Browse Month: March 2013

Capital Markets Briefing From ReisReports

Let’s take a deeper dive into 2012’s commercial real estate history.  What do we find?  Increases in commercial mortgage origination volume, strength in the apartment sector, and the gradual return of bank-owned properties to the post-crisis market are among the indicators highlighted by Reis Senior Economist Ryan Severino in today’s video from ReisReports.  Among the questions posed and answered:

  • Is capital flowing into the sector again?
  • How eager are investors to place capital?
  • Did 2012 outperform 2011?
  • Is mortgage performance still improving?
  • Are we now in another credit bubble?

Capital Markets Briefing Q4 2012 – Part One from Reis Reports

I enjoyed this clip and I find Severino a welcome voice.  A couple of observations:

First, recent changes to the GSEs policies regarding multifamily lending as mentioned here at The Source don’t seem to be reflected in the numbers, as Severino characterizes the GSEs in a more flat manner.  Fannie and Freddie’s declining participation in the multifamily market is an evolving story that bears a closer look.

Second, I think it’ s notable that Severino mentions that credit market dynamics once again appear to be distanced from the facts on the ground, even if he and I seem to have opposite views as to what drives some of those facts.  He characterizes payroll tax hikes as a factor, referring to a Wal-Mart VP declaring a sales disaster in the wake of new taxes.  I find this party-line blaming of tax policy for Wal-Mart’s customer base’s shyness at the cash register particularly ironic as it comes from no less than the nation’s largest private employer, whose decades-long record of aggressively holding down wages – wages that are spent at such cash registers –  is beyond argument.

High unemployment persists and the middle class remains more or less locked out of the wider recovery.   “It is almost as if there is a bit of a disconnect between the economy and the real estate capital markets,” says Severino. While he doesn’t call this disconnect a bubble, I think he’s right to consider the possibility, because the last credit bubble was an unmitigated disaster for all of us.

Lender Language: Borrowers And Borrowing Entities

Let’s take a look at the language of lenders.

Jointly And Severally

Ever wonder what the lender in a commercial real estate transaction means when the term jointly and severally liable is used?  You hear it as a key part of loan terms when there are co-borrowers in a real estate transaction.

The term jointly and severally usually applies to situations when the borrower in a transaction is a) a real person and b) is actually more than one person.  In other words, it applies to co-borrowers.  It refers to the fact that each co-borrower is fully responsible for repayment of the loan.  Specifically, it means each co-borrower is 100% responsible for the full repayment of the loan regardless of borrower ownership fraction in the property. It does not matter if the co-ownership share in the property between, for example, two co-borrowers is 50% each — in the event one of the co-borrowers becomes incapacitated, the other co-borrower is on the hook for repayment of 100% of the loan.  Another way to put it is that jointly and severally means the debt is not shared.

Borrowing Entities

That’s fine for individuals making a loan request.  But what about when individuals aren’t making the request, but rather form a legal entity that then borrows to finance a commercial real estate deal?

[DISCLAIMER: As always, never take anything you read here at The Source as legal advice.  Always retain qualified commercial real estate counsel!]

Speaking only generally, the phrase “borrowing entity” is a bit of jargon in lending that is synonymous with the “legal entity” that is created and requests the loan.  In its simplest terms, the borrowing entity is a) not a real person b) an organization concocted by a person or a set of persons that provides a distinct legal identity set apart from the persons forming it. A classic form of this legal entity is a corporation, but it could also be a limited partnership or a trust.

The borrowing entity can borrow capital, own property, sue and be sued under its own name, and make contracts.  As such, it provides protection to its principals, and it’s the name on the deed when the deal is done.  As you can probably guess, this only scratches the surface in terms of describing possible borrowing entities.  The structure of a borrowing entity can be straightforward, or it can be incredibly complex, requiring organizational flow charts maintained by counsel to keep track of management responsibilities, general partnerships, shells and the like.   Because lenders will need to know who they are lending to, the structure must to be clear to them, or there just won’t be a loan.

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$800 Million Silicon Valley Office Deal

Location in the state of California

The tech sector economy continues to lead in the eye-popping category: the Oakland Tribune this morning reports a 73-building Silicon Valley commercial real estate deal. The transaction includes extensive renovations. The office and research buildings are located in Northern California technology meccas North and South San Jose, Sunnyvale, Mountain View, Santa Clara and Fremont.

Driven by major expansions of tech companies including Apple, Dell, Samsung and Google, the demand for office space in the area has been nothing less than white-hot.  Reports from a year ago indicated Apple was in the market for up to 800,000 square feet of office space to allow room for approximately 3,000 employees.  This takes place against the backdrop of Apple’s construction for 2015 opening of its “mothership” Apple Campus 2 headquarters building in Cupertino, shown in development proposals as a giant ring with 2.8 million square feet supporting 13,000 employees.

The package of office properties, many in prime locations, was purchased by a partnership of real estate firms from Canada (Ivanhoe Cambridge) , San Francisco (DivCo West)  and Texas (TPG Real Estate).  The new partnership operates as M West Properties.

The seller was Mission West properties, headed by developer Carl Berg.  The buyers paid $400 million in cash and assumed $400 million in debt.  A press release from Mission West at the time of the deal closing announced a $1.3 billion “enterprise value” to the deal, vaulting the really big number to a really really big number.

Deal partner Ivanhoe Cambridge is a Montreal-based pension fund who aims at Silicon Valley office and apartments as its investment strategy,  saying in a statement “The $400-million-plus investment covers all aspects of the acquisition transaction and is a further step in building up Ivanhoe Cambridge‘s critical mass of assets in the Valley in the office and multiresidential segments.”

Not Multifamily, Multiresidential

Emphasis above is my own, notable for disappearance of the word “multiamily” when talking about investment in Silicon Valley’s apartment buildings.  As deal partner Ivanhoe Cambridge is a pension fund, I was reminded of the cultural reasons pension funds have traditionally shied away from multifamily investments – the prospect of a benefits provider, as a landlord, forced to evict one of its own beneficiaries, was according to some  perceived as a public relations nightmare, and kept pension funds away from “buildings with beds in them” as a result.

But pensioners aren’t mainly the tenants in Silicon Valley’s apartments.  Nor are, it would seem families – the tech industry employee working at Apple or Google is typically young and childless and spends most time in the office – hence the back rubs, basketball courts and gourmet food perks of such jobs.  How long can that work/life culture and the resultant property mix last in San Jose and environs? Watch the market to find out.

Trickle-Down Fails The Urban Renewal Equation, Too

English: View of the Warehouse District in Min...
View of the Warehouse District in Minneapolis, Minnesota along 1st Avenue.

In “More Losers Than Winners In America’s New Economic Geography,” Atlantic Cities Editor Richard Florida faces a fundamental problem in urban planning and commercial real estate.  The active attraction of the affluent and educated to a city’s central neighborhoods has long been touted as an economic cure-all for cities more broadly. The premise was that these high-tech high-education worker enclaves would  cause the surrounding rings of neighborhoods to experience follow-on benefits of price stabilization and heightened quality of life.

All that was needed, went the doctrine, (sometimes called “Creative Class”) was city government to subsidize the creation of such enclaves and the magic would happen.  The more stolidly middle-class worker would benefit from the help handed to the upper class in a familiar “trickle-down” mechanism.

The mechanism is familiar because we hear about it a lot.  Over the past 30 years, we’ve seen it touted in tax policy and in the lionization of “job creators” as public priorities are constantly rearranged to serve concentrations of wealth first, always with the promise that such largesse will “trickle down” to the middle class.

But we almost never actually see anything trickle anywhere.  Certainly not today: corporate profits, productivity and equity markets are near all-time highs and effective tax rates on wealth concentrations spent the decade at all-time lows.  There is nothing the top needs that it doesn’t already have to create jobs.  If trickle-down worked, we’d be drowning in jobs nationally. Yet the unemployment numbers are stubbornly slow to recover.  Real wages have stagnated since the 1970s.  Trickle-down just doesn’t trickle.

Policy Advocates Forced To Take A U-Turn

While there’s not a thing wrong with educated, higher-paid people coming to live in troubled areas of major cities, it’s a trend that has expressed itself organically for decades.   The problem occurs when cities, facing declining populations and tax bases fall under the spell of dubious economic theories.  They make arrangements to subsidize this trend, with the wrong expectations.  As it tuns out, the problems and property values of neighborhoods surrounding such affluent enclaves are their own, and such subsidies do not work to help them.

Atlantic Cities Editor Richard Florida would know: he spent most of the 2000s advocating that cities make such subsidy.  Now he is forced to admit that help to the wealthy and developers does not trickle-down to the surrounding neighborhoods.  In fact, it tends to make those neighborhoods less affordable and more susceptible to flight to the suburbs.

I’ve been examining the winners and losers from this talent clustering process in ongoing research with Charlotta Mellander and our Martin Prosperity Institute team. This research divides workers into three socio-economic classes — highly skilled knowledge, professional, and creative workers, and less skilled and lower paid blue-collar and service workers — and takes into the account the wages and housing costs borne by each.

Our main takeaway: On close inspection, talent clustering provides little in the way of trickle-down benefits. Its benefits flow disproportionately to more highly-skilled knowledge, professional and creative workers whose higher wages and salaries are more than sufficient to cover more expensive housing in these locations. While less-skilled service and blue-collar workers also earn more money in knowledge-based metros, those gains disappear once their higher housing costs are taken into account.


The trickle-down effect disappears once the higher housing costs borne by less skilled workers are taken into account. The benefits of highly skilled regions accrue mainly to knowledge, professional, and creative workers. While less-skilled blue-collar and service workers also earn more in these places, more expensive housing costs eat away those gains. There is a rising tide of sorts, but it only lifts about the most advantaged third of the workforce, leaving the other 66 percent much further behind.

Housing and economic policies need to be informed by knowledge, not fads.  When the leading salespeople for a policy are forced to admit the benefits for all they promised aren’t there, it’s time to look at the assumptions made in our property markets and to separate wishful thinking from economic reality.

Photo Credit: Wikipedia

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Fannie And Freddie To Cut Multifamily Lending

Seal of the United States Federal Housing Fina...

As private capital scrambles back to the perch in the housing market, your friendly neighborhood GSE is about to change its lending patterns to multifamily property.  And it won’t result in more GSE capital in the market.

The Federal Housing Finance Agency (FHFA) outlined 2013 goals for Fannie Mae and Freddie Mac earlier this month that aim to lower the exposure the GSEs have to the national housing finance system.  While most of the direct regulations are aimed at the single-family financing system, the multifamily sector needs to look closely at provisions in the regulation that affect multifamily.

When the FHFA says it intends to “contract the [GSE]s dominant presence in the marketplace while simplifying and shrinking certain  operations (by lines of business) – 50 percent weight” it specifically means aims to reduce the unpaid balance amount of new multifamily business relative to 2012 by at least 10 percent.

This will be accomplished by “tightening underwriting, adjusting pricing and limiting product offerings, while not increasing the proportion of the Enterprises’ retained risk.  (Reductions between 0 and 10 percent will receive partial credit.)”


The National Multi Housing Council is among the protestors over this regulation and its “arbitrary caps” and potential “restrictions in product lines”.  But the moves are essential to the restoration of balance to the financing markets, says FHFA Acting Director Edward J. Demarco. In remarks to  the National Association for Business Economics Policy Conference, Demarco said:

Unlike the single-family credit guarantee business, the Enterprises have a smaller market share and there are other  providers of credit in the multifamily market. The Enterprises’ market share of new multifamily  originations did increase during the financial downturn, but in 2012 it returned to a more normal  position.

Another difference from the single-family business is that each Enterprise’s multifamily business  has weathered the housing crisis and generated positive cash flow. In contrast to their common  approach to their single-family businesses, Fannie Mae and Freddie Mac do not take the same  approach to their multifamily businesses. Each approach also already embeds some type of risk  sharing. For a significant portion of its business, Fannie Mae shares multifamily credit risk with  loan originators through its delegated underwriting program. For a significant and increasing  portion of its business, Freddie Mac shares multifamily credit risk with investors by issuing  classes of securities backed by multifamily mortgages where the investor bears the credit risk. Given that the multifamily market’s reliance on the Enterprises has moved to more normal range,  to move forward with the contract goal we are setting a target of a 10 percent reduction in  multifamily business volume from 2012 levels. We expect that this reduction will be achieved  through some combination of increased pricing, more limited product offerings, and tighter  overall underwriting standards.

Bottom line: as the markets continue to normalize, watch for the measured retreat of the GSEs from the markets that drew them in so deeply and so dangerously.  And watch as multifamily too feels the weight of the changes.



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Biggest Banks Eyed For Breakup

Goldman Sachs Headquarters, New York City

At long last, the case for “too big to fail” banks is falling apart.

In the wake of the residential mortgage crisis, our industry has for years now struggled with finding the sources of capital its needs to finance the commercial real estate transactions that drive the broader economy.  The role of banks is to allocate that capital to our sector, to manage risk and to both set up and follow rules that promote stability and predictability as that capital circulates into and out of our transactions.

But risk management and rules have fallen by the wayside.

When US Attorney General Eric Holder last week testified to Congress that some banks are so big that DOJ is afraid to bring charges against megabanks, not even the most strident opponent of government regulation could fail to notice that the country’s top law enforcement official was actually giving up on law enforcement, at least when it came to TBTF banks.

The reason given by Holder was the same reason given by the banks themselves when accepting the bailouts: what’s bad for megabanks is bad for the entire economy.

In other words, first, in 2007, the banks in crisis managed to call off the basic rules of the market.  Now they have effectively called off the law itself.

You can’t get much more unregulated than that.

If you’re not a megabank, and you gamble and lose, then you leave the table.  But if you’re JPM Chase, you get a pat on the back and a pile of new chips on a silver platter.  Plus a few handfuls for your own pinstriped pockets.

If you’re not a megabank, and you launder drug money, or even posses the tiniest quantity of drugs,  you are facing hard time in prison.  But if you’re Britain’s HSBC, you can admit to servicing Mexican drug cartels and internationally sketchy, terrorist-associated accounts to the tune of hundreds of billions and then atone for your transgressions with a mere $1.9 billion settlement.

For anybody keeping score, that’s about five weeks’ income for that bank.  Calling that a slap on the wrist is an insult to both slaps and wrists. It’s more like a hug and a wink.

Then there’s something much closer to home.  There’s what out-of-control banking culture has done to our leases.

As I’ve written here before, the LIBOR rate-fixing scandal has cost our industry in untold ways.  By messing with the cost of capital and by distorting the interest rate governing rent increases, the TBTF banks have happily bit into our industry’s margins for no other reason than to cover their derivatives traders.

In other words, once one of our own even manages to with the uphill battle obtain capital to finance a bedrock transaction in the tangible supply and demand economy,  the capital costs have been manipulated by banking in order to ensure the banks win on their derivatives trading, a market that is about as speculative and inessential as it gets.

Breaking Up Isn’t So Hard To Do

In this fight over capital and rules, the case for the existence of TBTF banks grows only weaker.  Mainstream pressure to break up these massive institutions is growing. Our pinstriped friends at JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley are simply running out of wiggle room and the writing is on the wall.  In fact, it’s on the Wall Street Journal itself, which has floated a bank breakup plan called “too small to save”.

When the WSJ is advocating for a power greater than the market to wake up and fix things, you know a profound change is in the air.

Speaking only for myself, the commercial real estate markets could only benefit from this long overdue correction.  I know the industry likes its pinstriped friends. It would like to see them get back to allocating capital and managing risk.  It would like to see them again in the market and under the law.  And so would its clients.

Commercial Property Ownership Experience: Critical To Success

cdcovers/jimi hendrix/are you experienced.jpg
Are You Experienced?

It stands to reason that any transaction you undertake without prior experience is likely to go against you in some way.  Commercial property transactions, as complex as they can be, are no exception.  Lenders, counter parties, managers, brokers, even counsel, all represent their interests to the maximum. When they’re on the other side of the table, you can bet that those interests will be represented at your expense if you lack the ability to see the deal in the terms they do.  You obtain that ability in depth in only one way: through direct experience.  Experience in commercial property ownership and management is critical to success.

Everybody Prefers Experience, Starting With The Lender

A borrower’s understanding of how to operate the property is high on the list of what a lender is looking for. Creditworthiness is king, then market conditions have their say, but no matter what, the lender is always looking for clues that the borrower has an understanding of what owning this property entails.  If the borrower’s answer boils down to a simple “I’ll be hiring a property manager,” a lender has every right to wonder about the management capability of the borrower.  This is not to say that hiring a property manager is a mistake, it’s to say that the borrower’s management acumen should be on display, not downplayed.  Take the intent to hire a manager as an example: the borrower’s management of that relationship between herself and her property manager is still seen by the lender as the lender’s best defense against the borrower running into trouble down the line with the property.  And trouble means endangered loan service.

Showing Experience

A  borrower needs to demonstrate to the lender an acumen at commercial property ownership and management. One way to do this is through the development of a document of that acumen.  Sometimes called an REO Schedule (Real Estate Owned), this list of real property, which can include single-family, is to make it clear to the borrower that the lender has experience commercial real estate purchase, ownership and operation.

This document has such an effect on lenders that if a borrower happens to be out of the market at the time of the deal, the Schedule should include a list of properties once-owned with dates of sale, descriptions including unit numbers, square footage and other vitals.

Bottom line: Commercial property is income property – show your lender that you’ve got the experience and can handle the ins and outs of an income stream, and you’re more likely to get the capital you need to make the deal.



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Central Carolina REALTORS® Commercial Circle Of Excellence Gala Event

Join us in our salute to the Central Carolina REALTORS® Association and their recent Circle Of Excellence gala event.  A ful reporting of the February 26th event is yet to come, but the photos are in and they are fabulous.

Membership Director Shannon Johnson, Past President Peggy Gainey, RPAC Chair Kathy Garrick, CEO Sharon Young, Secretary Jane Drake
CCRA Membership Director Shannon Johnson, Past President Peggy Gainey, RPAC Chair Kathy Garrick, CEO Sharon Young, Secretary Jane Drake
Past President Peggy Gainey,Vice President Brenda Hanna, Past President  Laura Derrick, Past President Jimmy Derrick
Past President Peggy Gainey,Vice President Brenda Hanna, Past President Laura Derrick, Past President Jimmy Derrick
Nick Kremydas and David Lockwood
Nick Kremydas and 2011 South Carolina REALTOR Of The Year David Lockwood


George Walker, Sharon Young and Henry Roe
George Walker, Sharon Young and Henry Roe


Watch for a full accounting of these fine looking folks and their event in these very (virtual) pages soon!


Why Establish A Commercial Overlay Board?

NAR Commercial Logo

A recent post here at The Source talked about how to establish a new Commercial Overlay Board connected with your local REALTOR association.  By way of quick review: establishing a COB is the way a local REALTOR® association expresses a specialty in commercial real estate, creating an organization and resources geared away from residential practice and toward the very broad and complex world of commercial practice.

That post generated a good question from Tucson’s Barbi Reuter, Principal / Broker at C&W PICOR, who asked:

This is a good outline of the ‘how’ – I’d love to see the ‘why.’ Could you help us understand the added value a COB can offer the commercial real estate community over organizations and services already in place? Perhaps a follow up post. Thank you!

Follow up we will!

What Does Establishing A Commercial Overlay Board Achieve?

1.  COBs improve the education of residential practitioners. In secondary and tertiary markets, the following scenario is quite common: a residential professional finds herself representing a commercial property by default. A small-town family business property owned by a homebuyer client, for example, might fall to her to represent and move. An owner-occupied commercial property can seem very similar to a resident-occupied home in market-making terms. In both areas, the broker needs to advertise, to show, to negotiate and to close.  But the differences are stark, and risk of legal entanglements and malpractice rises sharply when residential practitioners inherit commercial deals.   The COB is there to offer education programs, seminars, and courses to keep members current on vital issues, better able to serve the public, and meet state-mandated continuing education license requirements.

2. COBs provide dispute resolution. A COB provides the body of commercial practitioner peers needed to enforce the Code of Ethics and Standards of Practice of the National Association of REALTORS®, and to administer mediation and arbitration as they relate to commercial transactions.  By design, various COB committees are active in this regard. Typical meeting agendas of a COB’s Membership Policy and Board Jurisdiction Committee include resolution of name and territory disputes between member associations with due process hearings.   Multi-state arbitration issues are also handled, as is the implementation of Article 14 of NAR’s Code Of Ethics.

3.  Separate identity.  A COB is a free-standing, self-governing, self-sustaining association of REALTORS®. This is opposed to a CS  (Commercial Structure) which  is a commercial group within an already existing parent association and may be allowed representation on the parent Board of Directors. For example, COBs are assigned a separate NRDS (National REALTOR®  Database System) identification number and are represented on the NAR Board of Directors, whereas CSs do not have a separate identity and are represented through their parent association.  This distinction can be valuable when local associations are facing sweeping changes in commercial property markets that demand a professional identity dedicated to and focused exclusively upon the commercial practice be established.

Creating a Commercial Overlay Board gains these and many other things.  For a full listing, NAR members with an NRDS login can check out The Commercial Overlay Board Guide.


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Apartments, Capital And Performance

English: Victory Hill - one of many blocks Sma...

As reported here in The Source roughly a year ago,  in 2012 the multifamily sector did just about exactly what Dr. Mike Eppli of NAIOP predicted it would: lead the charge into recovery. Rising rents and lowering vacancy rates, Eppli said, were in the cards, driven by the fallout from the housing crisis.  Eppli saw a national demographic that broke with its traditional history and headed not into home ownership, but rental.


The result in the national apartment sector is clear: 4% vacancy rates — a landlord’s market — and rising rents are moving to meet the needs of hundreds of thousands of would-be homebuyers displaced by the downturn. And the trend isn’t over, as NAR Chief Economist Lawrence Yun in the most recent Commercial Real Estate Outlook wrote


Areas with the lowest multifamily vacancy rates currently are New Haven, Conn., at 2.0 percent; New York City, 2.1 percent; and Minneapolis and Syracuse, N.Y., each at 2.5 percent.

Average apartment rents are expected to increase 4.6 percent this year and 4.7 percent in 2014, after rising 4.1 percent in 2012. Multifamily net absorption is projected at 270,600 units in 2013 and 253,200 next year.


Capital Challenges Persist


Independent of the sunny apartment market numbers are the persistent constrictions on capital to make deals happen.  The recovery has been uneven, and our experts in capital allocation in the banking sector seem to have only two settings on their risk tolerance control panels: too much (2007) and not enough (today).

We’ve written about a variety of approaches to take to find elusive capital sources.  Credit unions, tax deferments such as 1031 exchanges.  1031 isn’t the only governmental help for finding capital in the apartment sector.  Private placement of investment funds went through a game-changing transformation last year.

Rule 506 Changes

November’s Source post on SEC’s changes to Rule 506 in conjunction with the JOBS (Jumpstart Our Business Startups) Act generated plenty of discussion.  For the first time in 80 years, the federal regulations defining what kinds of investor can be categorized as “sophisticated” thereby allowing deal principals in certain circumstances to skip the preparation and delivery of disclosure documents.  These simplifications and streamlining of the process brings more capital to the table for apartment building deals because it allows the small investor a chance at the cap rates and cash flows apartments offer.

Of course, nothing has been simplified to the point that good counsel is not needed: small investors can fit nicely in your private placement just as easily as they can present serious problems.   Always consult qualified counsel in any private placement.

But be aware that the small investor has been set up as a change agent and a new source of badly needed capital in the apartment market.  There’s work to do — as always — but the additional options can fuel the apartment recovery trend even farther in 2013.


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