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Wednesday, February 25, 2009

Commercial Real Estate Bubble Is Set to Burst

What we have done is guaranteed hyperinflation in the United States. We have guaranteed the destruction of the United States. We will have riots starting in the first quarter of next year; we will default by the summer of 2009.


America will see a major economic collapse followed by riots, martial law (??) , food shortage… etc will follow. Why is US Army redeploying troops to America? Why is the Pentagon openly discussing possible collapse of American society? Martial Law?? These are all very dire predictions for the future of America.

Here’s what we’ve got: the Fed has committed to $8.5 trillion of taxpayers’ money to bail out the worst run companies and banks. It hasn’t worked. Now, they’re at a 0% to .25% on the Fed Funds rate for funds for banks, which means if you go down and you pay $100,000 for a T-bill for 90 days, your return is zero, which is to imply that there is zero risk to investing with the government. Anybody who actually believes that is going to be in for a real shock in the first quarter of next year.

Global systemic crisis – New tipping-point in March 2009: 'When the world becomes aware that this crisis is worse than the 1930s crisis'

LEAP/E2020 anticipates than the unfolding global systemic crisis will experience in March 2009 a new tipping point of similar magnitude to the September 2008 one. According to our team, at that period of the year, the general public will become aware of three major destabilizing processes at work in the global economy, i.e.:

• the length of the crisis
• the explosion of unemployment worldwide
• the risk of sudden collapse of all capital-based pension systems

A whole range of psychological factors will contribute to this tipping point: general awareness in Europe, America and Asia that the crisis has escaped from the control of every public authority, whether national or international; that it is severely affecting all regions of the world, even if some are more affected than others (see GEAB N°28); that it is directly hitting hundreds of millions of people in the “developed” world; and that it is only worsening as its consequences reveal throughout the real economy. National governments and international institutions only have three months left to prepare themselves to the next blow, one that could go along severe risks of social chaos. The countries which are not properly equipped to cope with a surge in unemployment and major risks on pensions will be seriously destabilized by this new public awareness.

In early November, General Electric Co.'s General Electric Capital Corp. moved to foreclose on a downtown Phoenix office building in a hearing scheduled for February. The 18-story office building is just another one of those nondescript rectangles that seem to punctuate the skylines of city centers across the United States. The owner: a San Diego company with the innocuous sounding initials of BCL Inc. The foreclosure makes that Phoenix office building special, in a gloomy sort of way, and a harbinger. Throughout the U.S., massive numbers of foreclosures have swept through residential real estate. By contrast, commercial real estate foreclosures remain relatively few and far between, even in cities the economic downturn has hit hardest. Bankruptcies are even rarer.

"Lenders don't want to default. Borrowers don't want a default. So lenders have extended to the extent they can," says independent real estate investor Terri Gumula. "Everybody's holding out."

The fate of the building on 111 West Monroe Street then is a "precursor," says Christopher Toci, executive director for Cushman & Wakefield of Arizona Inc., of what he and others expect is a massive problem to come.

"It has the potential for being a God-awful mess," adds David Jones, a longtime real estate attorney with K&L Gates LLP of Charlotte, N.C.

Right now we are witnessing what in many respects may prove to be the proverbial calm before the storm. Commercial real estate owners will soon face gale-force winds on two fronts. The rapidly deteriorating real estate market has only recently hit commercial properties. More critically, loans issued in the boom years are only now coming due, with little or no prospect of refinancing. "The velocity [of distress] is going to increase tremendously," says Ed Casas, managing director for Navigant Capital Advisors LLC, which advises hedge funds and private equity on distressed real estate. "It's just begun."

Just how bad the destruction will get is difficult to say. No one predicts the kind of unprecedented devastation residential real estate has experienced, where subprime mortgages alone, which reached $600 billion in 2006 and formed the underpinnings of several trillion dollars in mortgage-backed securities, collateralized debt obligations and credit default swaps, created vast wastelands. But the commercial mortgage failure numbers could be staggering as well.

"What worries people the most is that even healthy assets can't get refinanced," says Dan Fasulo, managing director of New York research firm Real Capital Analytics. "There's so much dislocation in the debt market. It no longer has the capacity to refinance all the loans that are coming due."

Real Capital Analytics considers about $21 billion worth of commercial real estate in distress, while almost $81 billion worth of additional property faces potential troubles in 2009. In all, roughly 5,000 individual properties are on Real Capital Analytics' watch list. Fasulo believes his current forecast errs on the conservative side.

Others believe the numbers could get much higher and that distressed commercial property in potential default may actually exceed $400 billion. Everyone expects the crisis will worsen in 2010 and remain nasty through 2011. "There will be a significant increase in default rates of commercial mortgages," says Stephen Tomlinson, senior partner in the real estate practice at Kirkland & Ellis LLP. But "you may not see a spike begin until the fourth quarter."

Christopher Grey is managing director and co-founder of Third Wave Partners LLC, which both invests in distressed real estate and advises investors. He predicts it will take three years before the market begins to recover. "There's a tremendous amount of adjustment to be made, but very little adjustment has taken place," he says.

There are ominous signs. The CMBX Indexes, which track 25 tranches of commercial mortgage-backed securities, now show "an unbelievably wide spread," says Grey, with an implied default rate of 20%.

Unsecured REIT bond spreads "are at all-time highs," Fitch Ratings Inc. reported in an outlook last month, which tagged office, industrial and retail REITs with negative outlooks. The stock market has already hammered commercial REITs, many of whose market caps have declined by more than 90% in a year. One dramatic example of a REIT teetering on the edge is General Growth Properties Inc., America's second-largest mall operator. General Growth narrowly avoided bankruptcy last year, when it was able to extend $900 million in debt repayments until February. General Growth still faces huge uncertainties with billions of dollars of short-term debt maturing soon.

Understanding why commercial foreclosures have lagged so significantly behind residences helps explain a great deal about what transpired during real estate's boom years. What's likely to happen in 2009 and 2010 offers a sobering look at assets that were considered robust and fairly safe until the fourth quarter of 2008. Now they are poised to become yet another part of the economic devastation.

Working through all this distress will be extremely difficult and time-consuming. Wrapped within those numbers is an often complex jumble of securitizations, debt tiers, priorities and liquidation preferences. In the best of times, these make decisions and workouts difficult. Now it's even more daunting.

Most of these properties are in bankruptcy-remote vehicles, which make it easy for lenders to take back assets without bankruptcy filings. What's more, current laws discourage commercial real estate-related bankruptcy filings. So it's more likely that borrowers would be inclined to just give up the keys and walk away.

However, most lenders don't want the property back, since there are few potential buyers. Money for refinancing remains almost nonexistent. With securitized assets, lenders are often at odds with each other on what course of action to take, depending on what part of the debt structure they fall. "It's a recipe for short-term paralysis," Casas says.

Commercial real estate encompasses everything from the toniest retail shopping complexes to modest strip malls, from low-rise office buildings to luxury hotels and skyscrapers. All face huge problems.

What's more, the economic distress will be wide-ranging, not just in the boom towns of California, Florida or Nevada, but in cities that stretch north to south and coast to coast, lawyers and commercial real estate advisers around the country say. "It's the same phenomenon all over," says Andrew Schwartz, a Boston-based partner at law firm Foley Hoag LLP. "The trouble is nationwide."

Schwartz cites his city as a prime example. In the past few years, real estate consortia paid huge sums for trophy properties. At the same time, star-crossed developers unveiled ambitious new developments. Now several major projects are on hold, including the $2.5 billion Fan Pier development and the $700 million redevelopment of the storied Filene's department store site. Developers can't get construction loans. At the same time, landlords of existing properties face rising vacancies and an inability to service loans.

Or take Phoenix, which was "one of the poster children for subprime mortgages," Toci says. That led to overbuilding in retail shopping centers and suburban office complexes. "A lot of [commercial] projects that were planned have either been reduced or are in trouble. One project in Tempe, a boutique hotel, just stopped," says Jeffrey Pitcher, a Phoenix-based real estate partner at Ballard Spahr Andrews & Ingersoll LLP. "We're at the stage where developers delay as long as possible the construction."

But Toci believes it's the economic downturn that is really doing his city in. "We've lost 58,000 jobs through November, and now Phoenix faces an oversupply of offices," he says. Tenants are going bankrupt, vacating properties or not renewing leases. "Operationally, there are serious weaknesses. Commercial real estate is just starting to tank."

Nearby Las Vegas is the site of one of the worst examples of residential speculative frenzy. Long after the housing bubble burst and residences were foreclosed on a massive scale, the city thought its economy safe, given its dependence on gaming and tourism. So ever-more-opulent casinos, upscale shopping centers and multibillion-dollar multiuse development projects continued to launch. But the economy has wreaked havoc on Las Vegas. That in turn has put enormous pressure on the city's livelihood.

"It all started feeding on itself," says David Barksdale, a Las Vegas-based partner at Ballard Spahr and the co-head of the firm's distressed real estate initiative. "Now it's spreading into the commercial side."

The city's most dramatic foreclosure to date came in September, when Deutsche Bank AG took over the $3.9 billion Cosmopolitan Resort and Casino project after developer Ian Bruce Eichner defaulted on $900 million in construction loans and the bank couldn't find willing buyers. But many more problems loom. Several new office complexes sprang up in the southwest part of the metropolitan area.

They broke ground two to three years ago, when "things looked great," says Barksdale. Now they're completed, but deserted. "Those buildings are empty," he says. "Those are see-through buildings."

Atlanta, on the other hand, thought itself relatively immune to commercial real estate pain. Not anymore. "I foresee a lot of commercial deals going sour," says Nicholas Sears, an Atlanta-based partner at Morris, Manning & Martin LLP. "Folks want to sell. They can't sell. Purchasers can't get new financing or assume existing debt, which can't be reduced."

Even a city like Milwaukee, which hardly went crazy during the property boom, is feeling the effects. "Banks have closed down their lending. Ninety percent of commercial lenders are just not lending right now," says Nancy Haggerty, a Milwaukee-based partner at Michael Best & Friedrich LLP. "Even some long-term lenders like life insurance we're just not seeing any more."

As the crisis unfolds, there will be inevitable comparisons to the savings & loan crisis of the late 1980s and 1990s. Easy money created a speculative boom and massive supply in commercial property, followed by a banking failure, a wholesale takeover of distressed properties by the federal government and a yearslong sorting out. Professionals, however, caution against a quick analogy.

"A lot of people are trying to draw parallels to the early '90s, but I think it's certainly a different animal," says Martin Caverly, a Los Angeles-based principal at private equity real estate fund O'Connor Capital Partners. Unlike two decades back, there isn't a huge oversupply of commercial property, except for retail, he explains. But the ownership structure of property is far more complicated and opaque, with crippling debt structures and a lack of affordable financing, which make workouts and disposition difficult.

"More and more my belief is that it will be a larger and deeper correction," Caverly says. "The deleveraging process will go on for quite a long time."

What's certain is that in terms of debt to value, many commercial properties of various shapes and sizes are well underwater.

"From a 90% loan-to-value, it's now a 130% loan-to-value," Tomlinson says.

Transactions are pretty much stalled right now. Grey estimates commercial deals in 2008 declined 90% more than in 2007. Even distressed players are in no hurry to buy. At a real estate conference late last year, a panel of private equity principals divided their world into two camps: Those with properties admit they're overbought and want to sell. Those with cash are sitting on their hands.

"It's very much a wait-and-see," says Pitcher. Potential buyers "want to see where everything settles out. They're looking, but they don't know where the floor is."

The shift has been dramatic. In early February 2007, Blackstone Group LP paid a staggering $39 billion for Equity Office Properties Trust. Most of the 100 million square feet of commercial real estate was financed by debt. During the next six months, Blackstone recouped $28 billion by selling off a little more than half of the properties. That included $7 billion New York property mogul Harry Macklowe forked out for some prime Manhattan real estate. Macklowe financed his purchase primarily through bridge loans from Deutsche Bank. At the time, Blackstone's maneuver was hailed as a brilliant model of leveraged dealmaking: Buy a property portfolio with short-term debt and quickly reduce debt levels by offloading a portion of the properties.

The music stopped in June 2007, when the credit crunch hit. Macklowe, for one, flamed out in spectacular fashion. He was stuck with loans he couldn't service and hugely overpriced real estate he couldn't hold. Deutsche Bank ended up taking back seven properties, selling five for huge losses. The sale of the other two fell through, and they are back on the market.

The Blackstone-EOP deal, it turns out, represented the last great hurrah. How Blackstone will dispose of its remaining properties is as yet unanswered. "They can't sell that stuff," says a rival PE investor. "There's not enough debt on the planet to float those trades."

In fact, the kind of flips Blackstone pulled off had been popular at least since 2005, when commercial real estate really began to heat up. The returns were equally dramatic as the Blackstone-EOP shuffle, although not necessarily on the same mega-scale. Biltmore Holdings LLC, for example, bought the 111 West Monroe Street building in Phoenix along with a vacant downtown redevelopment site in April 2005 for $20 million. After investing a further $6 million in upgrades on the office building, Biltmore Holdings sold the two properties for $52 million in February 2007. BCL paid $40 million for the building alone.

Why commercial real estate, which mirrored residential real estate, boomed is easy enough to understand. Financing was plentiful. Securitization was commonplace.

In some ways, the more expensive the asset, the easier it was to finance the purchase.

Why the collapse of the commercial real estate market didn't occur sooner is equally obvious: cash flow. Tenants filled buildings and paid rent. Because the terms of most loans were anything but onerous, as long as borrowers made interest payments, they were safe. "Rents haven't backed up far enough. Vacancies haven't ballooned high enough" to reach crisis point, says Richard Hollowell, a managing director with Alvarez & Marsal Real Estate Advisory Services. That won't happen for another three to six months, Hollowell believes.

"Until the fourth quarter of 2008, you didn't see a significant deterioration of property fundamentals. Even deals done at the top of the market were covering debt service with cash flow or reserves," says Tomlinson.

"Defaults won't materialize until reserves are depleted, and they can't [cover debt service]."

Even through the summer of 2008, with credit markets frozen, there wasn't the kind of wholesale panic that was sweeping through residential real estate, and a false sense of hope prevailed. The Macklowe debacle wasn't repeated, and more optimistic observers viewed it as an outlier. "Overall, businesses were treading water. Underlying fundamentals were holding up," says Gumula. Commercial real estate owners "could make their debt service, so defaults were rare."

All that changed after the mid-September financial meltdown. "Up until Lehman, we were pleasantly surprised by tenant activity," she says. "Yeah, deals took longer to get signed, but up until September, plenty of leases were getting done."

Since then, it's been a dramatically different story. The economic downturn began take its toll on commercial occupancy rates. Typically made for three, five or seven years, commercial real estate loans are coming due, with few financial institutions willing to offer refinancing even at onerous terms. The combination can be deadly.

In boom days, borrowers could regularly obtain 90% financing. Those days are long gone. According to a Cushman & Wakefield Sonnenblick-Goldman LLC survey last month, the few financing deals quoted or completed were typically 60% loan-to-value.

Retail complexes were the first to exhibit signs of distress. That makes sense, since many shopping centers got whacked by both the residential real estate meltdown and the more general economic malaise. With the residential real estate boom came exurban sprawl. "One of the first amenities is a neighborhood retail center," Jones explains.

After the subprime crisis, however, residential developments were stillborn. The population that retail developers had expected never materialized.

Local retailers find it increasingly difficult to pay the rent, and they close stores. The retail developer defaults on an existing loan. He can't refinance, because there's no retail stream. A lender is forced to take that property back but doesn't want to because there are no buyers.

"It's a daisy chain," Jones says. "In some ways it's related to residential real estate, in some ways it's related to the general slowdown of the economy. The two feed off each other. It's a race to the bottom."

Shopping centers may have been the first to go. But it's the huge trophy acquisitions that are poised to cause the largest headaches. "A tremendous number of assets were bought in '06, '07, using short-term money. These were megadeals," says Casas. Now they're coming undone.

When Casas is asked to name those transactions that must be restructured, his partner, Neil Luria, pipes up with "any building sold within the last two years." Luria, a Navigant managing director based in Cleveland, is sitting in the lobby lounge of the Waldorf-Astoria Hotel in Manhattan. He gestures outside. "Just walk down the street," he says. "L.A., Chicago, New York, all the major markets have a number of high-profile trophy properties that will go through major turmoil. They are dropping precipitously in value, 40% to 50%."

Securitization enormously complicates these large transactions. Residential mortgage-backed securities may dwarf the amount of commercial mortgage-backed securities issued, but $40 billion worth of CMBSs is due this year, $55 billion in 2010 and $73 billion in 2011.

Like pools of residential mortgages, big commercial mortgages were sliced and diced into various bits and pieces. A single building may have a dozen different tranches of debt. Senior debt alone may have been parceled out into a dozen different pieces. Those pieces could have been combined with other commercial mortgages.

The complex financing structure makes the most fundamental decisions difficult. The senior-most debt holders may want to foreclose, since they're still in the money, even with a highly distressed sale. But junior debt holders would be wiped out in such a sale, so they'd be much more likely to choose some kind of restructuring and resist foreclosure.

Who makes the decisions complicates this even further. In normal times, a servicer is responsible for collecting interest payments from the borrower and distributing that money to lenders, with amounts dependent on returns within the various risk levels. So, for example, a senior lender may get 5% a year, while the junior-most doubles that.

If a borrower defaults, however, the role of the servicer is replaced by a so-called special servicer. That entity is appointed by the junior-most debt holders still in the money and is often an affiliate of the lender. The special servicer's loyalties and desired course of action may be very different from the senior lender.

You can imagine what a workout meeting looks like. "To get 50 partners together to work at a deal for pennies on the dollar, forget about it," Fasulo says.

Expect plenty of litigation to follow, say some lawyers (naturally). "More junior classes are not going to go quietly," says Schwartz. "Hedge funds playing with other people's money are not going to go quietly." Schwartz foresees a rash of valuation-oriented litigation. Servicers, especially, "are treading in very treacherous waters," he says.

Bankruptcies don't appear to be a particularly good alternative, either, especially for owners. After the S&L fiasco, when developers routinely put their bad properties into bankruptcy while keeping their good projects, loan contracts now carry what are termed "bad-boy" clauses. These state that owners can be held personally liable for their bankrupt properties.

Pretty much all the securitized buildings are housed in special-purpose entities. Because they are single-asset LLCs, they get only 90 days from the time they file to fashion a reorganization plan with a good chance of success, or creditors can petition the court to lift any stays. That kind of timetable isn't at all realistic in these times, when just finding debtor-in-possession financing is a major undertaking.

One of the very few property-related bankruptcies so far focused on a Chicago property called Hotel 71. The complicated case was anything but satisfactory. Distressed private equity shop Oaktree Capital Management LLC actually tried to foreclose on the equity of the holding company. The developer put the company in bankruptcy to prevent foreclosure. At that point, secured lenders of the actual property commenced a second foreclosure, this one of the hotel itself. The lenders eventually carried out an auction. Bids were well below value. "We ultimately decided to take the property back," says Brad Erens, a Chicago-based partner with Jones Day, which represented the special servicer.

Erens, for one, believes commercial property-related bankruptcies will inevitably follow. "At some point, borrowers will file. We just haven't seen it yet."

But Tomlinson counters that the bankruptcy-remote structures coupled with the bad-boy-type springing guarantees will "significantly dampen foreclosures that turn into bankruptcies." He adds that bankruptcy judges will probably have to rule on the legitimacy of bankruptcy-remote vehicles. "I think they ultimately will be upheld," he says, but cautions: "There's no playbook. A lot of things will be done for the first time. Literally."

What could really bring the crisis to a head is a crackdown by regulators on financial institutions demanding they clean up bad loans. If regulators demand lending institutions revalue the assets that secure the loans and institutions demand that borrowers fork over a hefty percentage to pay down the loan, financial institutions will have to foreclose.

Even now, banks are taking a chance by holding on, says Barksdale. If they modify the loan for 12 or 18 months, "they might have an asset worth significantly less," he says. But if they foreclose, "no one is buying."

Or offers they do extract may be going for a quarter of the value banks have on the books, he says. To date, the impetus has been to do nothing, if at all possible. "Things will continue to be pushed out until there's pressure from the outside accountants and regulators," Hollowell says.

Only when owners can't pay their debt will lenders be forced into action. That was the case with 111 West Monroe Street in Phoenix. Principals at BCL didn't return phone calls seeking comment. But those familiar with the building's fate say BCL defaulted after an equity partner collapsed.

That partner: a bankrupt firm called Lehman Brothers.


As economic activity and PONZI finance fall off the face of the earth, we enter the stretch run of the CON game known as the Bond and FIAT currency markets. Although both are headed for their ultimate demise, the path will be quite different. In 2009, these challenges will be headed your way. Prepare properly and thrive, or fail to do so and fall to your demise.
As every government policy failure appears, public servants will stroke the fear in the ‘something for nothing illiterate’ and use it to nationalize and destroy more and more of the private sector. They will double down on the spending, borrowing, printing and taxing required to pay for the next absurd idea to come out of the G7’s capitals. Look no further than Obama’s “Economic Recovery and Stabilization” stimulus package which spends 12 cents of every dollar on economic stimulus and 88 cents for sustaining and enlarging government spending and programs. A perfect name to DUPE America the Illiterate.

Morally, fiscally and intellectually BANKRUPT public servants and crony capitalists. Now we know why the banks and financial sectors were the greatest campaign contributors in the last election cycle and Obama’s inaugural election. Decisions are being made upon political considerations, not economic ones.

This is a nightmare on WALL STREET and MAIN STREET . A one percent loss on outstanding loans and derivatives turns ALL the biggest banks in the G7 into TOAST. What do you think the odds are of this happening? 100%. Once you see the picture you will understand why they are extremely cautious with their lending; they are on a tight rope. I don’t care how much the mainstream financial media hoot and howl, these banks are WORTHLESS and so are their debt offerings.

Black clouds are gathering above the horizon. The IMF just announced that the world trade collapsed by staggering 45% in the last quarter of last year. Even the euphoria of Obama’s inauguration didn’t last long. The same day Dow closed below 8,000 as banking fears were gripping the European markets and bringing shockwaves from the United Kingdom too. British Banks got a £1TN injection which didn’t prevent RBS shares to plunge 70%. London is faced with a bloodbath. Brown admitted there is not yet a limit on how much risk taxpayers must bear as a result of his rescue plan, but he even promised financial institutions that they will get more cash if they pass it on . Looks like the Brits are too being set up for the mother of all crashes. With the UK government debt alone and future liabilities not included, this means that every new baby is born with £17,000 debt.

The industrialized economies are on the verge of bankruptcy. China will not be of much help. It has its own set of problems preventing its economy from dropping below 5%. The question is: when will the global collapse be, not whether? Will fiat currencies tank? Will there be financial chaos? Time will tell. Celente and GEAB forecast by March 2009. We will know soon!

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