I’ve Still Got Chills From The Real Estate Market

Michael Panzner
updated | Author's Website

I have to admit that I appreciate a good horror story. Stephen King and all that. But that doesn’t mean I’m not occasionally feeling the effects afterward. Not that I can’t sleep or anything. But the chills sometimes linger for a while.

The one thing that tends to make these stories easy to get over is the knowledge that they are just that — stories. Fiction. The product of somebody’s imagination (or maybe his or her nightmare — who knows?)

But the same doesn’t hold true when I hear about real-life nightmares. You know. The stuff on the 11 o’clock news (I’ll spare you the details). Pretty scary. And hard to forget.

And maybe this is a little odd, but I sometimes feel the same way when I think about the kinds of economic and financial disasters that I see unfolding. Lots of losses. Many people hurt. Widespread suffering.

In fact, believe it or not, when I wrote my book, I had moments when I frightened myself with the things I was writing about. Those chills didn’t disappear very fast at all.

All of this is a lead-up to a post, “The Real Estate Nightmare I Found In Las Vegas,” I discovered (hat tip to Naked Capitalism) that tells a pretty scary tale about the real estate market. It was written by Tom Lindmark over at the Metropolitan Real Estate blog.

It’s Friday night about 8:00 and I just returned from the IMN Distressed Real Estate Conference in Las Vegas. I want to give you some initial impressions this evening, basically just a skeleton outline and over the weekend and probably into next week I will try and add some flesh to these bones.

As a preamble, I attended an IMN Conference at the end of May 2007. That one was also real estate oriented and approached the subject from the standpoint of pools of capital dedicated to real estate investment. It couldn’t have been a more upbeat conference. There were a lot of fund managers who left you with the impression that they were well on their way to controlling a better part of the real estate assets of the country. So high was the confidence level that the buzz around the meeting rooms was all about getting into foreign markets. Today it seems like that wasn’t a year ago but more like I am living on a different planet.

In no particular order here is a synopsis of this year’s conference:

  1. No one has any idea when we will reach a bottom simply because no one knows how many classes of real estate are going down. The most optimistic guess was 2010 but most wouldn’t even hazard a guess. Some of the grey hairs think 5 or 6 years.
  2. The problems in the residential side are quickly spilling over to the commercial real estate market.
  3. The spread between bid and asked prices is as large as the Grand Canyon. Banks and particularly the community banks can’t afford to take the write-downs the bid price implies.
  4. Aside from say multi-family and really solid income producing properties (producing solid verifiable income now, not projected income) there is no debt available. There is lots of equity looking for 20% and up returns. Since these will have to be largely unleveraged, the asset price required to deliver the return is abysmally low. Further driving down implied valuations is the fact that the equity is Wall Street money with 3 to 5 year time horizons. No one thought that was achievable (with the exception of the Wall Street boys in the audience, of course).
  5. The complicated capital stacks of the past are history. Simplicity is in and you can kiss non-recourse goodbye.
  6. Builder lots are selling for improvement cost or less. Basically, the land is free. There is no debt available and the volume of transactions is approaching zero.
  7. Small and mid-level banks are in trouble. So are the big boys but the govies will take care of them? Several of the deal guys said that banks they contacted three months ago about buying assets are all of a sudden calling back. Three months ago they said everything was fine. The idea du jour is to buy the bank to get the bank’s real estate. Sounds screwy to me but I’ll write some more about this one tomorrow.
  8. Most think this is a credit driven problem, not a supply problem which was the case in 1991. They think the crunch is really going to start hitting when commercial loans mature and need refinancing. Unlike 1991 there is lots of equity on the sidelines which is a good thing. The bad difference from 1991 is that we got into this mess with a good economy not a recession. So if the economy goes south it could get real rough.
  9. Banks have been rewriting their loans and creating new interest reserves to keep the Zombies alive. The regulators have said full stop.
  10. The big buzz word is “value added” as in look at my Excel spread sheet and how it shows us increasing rents and occupancy and how much money we will make with which to pay you back. Most of the fund providers aren’t buying.
  11. Underwriting is getting tougher and tougher. As one participant said,” …if you have financing take it and close the deal NOW.”
  12. Mezzanine is going to be important as the level of available senior debt in the capital stack shrinks. Most Mezz lenders now only going up to 85%. They are also adjusting any appraisals by five to ten percent.
  13. Lot prices in the hardest hit areas are back to 2000 to 2001 levels.
  14. There is an absolute disconnect on valuations among buyers, sellers, senior debt, mezzanine and equity. Thus no deals are coming together.
  15. Appraisals are good for no more than a month as values are deteriorating so rapidly. Some felt that the appraisers were only picking up sales comps and missing the comps that could be derived from note sales. Basically, no one trusts appraisals.
  16. The Indy Mac performing loan sale that was reported to have been done at about 60% of asking price has fallen apart. Most of the bids at the 60% level were withdrawn after further due diligence. The actual prices the stuff went for is between 20% and 45%. By the way Indy Mac had current appraisals supporting their asking price.
  17. The Wall Street Wizards are proving to be particularly inept at working out real estate problems. Essentially, they don’t know anything about operating real estate. On top of that, many of the banks don’t have expertise so there seem to be a lot of bad decisions going down (much more about this later).
  18. Things are going downhill so fast that deals that were struck 3 months ago need to be restructured.
  19. Finally, the conference concluded with a representative from the Fed and one from the Office of Thrift Supervision. They dodged, weaved and evaded the hard issues. My take, reading between the lines, is that they are scared to death. Again, I will expand on this in the next couple of days.

We went to this conference, frankly hoping to meet some people and start networking to possibly pick up some assets on the cheap. We did this back in the early 1990’s and it worked out well. We were shocked by what we heard. This is not just a problem with residential real estate. It is a problem with every class of real estate. There are one or two positives that may help lead us out of the situation but, so far, I think that the looming negatives may overwhelm everything.

It is no time to be buying.

And I’ve still got chills.

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