in your region as compared to, say, the notorious Florida condo market?
Greenstein: The condominium markets in Minnesota and Florida are quite different right now. Few part-time residents purchase a condominium in Minnesota, while Florida attracts buyers from the entire nation and other countries as well. While Florida has seen an increase in activity the past month or two, condominiums in Minnesota are one of the most difficult pieces of real estate to sell.
The foreclosure of condominiums is still rapid, but the Minneapolis area alone has seen a significant decrease in new condominium sales since November 2007. The majority of condominiums for sale are found in or close to downtown Minneapolis. According to the Minneapolis Area Association of Realtors, condominium sales dropped 25.4% since November of 2007.
Currently, it takes an average of 108 days for a Minneapolis condominium to sell. The number of new condos for sale has decreased by 28%, leaving less competition than there was in 2007. However, the number of condo closings in Minneapolis is still the same as it was in 2007.
Q: Do you expect to see a dramatic increase in commercial loan sale activity? What sorts of legal cautions should buyers and sellers of individual distressed loans and loan portfolios keep in mind?
Greenstein: There are several questions that buyers and sellers of loans need to know upon entering into any kind of transaction regarding the loan.
First, there are questions of who owns the loan and what interest they have in the loan. With the way mortgage-backed securities have been structured to create products of desired risk, it is often complex to determine what interest an institution has in a particular loan.
Often, an original lender may not even have a right to restructure or amend a loan because it has been sold or certain interests in the loan may have been sold. It is also common that multiple institutions have some ownership interest in the loan, although only one may have the authority to change the original terms of the loan.
Sometimes, no one institution may have authority to change the loan. This situation creates problems for many holders of interests in distressed loans, as well as the borrowers on the loans.
As a buyer, you must know what you are purchasing, and as a seller, you must be aware of what you can offer potential buyers. This is important for both parties after the transaction is complete, and it is important during the negotiation of any transaction because of pricing, risk and other concerns.
Another important question for buyers and sellers of individually distressed loans concerns the governing documents of the loan agreement. It is important that the parties know what documents govern the loan and what rights those documents grant. Often, with loans that have been securitized, there are security agreements beyond the original loan documents that limit the authority to amend the terms of the loan or the security agreement.
Such documents may include a servicing agreement or a pooling and service agreement. It is important for participants in distressed loan transactions to obtain these documents and have them reviewed by an attorney for language limiting the authority to alter terms, as well as to understand the nature of the ownership interest in the loans.
Q: Are many borrowers turning to creative or unusual tactics these days to get financing done? What strategies have become popular? Are there any additional legal complications?
Greenstein: Commercial borrowers up to the several million dollar threshold – typically for office or retail space – have yet to really feel the full crunch of the credit crisis in the commercial real estate area.
Deals such as those in the Twin Cities have not required the borrowers to seek any creative or unusual methods of financing as of yet. Those deals that have been done recently have followed the typical practices for commercial lending.
Therefore, although this may be an issue in the future, it has yet to become an issue for a certain level of borrower.
