Eric Von Berg - Newmark Realty Capital - 595 Market Street, Suite 2550, San Francisco, CA 94105 - for loan quote: evonberg@newmarkrealtycapital.com 415 956 9922

May 31, 2014

Protesting Google’s buses is insane

It's time for Google to fight back by funding urban housing... in downtown San Jose!

The well-publicized media events where “activists” block and board Google buses in San Francisco’s Mission District set me off.  These events lead to the requisite articles about how high-paid tech-workers are driving out San Francisco’s low-income households and leading to Ellis Act evictions. The headlines scream "evictions up by 170% in 2013 from 2010"… but rarely mention the grand total was just 116.
Why do these protests frost me?  Let me count the ways...
  1. This is not about San Francisco, it is about the Mission!  The Mission District is becoming a desirable place to live.  Desirable neighborhoods become expensive.  If you have limited means you don't generally get to live in the district of your choice.  I would like to live in Pacific Heights, but I cannot afford it.  Activists, how about moving into the Bayview or the Crocker Amazon and make those neighborhoods hip and desirable?
  2. Old time San Franciscan’s already have uniquely strong protections against being priced out!  Unlike most major cities in America that have freely operating real estate markets, San Francisco has (1) Prop 13 to help homeowners avoid rapidly escalating real estate taxes if their homes jump in value, and (2) rent control over the majority of SF’s rental stock.  Yes, renters are accepting buy-outs from landlords, some as high as $40,000 to move, but these are voluntary transactions, entirely at the tenant’s option.  Ellis Act evictions are up from the depths of the economic collapse, but so are the number of sales, rent levels, home values and all other measures of real estate activity.  Ellis Act evictions are still very rare, annually accounting for only 0.05% of the total San Francisco rental stock. Also, these Ellis Act units do not disappear:  They are housing for the owner’s relatives or converted to TIC ownership, which is the entry housing option for many renters trying to move into home ownership.  
  3. Who are these “activists” anyway?Although the news stories are about long-time San Francisco residents of limited means; the angry protesters are not long-term residents.  They are generally young hipsters who are the same age as the tech workers.  These young people want to live in hip neighborhoods for the same reasons.  The difference, they studied the wrong subjects in college and are now part-time activist baristas.   Activists having special sway with the media is a San Francisco phenomenon; “I hold no public position or office. But my voice counts more than your average voter! Why? Because I am an angry zealot.”  

Yet the Google bus controversy highlights an important issue

The Bay Area’s largely car-centric suburban housing stock does not meet the needs and desires of its influx of millennial in-migrants.  The Bay Area needs a genuine urban alternative to San Francisco.  Downtown San Jose is on the cusp of meeting this need.

Downtown San Jose is at the inflection point of becoming a hip and vibrant place.  See this excellent recent report by SPUR about the emergence of Downtown San Jose:  .

Jerry Brown killed the skimming of tax increment by redevelopment districts.  San Jose was one of the most aggressive skimmers, creating massive, interlocking redevelopment districts that allowed it to use the tax increment from all of the business development in North San Jose’s Golden Triangle to fund projects downtown.  The redevelopment punchbowl was taken away but not before the City spent over $2 billion dollars in redevelopment funds in Downtown San Jose on transit projects, museums, parking, an arena, convention center, parks and street beautification.  Downtown San Jose is safe, clean and beautiful but it is a ghost town after 6 PM.  The 200+ restaurants and bars downtown struggle when it is not Sharks Hockey night.

Without the redevelopment slush fund, San Jose’s city planners are being forced to do what makes sense; incentivize the free-market to bring in high-rise housing to populate its downtown.  A few thousand young, well paid tech-workers living, eating and hanging out downtown will change everything.  Yet the City should not allow a bunch of low-rise, stick-built apartment houses to spring up downtown.  Transit oriented development makes sense only if it is dense: San Jose should demand minimum height limits downtown and continue its current economic incentives for high-rise residential developments.

The Cash-Rich Employers of Silicon Valley should fund high-rise rental projects.  High-rise construction requires developers to meet Type-1 fire safety codes.  This means buildings that don’t burn made of concrete and steel.  Type-1 is expensive construction in earthquake country.  Until very recently the only residential buildings that could afford this type of construction in Downtown San Jose were luxury condos (And, most of these projects still when back to the banks).   Apartment rents in San Francisco are now high enough for Type-1 construction, but San Jose’s rents are not quite there.  So the City of San Jose gave some temporary breaks on development fees for high-rise residential and temporarily suspended inclusionary housing requirements.  As a result two apartment towers are under construction in Downtown San Jose.

But, these City incentives will expire at the end of 2014.  Likewise banks are starting to lose their fear of funding condo projects.  Condo developers historically outbid apartment developers for land.   Luxury condos miss the mark, Silicon Valley’s young newly hired tech workers seek apartments to rent.

Google, Apple and the other cash-rich Silicon Valley employers should create venture funds to back high-rise, transit-oriented apartment projects.  These would not be corporate housing projects. These apartments would be market-rate, open to any renter.  If a developer can propose a project that can achieve an initial unleveraged return equal or higher than a current cap rate, say 4.5%, these tech giants should fund the equity for that project.  These tech companies would show they are helping solve the area’s housing problems.  They will earn 4.5%+ on their excess cash, far better than they are earning today.  And they will not lose money.  They can sell the projects or their positions upon completion to restock their transit-oriented housing incentive fund and likely make a tidy profit.

Google forget San Francisco!  Go to the genuine urban alternative that will accept your tech workers with open arms, downtown San Jose!

November 26, 2013

2013 Bay Area Economic Engine - Creative Destruction

Here again is my annual assessment of the Bay Area's Economic Engine.  Feel free to download it for your own use... and as always feel free to call or write me with questions or comments!

Warning... data alone does not tell the whole story

If you just look at the data, you might see the recent boom in San Francisco and Silicon Valley has slowed slightly; the Bay Area added 52,000 jobs in the 12 months ending October 31st, 2013, compared to 99,000 in calendar year 2012.

I predicted this "slowdown" in last year’s Bay Area Economic Engine. Here's what I wrote then:

Much of the 2010-2012 surge in employment and demand for space was due to companies with disruptive technologies… As these innovations gain market they replace something else. In 2010-2012 these winning companies were launching and growing while the losing companies were still in place. Now we are beginning to see the fallout from the disruptive technologies; upcoming layoffs being announced for chip manufacturers, network equipment manufacturers, PC’s, console video game companies and companies that produced products made redundant by the smartphone…

And so it was... 2013 saw major layoffs... HP 28,000, Cisco 4,000, Lockheed 4000, EMC 1,000, Electronic Arts 900, Symantec 800. But the magic of the Bay Area tech culture is “creative destruction”… Google moves into 500,000 sf of space at the old Mayfield Mall in Mountain View last occupied by HP. Oracle buys and decimates Siebel Systems and that San Mateo space becomes a 1,000,000 sf campus for Sony’s PlayStation group.

Watch corporate IT spending and know the health of Silicon Valley?

Not true this year... 2013 proved this adage to be wrong. With corporate IT spending flat, cuts in defense spending, sequestration, personal computer sales falling, Intel missing the tablet market and computer gaming companies suffering, you might expect Silicon Valley to be on its rear.

Emerging technologies more than compensated... smart phones, tablets, social networking, cloud computing, the consumerization of IT .... these technology trends are still in their infancy and are all are growing up in the Bay Area.

What does that mean for the Bay Area?  The headwinds we saw last year are largely behind us and with the overall US economy recovering; our Bay Area Tech Boom may just be beginning.

DOWNLOAD the 2013 Bay Area Economic Engine by clicking here

October 6, 2013

Commercial Real Estate Investors join the Carry Trade

Learning to trust the Fed – Freely Floating and Fearless

Long–term interest rates are up about 150 basis points since the low we saw in May of this year.  The consensus is that with the economy strengthening and the Fed announcing they will taper their long-term bond buying, the bottom we saw in interest rates will not be back in the current economic cycle.

Yet talking to investment brokers, cap rates for apartments and core assets are up only 50 basis points, if at all.  Positive leverage, where the cap rate is higher than both the long term interest rate and the debt-service-constant, has occurred very rarely over my career.  Usually real estate investors need appreciation in rents and/or values for a project to make sense.  With positive leverage, real estate investors can start out with a decent return from day one.  This has attracted a huge amount of money to commercial real estate, running up prices and driving the excess profits out of the industry.
Core real estate assets shot-up in value and cap rates plummeted. Now, at least on a debt-service-coverage basis, positive leverage is behind us and we are seeing little inflation that we can count on.

So, why are values not falling?

The answer lies in how the winning bidders are financing their acquisitions today.  

Often the buyers for stabilized, institutional quality, core assets are REITS or large investment funds.  These real estate hedge funds have amassed money from pension funds and endowments, where the fund sponsor receives a promotional incentive bases upon the IRR achieved for each asset or based on the performance of the fund in general. 
Many of the winning buyers today are relying on floating rate debt for a large portion of their leverage, if not funding 100% with funds that float over LIBOR.  The big banks are back an are very aggresive.  The best borrowers for the best assets can get spreads of 150 BP to 175 BP today for moderate leverage on stabilized assets.  With the short-term LIBOR rate stuck at about 25 BP, these investors are borrowing floating rate money at 2.0% or less.  It is fairly easy to make the numbers work even at a 4.5% cap rate if your leverage is coming in at 2%:

The Carry Trade: Arbitraging higher long-term bonds, using short-term leverage

The carryb trade is a staple of the non-real estate hedge fund world.  With high leverage an investor can make a decent return on its equity by playing the usual upward slope of the yield curve.  For the vast majority of time, long-term rates are higher than shorter term rates.  This is a great way to make a tidy profit… until it stops working.
Commercial property has longer term leases and cap rates generally track longer term bonds.  For those of us who were around for the S&L crises, we were taught that lending long and borrowing short is a recipe for disaster. 

Yet how many years need to go by with the Fed committed to a near zero Fed-Funds rate, before we learn to believe in it and make money by relying on the Fed to execute on their stated plan. 

The current manipulation by the Fed of a free-market for money, takes returns away from those who invest and gives the advantage to those who borrower.  This financial repression is a government redistribution of wealth that has gone on for over 5-years.  This situation is very likely to continue longer than it should: The Federal Government’ as the biggest borrower of all is getting hooked on this form of financial steroid.  Yes, Quantitative Easing will eventually come to a close. However, Janet Yellen, the incoming Chairmen of the Fed is making no noises about changing the near zero percent target for the Fed Funds Rate, i.e short term rates will remain low for the foreseeable future.
An investor, who does not take advantage of a clearly manipulated market, can look foolish. 

For the real estate fund manager, the issue is really one of disclosure. 

The pension fund or endowment investor that invests in real estate funds also invests in financial hedge funds.  These investors are making returns of the Carry Trade already.  The investors are making two forms of profit, (1) a real estate profit and (2) a profit from the Carry Trade, the mismatch of asset and liability maturities.  For the real estate fund manger, it comes down to an issue of disclosure; simply layout the proposed leverage strategy for the fund and disclosing the advantages and the risks.  

The advantages can be shown with a simple calculation   If an investor believes we are will face a near zero LIBOR rate for the next five years, an un-hedged bank floating rate deal creates a borrowing cost of around 2.0% (LIBOR plus 1.75%).  A ten-year fixed interest rate today might be 5.0%.  With 66% leverage, the 3% rate difference will return an extra 9% per year on the 1/3rd equity.  Over a 5 year holding period the carry-trade portion of the investment will return almost half (45%) of the invested equity.   

Learning to float fearlessly. 

If you believe in the Fed's commitment to manipulate short term rates to the low side, you negotiate your floating rate loans differently.  Do not let your bank force you to buy a cap or hedge: if forced, buy the cheapest insurance possible; highest cap and shortest term.  For the last 5-years caps and hedges have been a waste of money and given the current higher costs of these derivatives this is overly expensive insurance. 

If you follow a freely floating strategy, engage a mortgage banker.  More and more investors are using mortgage bankers to create competition among banks and other floating rate lenders.  Newmark Realty Capital is glad to help with this strategy. 

July 30, 2013

Why Life Companies continue to pursue long-term, fixed-rate Commercial Real Estate Loans

The historic low in long term interest rates likely occurred in July 2012. Now we are facing increased volatility in interest rates and long-term interest rates will climb. This situation seems obvious to all the players in the capital markets. 
So, with the almost certain prospect of rising interest rates, why are the life companies still aggressively pursuing long-term, fixed-rate commercial real estate loans?
The current monetary policy of a zero-interest Fed Funds rate and successive Quantitative Easing’s is a form of price controls; artificially decreasing the price of capital.  This manipulation of the free market for capital shifts earnings from investors to borrowers.  Companies have artificially high earnings because their bond costs are artificially low.  Leveraged real estate investors enjoy an even bigger subsidy, since their degree of leverage is generally higher than that of corporations. 

In the face of what is often called the Fed’s policy of “Financial Repression”, why is anyone willing to play on the lending side of a rigged game?   The reason: As rates were falling long-term bonds were very profitable.   The low yield from the stated interest rate was more than made up by the appreciation of the market value for these bonds as rates fell. 

The rigged market has created a bond bubble 

The ride has been good, but investors admit that the risk to return ratios are out of whack.  As in any bubble, we know the situation will reverse, but as long as we are convinced a greater-fool will buy from us at a higher price tomorrow, we convince ourselves we are not one of the fools.  If greed keeps us in the game too long, we are proven foolish.  The trick in any bubble is to sell before the crowd begins to sell.
Given this competition to not be the last one still sitting, even rate stability can drive bond holders to race for the exit door.  We saw this in the mini-panic caused by some very mild words from Ben Bernanke in June:


“Tapering” = Quantitative Easing will slowly, eventually end. 

We all knew this, but bond investors fled and both interest rates and spreads jumped.  10-year Treasury Swap yields were 2% on May 27th and 2.75% on July 9th.  CMBS spreads increased as the same time.  Since there is no good way to lock in an interest rate on a CMBS mortgage, 10-year fixed-rate CMBS mortgages that were getting  signed up in the high 3% range were closing (if they closed at all) in the low 5% range, many times with the dollar amount of the loan drastically reduced. 

In the midst of this, the life insurance lenders were an island of stability.  They honored their commitments holding rates on loan applications where rates were locked and continued quoting loans and taking new loan applications generally at the same spreads as before the mini-panic.
A savvy real estate investor, John McNellis (who has known me since I had hair), asked during this confusion in the capital markets: “If the life companies know that interest rates will be rising, why don’t they just pull out of the market and wait to put their money out when rates will be higher?”

I had my own theories, but I posed John’s question to a few of Newmark Realty Capital’s life insurance lenders.  Here is their feedback:
  1. Life Companies are Investors not Speculators:  Market timing investing does not work for life companies, especially now when holding cash is so costly.  Chief Investment Officers (CIO’s) who try to time the market can be successful several time in a row, but one miss can cost the CIO his job.  No one gets fired for matching the terms of assets and liabilities.  Life companies have various product lines, many of which have long liability durations that pair well with long-term fixed-rate mortgages.  The CIO’s job is simply to make a profitable spread between the long-term asset (the mortgage) and the long-term liability (the annuity or insurance product).  If they just stay constantly in the markets they hope to average out over time.  If not, they can sell or close out the line of insurance business.  Because of the low-rate environment, Met Life announced they planned to get out of multiple lines of business this year. 
  2. Mortgages do not have to be marked to market:  Bonds are actively traded securities, as such accounting standards require them to be “marked-to-market”.  Mortgages are much more illiquid and are generally held to term.  Thus, mortgages just sit there on the balance sheet at their face value.   Bonds can be very profitable when overall rates are falling as these securities increase in value.  But the reverse will be true as rates start to rise.  Over the last 30-years constantly dropping rates has created a tailwind for life companies as their bond portfolios rose in value.  During this time (my whole career) the bond group was treated as the A-Team in the investment departments of most of Newmark’s insurance company clients.  In the last few years this reversed.  CIO’s are giving their Mortgage Department first billing.  They are being told; “Find good mortgage deals and we will find the funds.”  Mortgages’ avoidance of potential mark-to-market losses as rates begin to rise is a big factor. 
  3. Call Protection.   Mortgages can be a better match for long-term liabilities than bonds.  The lender gets to write the documents in a mortgage and the borrower gets to write the documents in a bond.  Thus fixed-rate commercial mortgage loans have the type of call-protection  (generally yield-maintenance prepayment formulas) that is lender-friendly versus the borrower-friendly call options in a corporate bond.  High-rate corporate bonds have a tendency to pay off when the corporation’s credit improves or when overall interest rates decline.  Commercial mortgages generally keep their yield until very close to the due-date. 
  4. Better Loss History.  Most life companies have a system to equate a mortgage’s risk level to an equivalent bond, with targets usually somewhere in the range of BBB+/A-.  Most life companies have fond that their mortgage portfolios have a loss history 15 to 20 basis points better than that bond equivalent.  Also, a defaulted bond gives you a total loss, but even a vacant building taken back by the mortgage department has some value.
  5. Better underwriting and access to information with a Mortgage versus a Bond.  In mortgage underwriting there is less need to rely on third-party underwriting and valuation.  Most life companies underwrite mortgages themselves directly from the underlying leases and only use appraisals as a final check, simply a closing item.  The specter of partiality by the Rating Agencies clouds the bond world (see  prior blog posts).  Likewise the creativity of corporate accounting is an ongoing challenge, with off-balance sheet entities and hidden derivative risks a real concern.

As the Fed calms the capital market with talk of postponing the end of QE3, it seems the question is not are the Life Companies back? They never went away!

June 3, 2013

Does Panama Canal expansion spell disaster for West Coast distribution buildings?

Will the expansion of the Panama Canal in December 2014 be a disaster for West Coast distribution buildings?
"Likely Not" said Curtis Spencer, President of IMS Worldwide Inc., one of the leading consultants to ports, shippers and big retailers on logistics strategy.

I attended a presentation by Curtis Spencer at the Spring ULI meeting in San Diego. His presentation countered much of the doom and gloom that is out there regarding the impact of the Panama Canal expansion on West Coast demand for distribution buildings.

He kindly agreed to allow me to share this with my readers. Click here for copy of his slides.

West Coast Competitive Advantages

Because of the large ships that can be accommodated, the Panama Canal expansion will drop sea cargo costs to the East Coast by 30%. IMS is telling their clients that much of the current cost advantage of West Coast shipping is absorbed by the railroads (that is why Mr. Buffet bought Burlington Northern Santa Fe Corp.) and they are predicting that after the Panama Canal expansion the railroads will drop their pricing to keep intermodal shipping competitive to most of the East Coast. IMS Worldwide estimates only a 1 in 10 chance that the railroads will stick to their current pricing and the West Coast will lose significant market share of the import/export business.

The recent economic downturn resulted in a glut of container ships. As a result the shipping lines shifted to a slow-shipping system. With excess ships sitting around, it cost them less to run their ships as slower speeds than to dock these ships. This resulted in such large fuel savings that IMS is predicting the industry will not shift back to maximum speeds even as shipping demand picks up. If slow-speed shipping stays the norm, the intermodal system used by West Coast ports to get product to the East Coast will still have about a one week advantage over the improved speeds after the Panama Canal Expansion to the East Coast.

West Coast’s Biggest Area of Concern

The International Longshore and Warehouse Union (ILWU) has a strangle hold on West Coast ports. The organized slowdown in 2002 in LA and Long Beach disrupted logistics for the entire nation. As a result, the union usually gets everything it wants. The typical crane operator in LA/Long Beach makes over $300,000 per year and is not required to punch in and out. A skilled operator can meet his/her weekly quota working about 20 hours a week.

Watch Mexico
Also, an important driver for increasing demand for distribution buildings in the US Southwest is the growth of manufacturing in Mexico. This demand growth is expected to continue due to the increased competitiveness of Mexican wages versus China:

See the attached slide presentation for details

May 7, 2013

Self-Storage Business.... and Perspectives on Creating a Financing Strategy

I had the privilege of attending the California Self Storage Association’s owners’ conference in Napa last week.  It was a fun time with meaty sessions, warm weather and good food and fine wine.  The CSSA is a great association that gives its members the type of value that only comes when there are more “givers” than “takers” in an association.  I am always pleasantly surprised how much Self Storage owners share with each other; a bit different from many other trade groups.

As a mortgage banker among the self-storage owners, I found myself addressing two common questions…

What is the lending community’s image of self-storage? 

My answer: Excellent among the lenders who have learned this sector, with more lenders getting on board all the time.

Where are rates today? 

My answer: The best they have ever been in my entire career.  We have recently closed several loans well below 4% fixed for 10-years on larger, well-located self-storage properties.

Greetings from California!

What follows is the start of a chapter I wrote for a book published by the California Self Storage Association, “Greetings from CA: Best Practices from the CSSA”   It was written a year ago, but it holds up pretty well.  If your read the entire chapter, just keep in mind that interest rates and cap rates are down 75 basis points since this was published!

The importance of asking Why? before What? or How Much? *

So you need a loan?  You and your partners are buying a self-storage facility or you have a loan coming up for refinance.  “This should not be too hard.” you say to yourself.  Lenders are coming back into commercial real estate and are looking favorably on self-storage as a product type.  As we come out of the recent downturn in 2012 self-storage may not be on top of the heap, but it is near the top.  Self-storage has a relatively low rate of foreclosures and a relatively high recovery ratio when loans do go bad.  In fact, self-storage weathered the downturn extremely well, except for those doomed facilities built at the top of the bubble near the edge of the exurbs still waiting for the rooftops to appear.  Lenders recognize that self-storage does not have the great swings in occupancy and rents experienced by other property types.  Lenders can trust self-storage income streams;  rents are real and a few years of strong collection reports is better than relying on an office or retail tenant’s credit rating that could be gone tomorrow.

With this favorable financing environment it’s not hard to get a loan for a stabilized self-storage project, but it is hard to be sure it is the right loan for your situation.  Efforts to finance without a financing strategy often fall into two approaches.

Scenario One: Ready! Fire! Aim!

You pick up the phone and call your mortgage banker.  He explains there are lots of options available and presses you for some guidance.  You say. “Show me what is out there.  Get me a variety of quotes so I can see what’s available.”  Your mortgage banker pulls favors and runs a wide variety of lenders through their paces and comes back with a mixture of quotes that looks to you like apples & oranges; different loan amounts, rates, loan terms, recourse provisions, prepayment penalties, impounds and other lender controls, and different amortization periods, all from lenders with various reputations as to surety of execution and loan servicing behavior. You want to keep things simple so you focus on only one of the many financing variables (usually the interest rate or total loan proceeds) and compare the options that way.   You pick a lender and financing structure that you worry you later may regret, but can’t quite put your finger on what is bothering you.

Scenario Two: Ladies and Gentlemen, Start your Engines!

This scenario is even worse than a single mortgage banker casting around without guidance, you and your partners start the financing search by each partner taking the initiative, dialing for dollars, calling multiple mortgage brokers and banks.  The competing mortgage brokers get into a footrace to reach lenders before the other guy, so they can protect their fee.  Their packages are sketchy and inaccurate because they prepared them in haste.  Their presentation of your story is fragmented, poorly rendered and the unprofessionalism reflects on you and your project.  The various banks contacted by your partners are competitive and jealous of each other and feel disrespected, but still begrudgingly prepare preliminary term sheets.  The quotes come in, with each source selling their solution and disparaging all other approaches.  Your partners each champion their financing sources and take it personally that you will not direct the financing to their favorite bank.  The quotes are hard to compare because they were based on different NOI projections and different financing requests.  You feel you are only getting half the story and you don’t like the pressure tactics from the lenders and brokers competing to secure the business.   Given this chaos how do you have confidence in your choice of lender and loan structure? "

* From the book: Greetings from California: Best Practices from the California Self Storage Association features a unique collection of self-storage insights and knowledge from this highly respected group of professionals.
TO PURCHASE: http://www.ministoragemessenger.com/cart/shopexd.asp?id=2484

Voted the 2011 Best State Association, the California Self Storage Association counts among its members some of the most experienced operators, property managers and marketing experts in the self-storage industry.

April 25, 2013

Are rating agency’s ratings based upon independent objective research or just on puffery?


S&P’s lawyers claim, it's puffery...

In our Federal Government’s belated response to the financial collapse, the US Justice Department filed a $5 billion lawsuit in February 2013 against S&P for their role in rating the mortgage-backed securities that became toxic.  S&P told investors that their ratings were the result of thorough research and that such ratings were “independent, objective and free of conflicts of interest”. 
The government’s suit claims: “… S&P knew these representations were material false and concealed facts, in that S&P’s desire for increased revenue and market share … led S&P to downplay and disregard the true extent of the credit risk…”

On Monday S&P’s lawyers filed a response asking that the case be thrown out. 

S&P said, “These CDO's are THE BEST!!!” Instead, they turned out to be “OFFAL!”
"... the Government claims that S&P engaged in a scheme to defraud investors by asserting that its ratings were independent, objective and uninfluenced by conflicts of interest when S&P knew or believed that in truth they were not. This claim fails because the statements at issue are not actionable. Each of the representations identified by the Government is the type of vague, generalized statement that court after court -- in this District, this Circuit and elsewhere across the country -- has held to be non-actionable in a federal fraud case such as this."

The S&P lawyers’ claim is that S&P engaged in “classic puffery”.  Marketing hyperbole is allowed as a form of advertising.  If the CD cover say’s “The BEST of Johnny”, could you really bring the CD back for a refund because you dont agree it's not Johnny Cash’s “BEST”?   No, you couldn’t. 

The S&P lawyers’ defense boils down to that famous line from the movie Animal House, when Bluto and Otter say to a crying Flounder as he confronts his father's ruined car: "You can't spend your whole life worrying abut your mistakes!  You fucked up, you trusted us!"

But, what is S&P selling if not it’s reputation as “independent and objective”?  Yet, their own lawyers claim S&P (and other rating agencies) are just stamping approvals on securitized loan pools to help sell the bonds  - Even if they have to hold their noses to do it.  And we in the investor public can only blame ourselves if we trust them.  

March 19, 2013

CMBS 2.0... 3.0... X.0?

This summer will be the three year anniversary of the passage of the Wall Street Financial Regulatory Reform Bill, aka the Dodd-Frank Act.

The bill laid out goals for the reform of CMBS: requiring issuers to have “skin-in-the-game”, requiring greater transparency, reducing conflicts of interests, and increasing the oversight powers for the holders of the mortgage backed bonds, etc.

It's natural for those of us far from K Street, the DC confluence of the Federal government and Wall Street, to assume these reforms are in place. And are they? ... no...not quite...surely, some of them are in place??

No, not even close! 

The earliest any Dodd-Frank mandated regulations could be issued is later this year. And even then these rules will not take effect for two years after adoption.
The CMBS 2.0 changes to the loan pooling process, agreements, ratings and underwriting have so far been voluntary.  CMBS 2.0 was a way to patch up a leaking boat to get the bond investors back on board.  Market participants now see these minor voluntary CMBS 2.0 changes being dissipated by market forces.  
Six Federal Agencies are involved in crafting the proposed risk retention rules; the FDIC, the Federal Housing Finance Agency, the Federal Reserve, HUD, the SEC, and the Treasury Department.  

Fine example of the economic principal of “Regulatory Capture”

The various interests in the CMBS industry, the originators, the issuers, the servicers, and to a far lesser extent the investors who buy the bonds (forget about the borrowers and the mortgage bankers), have the ear of different regulatory agencies... and are having these advocate-regulators pull the process of “reform” in different directions. This regulatory uncertainty is not good for the commercial real estate finance industry, but for some of the players involved a stalemate preserves the status quo, which is a win. Certain proposed regulation could blow current players in the CMBS market out of the water. The consequences of regulation on a largely unregulated industry could be enormous.  So considerable lobbying effort and funds are being deployed. 

Nothing is final, however, a semblance of a compromise is being put forward on the risk-retention part of the Dodd-Frank regulations of CMBS:

Original Concept in Dodd-Frank
First Loss Piece to be held by issuer
First Loss Piece to be held by B-Piece buyer
Risk Retention to last for 10-years           
Risk Retention to last for 5-years
Issuance Profit to be added to Risk Retention
Issuance Profit can be pulled out up-front
Amount of retention = 5% of “Pool” value
Uncertain: Issuers want 5% of “Nominal” value

The Lobbying Battle to substitute a single word... “Nominal”
Millions of dollars of lobbying is being spent on the effort to insert one word into the Dodd-Frank regulations.: That word is “Nominal”.  The CMBS industry issues various classes of bonds with a single blended return. These tranches of bonds sell at various premiums or discounts based upon the priority they hold in receiving cash flow from the mortgage pool.  Holders of triple-A rated bonds get paid first, then comes the next lower rated bond holders, and so on.  The last one to be paid, the holder of the first-loss position holds the B-Piece.  Under CMBS 2.0 the B-Piece buyer holds all the bonds below “Investment Grade”, i.e. below BBB-.  Thus the B-Piece is the insurance policy for the investment grade bond holders

The securitization world loves to talk about the “Nominal” value of bonds.

If 7% of the bonds stand to be wiped out before you lose a dollar, that sounds much better than if the bonds standing behind you are discounted by 30 cents on the dollar. 

The typical B-Piece, the below investment grade portion of a securitization is about 7% of the face amount of the bonds, but only 1.5% to 3.0% of the money raised.  This means that the holders of the investment grade portions of a securitization have a cushion of protection that does not even add up to the securitization profits plus the costs of issuing and selling the securities.  To get this slimmest modicum of insurance, the buyers of the investment grade portion of a CMBS issuance are putting up more than the face amount of the mortgages and giving away substantial returns. 

Conclusion:  Buyers of investment grade rated bonds are paying more than the total of the face amount of the loans. 

CMBS Loan Pool Economics - Typical - Simplified
Pool of Loans Total Principal Balances 100.0%  
Total Bond Proceeds (sale of securities and servicing) 104.8%  
Cost of Securitization 0.8%   Rough Guess - ratings, legal, sales commissions, etc.
Profit to Conduit 4.0%   Based on Industry Reports of 2% to 5% typical profit.
Example - NorthStar Realty purchased $74 million B-Piece of $1.14 billion securitization for $23.3 million. (Morgan Stanley, BofA Merrill Lynch Trust, 2013-C8)
Face Amount
Cents/Dollars Discounts/Premium
% of Capital Raised
% of Loans
Face Amounts
Typical Subordination - Below BBB
 $                       0.31
Investment Rated Bonds (plus sale of Servicing)
 $                       1.05
Getting investors to line up to buy the bonds (most of the recent CMBS issues have been oversubscribed)... now that is the real financial engineering.

February 13, 2013

Newmark Realty Capital’s Correspondent Lenders start 2013 with Large Production Goals


Commercial property borrowers can look forward to another good year in 2013!  

Money is cheap and plentiful.  Yields are low but for life insurance companies and other lenders looking to make long term fixed rate investments, commercial loans offer relatively high risk-weighted returns versus corporate bonds, government bonds and other fixed income assets.
Banks, CMBS originators, the GSE’s and life insurance companies all have big appetites for 2013. 
2013 California Correspondent Lenders Targets
The banks are now generally healthy and needing to lend.  The CMBS world is achieving pricing that is getting near that of the life companies.   New issues of CMBS bonds are selling well and the conduits are beginning to use some of their old underwriting tricks.   For deals that need max proceeds once again they are the lenders of choice.

Each of Newmark Realty Capital’s correspondent lenders is either holding or increasing their production goals for 2013 over 2012. 
Most of our life insurance commercial mortgage departments are being told by their Chief Investment Officers, bring it on! If the mortgage department meets its production targets for 2013 early in the year those targets will be raised.   We do not expect to see any life insurance lenders going out of the market in 2013.

Looking back on 2012

These higher targets come after a strong performance on our industry last year. Mortgage Banker’s Commercial Property Loan Production for 2012 was up 24% over 2011.
20112012% Change
Life Company & Pension Funds
$49 B
$49 B
$58 B
$82 B
$22 B
$32 B
$55 B$65 B18.20%
Total$184 B$229 B24.40%

January 1, 2013

It’s the Deficit, Stupid...

My alarm clock went off the other day and the radio came on to an interview by Rachel Martin with Thomas J. Wilson, CEO of Allstate, who was speaking on behalf of the organization, Campaign to Fix the Debt.

This was an interview I wanted to hear.

Allstate is an important correspondent lender for my company, Newmark Realty Capital. They are a no-nonsense Midwest firm, well respected: When their leaders speak, people listen. I find Allstate’s management more prudent in their remarks than most insurance companies, who as a rule, are generally quiet and considered in their public profiles.

With the “Fiscal Cliff” looming, I was hoping to hear a grand plan - a solution that would break the stalemate and lead to long term deficit reduction. But, what I heard was a simple plea for the public to make it clear to our politicians that deficit reduction needs to be a high priority. Tom Wilson also stressed that a solution would not be hard if our leaders can take a balanced approach, cutting spending and raising revue. Our politicians simply need to do their jobs, i.e. compromise for the sake of our nation.
Politicians all learned years ago "it's the economy, stupid...". Candidates who ignore the plight of the unemployed do so at their own political peril, so during the last campaign to talk about belt-tightening to fix the deficit was a political no-no. We are now in a time of unprecedented fiscal and monetary stimulus, designed to butter the bread of voters in the here-and-now. Little attention is being paid to the tab that will be paid by our children for today’s deficit spending. And as I blogged in June 2012 and August 2011, too little attention is being paid to the distorting effects on our economy from unprecedented and untested credit-market manipulation by the Fed for short-term political gain.

We have a window of time to make a difference.

The candidates of last year are no longer candidates - they are elected leaders. The members of the House and Senate need to turn their heads around and start leading. They need to stop pandering and start making tough compromises for the sake of the nation. Not the nation of the next election cycle, but the nation our children will inherit.  Putting off any meaningful spending cuts for two months, accomplishes nothing.

If our elected officials cannot do their jobs, then our country will need the, now postponed, arbitrary spending cuts of the Fiscal Cliff. Our Federal Budget has become morbidly obese and will need gastric banding, a drastic measure not recommended for those who can lose weight through measured diet and exercise. A drastic measure for a Congress that cannot push itself away from the table.

And our media does not help. Pundits of both political persuasions hype the conflicts that lead to inertia, and focus the public’s attention on the hunger that will follow any belt tightening. Listening to the news the other night, I heard this remark from a reporter, “Europe has proven austerity does not work. Their economies are stalling and unemployment is rising. We cannot go down that road.” With other words, if you diet, you get hungry. Well, duh. But, if you do not control yourself, you will eventually be put on a forced diet, like Greece. We cannot go down that road.

Our corporate CEO’s are saying it, and our real estate industry leaders should should shout it out too... “It’s the Deficit, Stupid!”