It is an open secret that commercial real estate owners withdraw cash from buildings.
When they do, unlike homeowners, criticism is often mild. After all, hotels, shopping malls, office towers, and other commercial buildings are run as businesses, where the primary goal is to make a profit.
“The real estate industry is about taking out cash, and on a tax-deferred basis,” said Scott Tross, co-chair of real estate litigation and dispute resolution at Herrick Feinstein, a law firm. “Thats nothing new. But in many ways, what is happening now is reminiscent of what happened ten or so years ago. ”
So Tross was referring to the deluge of late payments, defaults, and foreclosures that swept away some of the biggest names in the US commercial real estate sector in the wake of the 2007-08 global financial crisis, and saddled the losses of its investors.
“There were people who borrowed as much money as they could, none of whom could go back. And if things move in their direction, that’s great, “he said. “If they don’t move in your direction, they just return the keys.”
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“If you want the positive side, you should also take the negative side.”
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That threat of borrowers drifting away once again hangs over the commercial property market. But instead of financial institutions spreading toxic assets around the world, it’s now due to the coronavirus, which forced much of the American economy to shut down in March, and months later it is still spreading endlessly in many American cities, as well as in Brazil and is to re-emerge again in parts of Europe.
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Another new twist is that borrowers, prior to this recession, took more capital out of US commercial buildings than ever before, when they have refinanced themselves in the commercial mortgage-backed securities (CMBS) market, a key source of loans for hotels, skyscrapers, warehouses and other commercial properties that end up packaged in bond agreements.
MarketWatch asked the credit rating firm DBRS Morningstar for a historical overview of cash withdrawals on refinanced properties on the CMBS market, a financing source that took off in the mid-2000s.
They tracked $ 136 billion in total withdrawals, compared to nearly $ 47 billion of capital invested in refinanced properties in the past 17 years or more. Most of it was mined not during the property boom of the past decade, unsurprisingly, but between 2013 and 2019, a period when CMBS funding rebounded and commercial property prices soared.
Why does any of this matter now? Debt relief talks already started in April, a month after the first round of coronavirus blockades, among the most affected commercial property borrowers and their lenders.
Since then, CMBS delinquent loans have risen to almost 10%, rivaling the worst levels of the global financial crisis, as shown in this Deutsche Bank chart.
And it’s likely that not only borrowers with CMBS loans are falling behind. Deutsche analysts said they expect commercial property loans held by the bank to follow the delinquency peak already evident on CMBS, in a client note this week.
Additionally, the commercial real estate financing industry, and now lawmakers handling a federal Representative Van Taylor of Texas bill, detailed here, want the Treasury Department to help alleviate the stress of commercial property by offering injections direct capital to owners.
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But there is concern that the proposed bill may not be enough to prop up America’s properties, or to prevent future building owners from being less opportunistic on borrowed money.
“I think people by nature are greedy, especially developers, who always want to leverage capital from one project and use it for another,” said Stan Bril, CEO of MCG, a private commercial and small business real estate lender.
He also believes the capital investment proposal is “like trying to put a band-aid on a cut,” he told MarketWatch. “There is nothing they can do to prevent the hammer from falling.”
Instead, Bril sees a lot of angst going forward, particularly after Covid-19 aid for small businesses runs out and the virus continues to spread endlessly, causing more local shutdowns and making it difficult for landlords to collect rent.
Strategists at Cantor Fitzgerald & Co. had a different opinion, calling the bill a “lifeline for commercial property owners,” in a note this week, but also warning that it will likely face challenges in becoming law, including which can be interpreted as “a bailout for large landowners, a group of wealthy, well-connected beneficiaries.”
Shlomo Chopp, managing partner of CPS, a specialist in commercial real estate exercises, said it is the prerogative of homeowners to withdraw money from buildings. “If you increase the value of the property, you have the right to withdraw cash,” he told MarketWatch.
“But we also live in a capitalist society. If you want good, you must also be bad. ”
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