How to lose $5.4 billion in less than 4 years.

Wiseman Capital Report

We just heard the news that Tishman Speyer Properties, which controls Rockefeller Center and the Chrysler Building, and Blackrock Realty defaulted on a 5.4 billion mortgage that was owed to several investors including, Gramercy Capital, Wachovia Bank, CW Capital, Winthrop Realty Trust, the Church of England, and an unnamed Florida state pension fund which invested $250 million. Even though Tishman Speyer Properties and Blackrock Realty tried to work out a payment arrangement with the lien holder they ultimately defaulted on their monthly payment of $16.8 million on January 8, 2010 and the decision to hand the property back to the lien holder was made this morning. We believe the collapse is based on three core events.

Problem #1 (Risky transaction)

The property has an estimated value of $1.9 billion which is a drop of almost 80% in value from the original purchase price of $5.4 billion in 2006.  How can a property decrease in value so fast when rent is stabilized and the property continues to produce income? It can be a combination of different things. In less than 3 years a recession, a lack of demand for rental property in the area, and a court decision that prevented Tishman Speyer Properties and Blackrock Realty from increasing rent, one of the reasons why the purchased the property in the first place, and forced them to payback over 200 million dollars to 4,000 tenants literally nailed the coffin shut for them.  

Problem #2 (Lack of equity)

Tishman Speyer and Blackrock contributed only 225 million dollars of a total 1.9 billion equity financing.  With Wachovia Bank lending $3 billion and several other investors contributing $1.4 billion of mezzanine debt Tishman Speyer and Blackrock Realty had very little equity into the transaction. Although reports suggest that at one point they had over $890 million dollars in reserve, which is now gone, with very little “skin in the game” Tishman Speyer Properties and Blackrock Realty can walk away.

Problem #3 (Commercial Mortgage Back Securities)

The mortgage was packed with other commercial real estate loans and they were sold as securities. The biggest holders of these securities are Fannie and Freddie Mac.  As these two agencies continue to struggle with other mortgage back securities that they own it us just a matter of time before they implode. Big picture as more losses are generated in the CMBS it will be more expensive for banks to sell their loans. Future CMBS’ will be sold at a lower price because of the apparent risk of owning these types of securities. The result will be that future loan transactions will be scrutinized with greater detail.

Apartment Financing Check

How large of an impact the current credit crunch will have on traditional commercial underwriting and the loan-approval process remains unknown. It’s also hard to predict when the crisis will abate. One thing, however, is clear — commercial investors are demanding more due diligence from lenders and issuing tighter purchasing guidelines.

On the multifamily side in particular, institutional lenders no longer focus solely on the economics of the asset as the principal determinant in making the loan. They used to accept vacancy reserves at 5 percent, allow expenses based on the last two years, and allow low debt-service-coverage ratios (DSCRs).

It used to be that borrower credit and capacity weren’t significant factors for lenders because multifamily was an attractive investment that rarely defaulted. That was then. This is now.

That said, let’s examine how underwriting factors have changed for these once easy-to-fund loans.

Income

To make the best case for your loan, forget everything but rental income — no fees for laundry, storage, keys, cable or late payments. Lenders will be cautious about properties with rents below market. These kinds of properties raise questions about marketability. Lenders will also be concerned with the building’s prospective ability to compete in its rental market in the long term and its ability to maintain current occupancy and rent structure.

If your borrowers’ building is in an area prone to using rent concessions to attract or retain tenants, they could receive an underwriting demerit. Finally, lenders are more diligently evaluating unit mix, with a closer historical analysis of turnover in studio and one-bedroom units.

Vacancy

Even if a property has a historical vacancy rate of zero, there is a cost-of-unit turnover in terms of rent lost during the time needed to make apartments ready for rental. As a consequence, lenders will impose a vacancy factor. What that factor will be depends on a number of elements, including: historical vacancy at the subject property; overall rentability of the units; unit mix; unit demand in the area; property and rental-unit condition; and overall competitiveness of the property.

One positive impact of the nonprime meltdown may be lower vacancies in multifamily properties in certain areas. With foreclosure rates at all-time highs, more people could move into apartments.

Depending on the market, the effects on multifamily housing also could be negative. When people vacate their homes because they can’t pay their mortgage, sometimes it’s indicative of greater economic problems in the area. As such, they may leave town altogether.

Although the growing foreclosure rate may have a positive effect on apartment occupancies, don’t assume it will produce any significant upswing in occupancy or lender consideration. Rather, investors will look for multifamily properties in areas with solid employment rates for the property tenants’ profile.

Expenses

In today’s environment, you and your borrowers also must examine operating expenses carefully. Know how the estimated expenses, as provided by the borrowers, compare with other apartment properties in the area. Also, confirm that the borrowers associated with the property have indeed listed all the expenses.

In other words, given the overall condition of the property — the rental units, surrounding structures and facilities — how much money needs to be included in the operating costs as reserve for future expenses? Are the expenses and reserve requirements consistent with other similarly constructed buildings in the area?

Consider the effect of reserve requirements on cash flow when evaluating the amount of debt a property can service. Some lenders take into account the reserve-requirement calculation in the operating expenses but don’t mandate a physical reserve account.

DSCR and loan to value (LTV)

Many lenders are raising the DSCR bar higher than 1.2 depending on property location, condition, operating history, tenant profile, neighborhood occupancy and stability of rental income for the area.

They are also reducing the LTV. While some institutional lenders say they will lend as much as 80 percent to 85 percent of value, by the time they assess net operating income and apply more-stringent DSCRs, the final loan amount may be in the range of 65 percent to 80 percent. Indeed, this is the range many institutional investors in multifamily notes currently seek. You can probably expect continued downward pressure on LTV.

Credit

In today’s capital markets, the credit of the borrowers becomes an increasingly important factor when underwriting multifamily loans for resale into commercial-mortgage-backed-securities markets. Investors look closer than ever at borrowers’ creditworthiness and capacity.

While lenders may permit some minor credit defects, an almost-surefire deal-killer is a 30-day late on a mortgage of any type. Lenders will look for higher-credit borrowers to offset existing portfolio weaknesses. Borrowers do not have to have a FICO score of more than 800, but a 640 may not work.

* * * In our current environment, you must understand how institutional lenders underwrite multifamily loans. If you still find it hard to find loans with these lenders, you may need to seek nontraditional funding.