Wednesday, April 14, 2010

Commercial Real Estate Losses: The Next Shoe To Drop

The U.S. economy ought to be thought of as a millipede.  It keeps dropping so many shoes, that it must have 1,000 feet!  The latest bad news, and not really factored into the unraveling fabric of the global economy, is the ongoing crash in commercial real estate.

The latest victim is none other than Morgan Stanley, or more accurately, the firm's clients, whose investments in one of its commercial real estate funds, have just learned that their $8.8 billion investment has now suffered a loss of a mind-numbing $5.4 billion dollars!

That would likely make it the largest  loss in the history of private-equity real-estate investing.  Over the past 20 years, Morgan Stanley's real-estate unit was one of the biggest buyers of property around the world, initiating $174 billion in transactions since 1991.  The firm's unfortunate clients include pension funds, college endowments and foreign investors.  The losses came from investments in properties such as the European Central Bank's Frankfurt headquarters, a big development project in Tokyo and InterContinental hotels across Europe.

The soured investments, made by the Msref VI International Fund, continue to be a sore spot for Morgan Stanley, as it tries to extricate itself from complex deals around the world.  In many cases, the company can't walk away from  the poor investments because the fund made billions of dollars in guarantees.

The struggling Msref VI fund once projected a 22.1% average annual return on its commercial-real-estate deals around the world.  It would appear safe to say that those projections won't be met (sarcasm intentional!).

During boom times, the fund generated fat fees for various segments of the bank.  In 2007 alone, Morgan Stanley grabbed $104 million in acquisition fees, $22 million in fund-management fees, $13 million in financing fees, $36 million in real-estate-management fees and $21 million in financial-advisory fees, according to fund documents reviewed by the Wall Street Journal.  The firm has not offered to disgorge those fees, but I'm sure they will put investors interests ahead of their own (sarcasm intentional!).

In South Korea, Msref VI projects a complete loss of its $350 million investment in an office building called Seoul Square, according to fund documents.  An investor group, led by Msref VI, acquired it in 2007 for $1 billion — the highest price ever paid for a Seoul office building.  The fund would prefer to walk away from the deal, but can't before making good on $91 million in renovations, guaranteed interest payments and other obligations.

Market analysis by the Congressional Oversight Panel (COP), which monitors the government’s Troubled Asset Relief Program (TARP), shows that $1.4 trillion in loans made over the last decade for retail properties, office space, industrial facilities, hotels and apartments will reach the end of their terms and require refinancing between 2011 and 2014.

The analysis forecasts that aggregate losses from defaults on commercial real estate loans maturing in the next few years could go as high as $300 billion, threatening to topple nearly 3,000 community banks nationwide.

The COP says community banks, rather than large Wall Street institutions, face the greatest risk of insolvency due to mounting commercial real estate (CRE) loan losses.  According to federal guidelines, 2,988 banks nationwide are classified as having a “CRE Concentration.”

Another day, another disaster.  These dropping shoes need to be used to kick the Washington cabal's behinds.  Instead, the global financial community is made to suffer.

Marko's Take

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  1. It's worse than that. There's something on the order of $1.3 trillion in commercial re loans coming due in waves over the next 3-5 years for loans made at the tippy-top of valuations and at 80-85 cents on the $. Today, those valuations are conservatively down 30-45% and the banks won't lend more than 55 cents, so you're looking at massive foreclosures or new money to refi--except, if you're the new money, won't you just wait for the fire sale? OTOH, one of the reasons banks aren't lending today (aside from the obvious that there aren't creditworthy borrowers) is that they've seen this coming and have been reserving like nobody's business the past 18-24 months. I think the banking system is likely to be relatively safer than you think.

  2. DHH

    There are so many hidden losses in the banking system, that I think the insolvency wave still has a long way to go...but, time will tell.


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