How good properties go bad...its the financing stupid.

Implications: With the current financial problems causing havoc in all sectors of the economy its easy to point fingers at the world of real estate, both residential and commercial. The real problem all started with overly aggressive financing which unfortunately, as we are witnessing, can turn good real estate in bad real estate. When multiple billions of dollars of commercial real estate are traded and the underlying fundamentals of the property’s cash flows hasn’t changed much, what is the one variable that is different? You guessed it.

Analysis:  I have to laugh at the media reports and others who are saying commercial real estate is the trigger that has taken down the major investment banks and the largest insurance company. Of course it has nothing to do with credit default swaps and hedge funds whose best interests have been all along the short selling of the instruments designed to hedge bad bets. Just today it was announced that WAMU is done. Gee what a surprise...NOT. They started the 1% teaser rates for home mortgages. They were one of the biggest proponents of that debt instrument. As for me, they deserved to go under.  

This has everything to do with buyer’s greed in trying to leverage every last nickel out of a good piece of performing real estate which had the lenders stamp of approval because they weren’t going to own the loan anyway. Let the next guy worry about it has been the mantra of almost every lender. Lets approve loans that are based not on current income of a property, but rather some totally unrealistic cash flow projection which is using the last 3 years rent spikes as a normal scenario. Lets not lose sight of the fact that for the past 5 years after Alan Greenspan reduced interest rates to historically low levels, levels that any intelligent business person would have seen as temporary, and as money was being pumped into the system at record levels, would cause ASSET INFLATION the likes of which had to be considered an anomaly. But the lenders did not care, the brokers did not care, and most of all the buyers did not care. All did not care due to their greed and arrogance.  

So back to the beginning, when a commercial property has in place tenants who have been paying their respective rents even if those rents were from 2-5 years ago, why would a buyer try and squeeze that cash flow to achieve which would be arguably a highly leveraged and risky return? We all know the answer.  

So a perfectly stable property with a stable tenant roster can go from being worth X in 2004 to being worth 5X in two short years. Why it is now worth 5 X, is only due to the financing which allowed the new buyer to pay that 5X amount. So what happened is the financing threw the property into under performing status, and the mortgage into default, and the bond holders saying how could have this happened? So why are all these mortgages being devalued...because of the crisis in confidence from bond buyers not really knowing what it is they are exactly holding or owning. This started with sub-prime and spilled over into commercial and other parts of the securitized financing world.
The Wall St geniuses spoiled the party with their greed and fancy financial instruments. And no one, except for a few us veterans of the industry, saw this as a catastrophe waiting to happen.  

So when we read all this news about how the mortgages which have been turned into bonds are going down in value, it has nothing to do with the basic real estate. It has to do with the bond market. Unfortunately because all of real estate and all of the business world is dependent upon the unobstructed flow of capital mainly through the use of debt, the collateral damaged that is being caused is off the charts.  

The vultures will swoop in, because they know at the end of the day, if they can buy or buy back those properties at 2X or 3X they will have a solid investment. That is if this crisis gets resolved without too much damage to the general business world.  

And for those who say in the article that CMBS lending won’t come back until late 2009 or 2011 or whatever date they want to pick are also dreaming. The CMBS market has been irrepealably harmed and will not be resurrected in a form remotely similar to what we have seen before this crisis.