Dark clouds and silver linings for investors

Real Estate Weekly, Nov 13, 1991 by Robert E. Waldron

Dark clouds and silver linings for investors

There are dark clouds looming on the horizon of the New York metro area's real estate investment market.

While we're not predicting "doom and gloom" for the area - because every market provides opportunities - we're not promoting false optimism either.

Our position is that an honest reality check reveals what every astute real estate professional already knows: there are extremely difficult challenges ahead, not for the next six months or the coming year, but for several years down the road.

Despite various official pronouncements to the contrary, the New York metro area's real estate problems are not over. In fact, they are just beginning.

Billions in Loans Due

Right now several billion dollars worth of real estate loans in the metro area are coming due. Many property owners and investors are not in a position to meet these payments and consequently, face the banks in a classic stand-off. The banks are threatening foreclosure: the owners are threatening bankruptcy.

To clarify and better understand this situation, let's look back at the mid-1980's, when many S&L's, commercial banks and other lending institutions were aggressively building their bottom lines.

Property Appreciated Dramatically

Since real estate was appreciating dramatically, these financial institutions weren't overly concerned about the value of the properties they were lending against. They were giving borrowers new five- and seven-year "bullet" loans with high loan to value ratios and collecting substantial points up front.

Business may have been booming, but the real bottom line was that many of these loans were shaky to begin with.

At the same time, real estate syndicates were busy purchasing properties, not for realistic returns but in order to sell tax write-offs to entrepreneurs and business executives searching for deductions. This created false property values.

Tax Reform Hits Hard

Then came the 1986 tax law. Suddenly, many investors lost write-offs and consequently stopped meeting their financial obligations under investor notes. This in turn sounded the death knell of many syndicates because - having guaranteed investor notes to the banks - the syndicates now had to use up their lines of credit to pay off the guaranteed notes.

Eventually, the financial shock waves caused by tax reform worked their way through investors, the banks and the syndicates, causing the real estate market to drop to the point where today, many owners have no equity in their property because their mortgages exceed the value of the property.

This problem is compounded by the fact that the owners can't refinance because their current income isn't sufficient to meet the mortgage payments. Additionally, the owners face another brick wall: they can't profitably rent space because of the serious glut of office space in the city and outlying suburbs.

Add to this mix the metro area's fiscal problems and the fact that, in contrast to the last recession, currently there is no healthy influx of foreign real estate money or investment activity on the part of real estate syndicates to drive property values up.

Owners and Banks in Stand-off

In other words, welcome to 1991 and the increasing stand-off between owners and banks. In one corner are the owners, facing the dire prospect of being wiped out by bank foreclosures. They also are threatening to declare bankruptcy in order to tie up the banks' real estate assets in court for years. This strategy basically is an attempt by the owners to, among other things, delay facing their investors with bad news resulting from the consequences of a tax reversal.

In the other corner are the banks, under government pressure to write-down loans that are not current and more prone than ever to "bite the bullet" by foreclosing the properties and selling or leasing them for whatever prices they can obtain.

The attempted solution to this stand-off, at least during the last two years, has been the "workout," with firms such as Waldron Associates working on behalf of banks and owners to turn the troubled properties around. For example, this includes providing assistance in restructuring debt, advising one or both parties in bankruptcy proceedings, negotiating new leases, marketing properties for sale, and more.

Representing both banks and owners, we've encountered a wide variety of complex workout scenarios ranging from cashflow mortgages (cash remaining after paying operating expenses is applied to the loan's interest while the principal continues to accrue) to situations where banks have offered owners additional loans to meet their existing mortgage payments.

A Losing Battle

However, despite the fact that banks traditionally try every available avenue to avoid foreclosure, they face many obstacles in what appears to be a losing battle: tighter federal regulations to write down loans; building owners with little or no equity in their properties who offer no prospect of being able to meet mortgage payments; and a depressed leasing and sales market.