Smaller U.S. banks may need $12 billion to $14 billion in additional capital to cope with troubled loans still on their books, the Congressional Oversight Panel said today in a monthly report.

The weakness of smaller banks is evident in the number of banks that have been closed by the FDIC. That’s not to say that only small banks are being affected. Corus Bank seems posed for an eminent FDIC takeover.

Mish details the woes of some of Georgia’s banks in Zombie Subdivisions and “Pig In The Python” Shadow Inventory.

The Atlanta Journal Constitution is reporting fire-sale prices on some lots have dipped to 20 to 30 cents on the dollar as the Volume of ’subdivision’ vacant lots overwhelms banks.

You think it’s hard selling a house these days? Try unloading a subdivision. And not just any subdivision, but one with few if any completed homes and a weedy patch where the swim-and-tennis center was planned.

That’s the reality many Georgia banks find themselves in amid a foreclosure crisis that has claimed not only individual homes but also entire failed developments.

Real estate investors are seeing their equity erode. This is causing some of them to threaten/warn of imminent default. And we may continue to see more of these defaults as time goes on.

Phoenix From the Ashes?

The Dirt Lawyer may have identified the silver lining in all of this where he writes:

While I agree we are waiting for some properties to “die,” in a sense, I take a more phoenix-like perspective to the whole thing. After all, the property is reborn by its transfer to a new owner. So I like to think of this as the bottom of an evolutionary cycle, after which a lender dumps the property to a new buyer on the cheap or holds it for a while. As I keep saying, however, the problem, at least for many prospective buyers, will be finding money, because traditional lenders are not lending much and the CMBS market — well, we’ll see when or if that phoenix arises.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Small Banks Still Facing Trouble

“The question really is how quickly will this adjust? When will rent come back, when will cap rates reduce and when will the fear be out of the market? Fear is a lot more of a powerful emotion than greed,” said Gosin. “You can control greed to a certain extent but you cannot control what you do under fear.”

Gosin also noted that banks have assets left on their balance sheets to refinance some of the loans, but the financial institutions are putting other concerns first.

“In addition to real estate, banks are concerned about consumer lending and they’re concerned about revolving credit,” he said. “With everything assaulting the banks, they are still hoarding cash and as a result they are not very easily going to roll over some of these loans.”

There is truth in Gosin’s statements. Investors are gripped  with fear.

Existing investors are frozen by the uncertain future for rents, vacancy, and interest rates. Many see the value of their property decreasing and they are uncertain of what to do.

Investors with capital are cautious and are only investing in projects that have very little downside.

Take for instance the Yellowstone Club in Montana. GlobeSt.com reports that the Yellowstone Club Trades for $115M.

The new owner is Boston-based CrossHarbor Capital Partners, a joint venture of Discovery Land Co. and members of the Yellowstone Club. Discovery Land Co., based in Scottsdale, AZ, developed the Kukio Resort, a private club on the Big Island of Hawaii in partnership with the Honolulu-based Kobayashi Group, according to published reports. CrossHarbor managing director Sam Byrne, who previously invested approximately $200 million in Yellowstone Club real estate, offered to buy the club last year for $470 million, according to reports.

Buying a property for 25% of what you offered last year is a pretty good deal.

CoStar reports that Macquarie Selling 75% Interest in 86 U.S. Centers for $1.3 Billion

CalPERS said that this portfolio is substantially comprised of the same shopping centers it sold to Macquarie in a 2005 portfolio transaction, under which Macquarie acquired a 75% interest in 100 centers from CalPERS/First Washington for an amount reflecting a total portfolio value of $2.74 billion.

The purchase is at a significant discount to what was paid in 2005 and reflects Macquarie’s desire to focus on Australia and New Zealand.

Unfortunately, government meddling only aggravates the uncertainty in the market. If the markets were left to correct on their own, investors could act based on historical trends. However, with Uncle Sam slapping the Invisible Hand of the market investors are unable to predict how long they will have to hold out.

Until the fear resides it is going to be a rough ride. Hold on to your hat.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Gripped by Fear

One of the most difficult tasks for commercial real estate professionals is determining where the market is today. Too few transactions, too much distress, unrealistic sellers, and opportunistic buyers make the demand for property and the proper pricing of property an exercise in futility.

Determining a rate of return commensurate with risk is difficult in these uncertain times.

Three news stories illustrate this point.

Retail Center in Vallejo, CA

GlobeSt.com is reporting that the First Grocery-Anchored Sale Closes, More to Come. The article details the sale of a 66,000 square feet Safeway anchored center in Vallejo, CA.

According to the article the property sold based on a 7.71% cap rate on current NOI. As well, the seller had an assumable loan at below market rates providing an attractive cash-on-cash return for the buyer.

The cash yield seems to be the bigger selling point. Dan Wald of Terranomics said that investors are requiring a 10% cash yield on investments.

While this property gives us an idea of the value, it is not a firm indicator. This center is well located at the entrance to a housing development. A superior location would induce a buyer to pay a higher price for the lower risk.

AIG Headquarters in Manhattan

CPN is reporting that the AIG Headquarters Sale Makes Splash in Quiet Manhattan Investment Market. (HT: David Stejkowski)

Youngwoo & Associates (YWA), a New York-based investment and development firm, together with Kumho Investment Bank (Kumho), entered into an agreement to acquire the AIG building, 70 Pine Street (pictured), and an adjacent office building, 72 Wall Street. The two buildings will total 1.4 million rentable square feet in the heart of Manhattan’s Financial District.

The rumored salesprice is around $100 million. This would value the property at around $100 per square foot.

While this may be the biggest acquisition in New York, the entire property is going to be vacated once AIG is wound down. This again doesn’t establish a firm enough foundation for other investors.

Office Building in Orange County, CA

The WSJ has an article explaing why Maguire Sells Office Site at 40% Off.

Maguire Properties Inc., a struggling Los Angeles-based real-estate investment trust, sold a newly developed office building in Irvine, Calif., for about $160 million, a price representing an estimated 40% discount to its construction cost.

The price of 3161 Michelson Drive, during a lean year for commercial real-estate sales, is the latest sign of the severe drop in values in the commercial real-estate market, which is threatening to become a major anchor around the economy just as it is struggling to come back to life.

This property like the AIG bulding suffers from vacancy issues. As well the seller was under pressure to reduce their debt load and needed to sell the asset.

The Bottom Line

Each of these sales while indicative of the current market demand and supply are not conclusive enough to determine a market pricing strategy.

Until owners begin to sell non-distressed assets, market pricing will be a moving target.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Mark to Market – Valuing Commercial Property Now

Real estate investors are still interested in purchasing prime real estate in a great location.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Walnut Creek Chili’s Property Sold

Here are some of his thoughts on the length of the current recession:

We think job losses and the recession will end in 2009. We’re expecting that job losses will bottom by the third quarter, perhaps into the fourth quarter. For 2010, if you look historically, we’ve had plenty of instances where sharp declines and severe and sudden recessions have been followed by years of growth spike and better-than-average growth — especially the first year after a recession. But this time around, we still have a significant amount of consumer debt to unwind and we’re still dealing with a lot of headwinds in housing and corporate debt. I don’t think 2010 will bring an economic spike.

Nadji acknowledges that retail is going through some issues and may not recover until 2011 or 2012. He ascribes this to a problem of overbuilding in the retail sector.

On Distressed Property

We also need to know how much distressed inventory is going to appear and move through the market. I believe a lot of buyers with lots of cash are sitting on the sidelines looking for signs of an economic bottoming and waiting to see the scale of distressed property sales. Over the next six months, we’re going to get a better reading on the market because both financial institutions and owners of properties are still having stress and they’re going to have to decide what to do with those assets. I think there will be more motivation to sell at more realistic prices than there was a year ago.

…

One or two high-profile deals are not going to refine the market. Its going to take a little more volume, and a sampling of different asset sales in different places starting to trade, for it to become more of a widespread conviction that it’s time to get back in.

Using Cap Rates in Today’s Market

Nadji that cap rates are not as important as they once were in the realm of commercial real estate.

That’s not to say that no one thinks about cap rates anymore — they certainly use it as a metric — but you have to look at return on cash, number one, and using the new underwriting parameters to clear this market for financing, which requires more equity up front and much more realistic rent growth projections and occupancy projections. That would lead you to look at the return on investment for years year one through three in terms of cash flow, which is right now far more important than just a cap rate, which you can come up with in so many different ways.

RTC 2.0?

Nadji doesn’t believe that the current recession and distress in commercial real estate will lead to a second coming of the RTC.

Rather, the forces are working to minimize foreclosures, and therefore this notion of an RTC 2.0 that will bring quality assets to market at huge discounts may not materialize the same way.

He suggests that there are still quality deals available that have cash, can underwrite to today’s rent and occupancy rates, and are seeking to add value to their projects.

This is a post from Peter Maclennan's blog Peter Pays Paul.

A Different Recession Produces Different Results

The Wilder Project in Orinda, CA is facing legal challenges according to Orinda project stumbles over another legal hurdle – ContraCostaTimes.com.

The lender for a luxury residential subdivision in Orinda’s scenic Gateway Valley has sued the site’s developer, seeking to foreclose on the project, which in February staggered into default on its $180 million mortgage.

The 1,600-acre Wilder project has a murky outlook now that the loan default, the lawsuit and a court’s decision to place Wilder into receivership have coalesced to create a number of fresh financial and legal obstacles for the development, which was first proposed two decades ago.

Merrill Lynch Mortgage Lending Inc. sued OG Property Owner LLC, the developer of the Wilder project, on April 7, Contra Costa County court records show.

OG Property planned to build 245 homes, an arts and garden center, five sports fields, a fitness and pool center, a city corporation yard, and preserve 1,400 acres of open space. The homes were pegged for sale at $3 million to $5 million each.

The Contra Costa Times is reporting that the project has been in the works for over 20 years and has faced many similar obstacles.

To make matters worse,

A dozen contractors, however, have filed liens against the property, claiming that the developer has not paid them for their work. The combined money owed to contractors, court records show, is $17 million.

It appears that a major investor is looking to buy out Merrill Lynch’s note. Barring this the project is likely to be tied up in court for some time.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Wilder Project in Orinda Faces Legal Hurdles

Lenders filed a record number of mortgage default notices against California homeowners during the first three months of this year, according to the research firm MDA DataQuick.

The company blamed the recession and of lenders playing catch-up after a temporary lull in foreclosure activity. A total of 135,431 default notices were sent out during the January-to-March period, an all time high in the  company’s database which goes back to 1992. That was up 80.0 percent from 75,230 for the prior quarter and up 19.0 percent from 113,809 in first quarter 2008, according.

According to the DQNews.com article Golden State Mortgage Defaults Jump to Record High:

The median origination month for last quarter’s defaulted loans was July 2006. That’s only four months later than the median origination month for defaulted loans a year ago, in first quarter 2008. That suggests a period where underwriting criteria were particularly lax.

Of the 3.7 million home loans made in 2004, less than 1 percent have since resulted in a lender filing a default notice. Of the 3.7 million loans originated in 2005, 4.9 percent have triggered a default notice so far. Of the 3 million in 2006, 8.5 percent have so far resulted in default. A particularly toxic period appears to have been August through November 2006 which had more than a 9 percent default rate. Of the 2.1 million loans made in 2007, it’s 4.6 percent – a percentage that’s likely to rise significantly during the rest of this year.

The lending institutions with the highest default rates for loans originated in August to November 2006 include ResMAE Mortgage (69.9 percent of loans resulting in a default notice), Master Financial (64.6 percent) and Ownit Mortgage Solutions (63.6 percent). Of the major lenders, IndyMac has a default rate on those loans of 18.9 percent, World Savings 8.0 percent, Countrywide 7.7 percent, Washington Mutual 6.3 percent and Wells Fargo 3.4 percent. Less than 1 percent of the home loans originated in late 2006 by Citibank and Bank of America have since gone into default.

The DQNews.com article also reported:

Foreclosure resales have emerged as a significant market factor, accounting for 58.1 percent of all California resale activity last quarter. A year ago it was 33.1 percent. Foreclosure resales varied significantly by area, from 13.0 percent in San Francisco County to 80.8 percent in Merced County.

Real estate values have not settled in California. This new “wave” of foreclosure notices is going to cause uncertainty in the markets for a while. This combined with the “shadow inventory” of as many as 80,000 homes reported by SFGate.com will keep prices depressed and may drive them lower.

This is a post from Peter Maclennan's blog Peter Pays Paul.

California’s Foreclosures Soar

Owners of several small commercial buildings in San Francisco already are behind on payments, and local industry observers are laying odds on which large property could be the first to be seized by a lender.

…

“Real estate fundamentals are softening dramatically,” said Richard Parkus, research analyst at the German bank. “Over the next 12 to 18 months, we expect to see pretty significant deterioration.”

Of particular concern for San Francisco is the fact that nearly 75 percent of the Class A – premier – office buildings downtown traded hands in the past four years, according to Tove Nilsen, director of market research at Colliers International. The flurry of activity propelled sales prices to record highs and drove the ratio of rental income to cost to all-time lows.

According the article vacancy in San Francisco has risen by 32% from the 1st Quarter of 2008 to the 1st Quarter of 2009.

Marcus & Millichap predicted in their 2009 National Office Report a rise in vacancy of 400 bps to 15.1% in 2009 for San Francisco. As well, they predict that effective rents could drop as much as 10.7%.

Falling rents and rising vacancies will drive the value on a leased office property lower. Lower values make it more difficult to obtain financing.

Another factor that is hurting owners’ ability to refinance is rising cap rates. Investors are acknowleding the greater risks inherent in real estate and are expecting a greater return. This desire for a greater return is driving cap rates higher.

It may be a while before we see the end of the commercial real estate cycle. Properties that provide a strong cash flow now may still be a good buy. Don’t expect to find financing in today’s market for a property that cannot service the debt at a ratio of $1.10 of income to $1.00 of debt service. More institutional lenders are requiring even hire debt service coverage ratios of 1.3 or greater.

This is a post from Peter Maclennan's blog Peter Pays Paul.

San Francisco Offices Facing Foreclosure

• The WSJ covers the Treasuries new plan in: Treasury Releases Details on Program to Buy Troubled Assets
• Calculated risk writes CRE: Cap Rate Expansion
• Retail News Blog explains: The Role Of An Appraiser
• CoStar warns of: The Return of the Miserly Lender
• Square Feet informs us that Moody’s Commercial Property Price Index Posts Large Declines
• Bloomberg. com is reporting that Defaulting Commercial Properties Hit Banks on Vacancy-Rate Rise

This is a post from Peter Maclennan's blog Peter Pays Paul.

Tuesday’s Recommended Reading

In a groundbreaking ruling as well as a rare victory for common sense and the overall good of taxpayers, Bankruptcy Judge Rules Calif. City Can Void Union Contracts.

In the first ruling of its kind, a bankruptcy judge held the city of Vallejo, Calif. has the authority to void its existing union contracts in its effort to reorganize, holding public workers do not enjoy the same protections Congress gave union workers at private companies.

If you recall, the city of Vallejo, CA filed bankruptcy over the high costs that it was having to pay for public services. I wrote more about the problems facing California’s cities here and here.

This is a post from Peter Maclennan's blog Peter Pays Paul.

Vallejo Can Void Union Contracts