Fitch explores the 'contradictions' of U.S. multifamily CMBS

I haven't read the Fitch report, Reuters reported that there is one out there asking the tough questions about why multifamily has the biggest loan performance problems despite improved property performance and gives NY as an example:

A notable example is New York City. Despite being the second-best performing city in the Case-Shiller index, the city has four big problems in multifamily CMBS; Stuyvesant Town/Peter Cooper, The Belnord, The Savoy and Riverton, the underperforming loans of which total $3.6 billion.

I'm going to take a stab at the answer for at least these four. The business plans were almost comical in their overconfidence in their ability to kick out rent control tenants and replace them with market tenants, they were highly overleveraged and underwritten to future revenues that never materialized, and they were breaking the law and evading taxes.

Improvements in Multifamily sector driven by NYC MSA

Herschmeyer at Co-Star notes:

Removing these loans [see list below] reduces the multifamily Fitch Loan Delinquency Index from 14.4% to 9.3% at the end of 2011. This moves multifamily from the worst performing of the five asset classes to the middle of the range with office (6.8%) and retail (6.9%) being the best performers and hotel (12.0%) and industrial (10.25%) being the worst.

In 2006 and 2007, issuers underwrote fixed-rate multifamily loans with stabilization plans, whereby rent stabilized units were converted to market. These loans, Stuyvesant Town/Peter Cooper Village ($2.8 billion), The Belnord ($375 million), Riverton ($225 million), and Savoy Park ($210 million) for a total of $3.6 billion did not see their stabilization plans pan out.

I might add to that last paragraph, "because each of the aforementioned projects were blatantly attempting to evade taxes, break NY state law, and all had ludicrous plans based on the expectation that they could simply kick out the rent control tenants and replace them with market rents - a strategy that has parted fools with their money for nearly a century". But I wasn't consulted, so I'll keep my thoughts to myself.

Riverton Auction - $125mm

Trustee won at $125mm, next closest was $121.1.

4) BN 11:22 *WELLS FARGO ACTING AS TRUSTEE FOR RIVERTON DEBT HOLDERS
5) BN 11:20 *WELLS FARGO WINS RIVERTON AUCTION WITH $125 MILLION BID
6) BN 11:19 *WELLS FARGO WINS AUCTION FOR NEW YORK'S RIVERTON APARTMENTS

6/1/09 Appraisal was $108k.
Outstanding Loan is $225k
2008 NOI was $4.4mm

Riverton headed to auction

Riverton was back in the news today.

Riverton, like a number of complexes during the real estate boom, was bought for top dollar in 2005 by a company led by the developer Laurence Gluck, who had a plan to increase profits by replacing tenants in rent-stabilized apartments with market-rate tenants.
...
Lawyers familiar with the Riverton foreclosure said the sale would probably take place in March. Several groups have expressed interest in buying the property, which has 1,228 apartments in seven buildings, many of them surrounding a 700-foot-long grassy mall. But it is unclear whether any of them will offer enough money to satisfy the lender, which is represented by Wells Fargo Bank.

“We’re very interested in buying the property,” said Adam Holland, president of Jackson Management, who heads a group of investors who are circling the complex. Like Stuyvesant Town and Peter Cooper, Riverton was built in the 1940s by the Metropolitan Life Insurance Company. It sold Riverton in 1976 to Jack Holland — Adam Holland’s grandfather — and Charles A. Vincent for $12.5 million.

They, in turn, sold it to Mr. Gluck of Stellar Management in 2005 for $135 million. A year later, Mr. Gluck refinanced, getting a $225 million mortgage and a $25 million loan. That enabled him to recover his initial investment of $44 million and collect tens of millions of dollars in profit.

See history on Riverton here

Riverton Appraisal Update

The Riverton Apartments in CD 2007-CD4 was one of the first headline defaults in CMBS due to overly optimistic proformas and more importantly, a rent-control flip plan by some private equity group. These will continue hitting the news wires and be a main focal point for CMBS defaults for news outlets over the next 6 or so months - just wait.

The Appraisal came in much lower than expected, though, according to a Citi report out last week (sorry no link). Appraised at $340mm in Jan 2007, by some guy who hopefully has since lost his job, the June 2009 appraisal came in at just $108mm - still just a 4% or 5% cap rate. Interest shortfalls are eating into the O class.

Sunny Day Real Estate - ProForma Underwriting

Sunny Day Real Estate was the original emo band of the '90s - The cover art is of the "Bronze Angel" in Vancouver, which I've always suspected was actually a Valkyrie, rather than an Angel, which scoop up the deserving and bravest heroes off the battlefield.

Proforma loans were less pervasive than the media would have you believe, but they are going to cause significant pain in the CMBS universe. There were about a dozen deals where more than a quarter of the loans were underwritten with some form of proforma underwriting. This came in two primary flavors:

• Cash flow proformas - Property lease rolls indicated that new lease rates would be significantly higher. This was common in NYC Office where old $30 psf leases rolling over the next few years were underwritten using $100+ psf leases - most of these are more likely to be in the $60-70 psf area assuming things don't get much worse than they already are. Also common in NYC Multifamily where the landlords devised the strategy of kicking out rent control tenants and replacing them with market payers. The loans typically required a significant debt service reserve account to be set up in advance to cover the planned shortfalls in mortgage debt service - a lot of these accounts will dry up in the next 12 months (a few have already: Meyberry, Riverton, etc.; but bigger ones are coming: PCV/ST, 666 5th Ave, etc.)
  
• LTV proformas - These were typical of loans that were, say, partially completed and leased out with a portion of the collateral under construction. No names jump to mind, but you can easily envision the Phase I shopping center that is leased with a Phase II under construction that is underwritten to a higher LTV. You can also picture the office tower with unsold condos and penthouses as collateral.

Trepp has identified about $38 billion of proforma loans (less than 5% of the market), but that doesn't seem to quite capture the issue. They looked at all conduit deals issued since 2005, and also included a few older deals and some non-conduit deals. The methodology was not disclosed to my knowledge.

Using data from Trepp and Intex, I backed into a number for cash flow proformas that is closer to 8% of the loans issued during 2006 & 2007. The dozen deals that Trepp identified as having more than a quarter of their collateral being proforma matched up with my results. It deserves some more attention, and I'll come back to the subject and post methodology and results at some point in the near future.

Rent Control Regulation Proposals

NY is proposing to make changes to rent regulations that would make it vastly more complicated to execute the deregulation strategies that are being undertaken by several private equity groups. The most notable includes the Tishman/Blackrock Peter Cooper Village/Stuyvesant Town (PCV/ST) and Stellar Management's Riverton, but the list doesn't end there.

Deal Junkie and Bloomberg did a fine job summarizing the changes. The largest new hurdle seems to be the increase in the destabilization threshhold from $2,000 to $2,700. Further, one year ago in March 2007, NY put into place legislation that made it demonstrably easier to sue your landlord if he repeatedly, and unsucessfully, attempted to deregulate your apartment based on false accusations.

Can't say that it is easy to feel sorry for the PE groups though. Some others include.

Savoy Park ($210mm, CSMC 2007-C1) sponsored by Vantage and Apollo
Meyberry House ($72.4mm, CSMC 2007-C4) sponsored by J.Goldberg and A.Cohen.
New York City Apt. Port. ($195mm, MSC 2007-IQ14) - sponsored by Insureprofit, which filed for bankrupcty last year.
Broadway Portfolio ($70mm, CSMC 2007-C2) - Vantage and Apollo
Esquire Portfolio ($31mm, CSMC 2007-C4) - Vantage and Apollo
Villas Parkmed ($300mm, CD 2006-CD2 - Stellar and Rockpoint are the same sponsors athat are involved in Riverton; This property is located in California, but is the same type of story.
The Axton ($21mm, MSC 2007-HQ12)

Riverton defaulting

Riverton's foreclosure is today. It seems that the mezz lender (CBRE) is going to take a turn at the helm to see if they can make it profitable after taking out the current equity holder (Stellar).

Reuters

Fitch

It's just the most obvious rent-control flip problem on the radar. There are several others I've written about previously. Jeff Bernstein details some of the new rent control laws in the pipeline that are going to further exacerbate the problem for PE landlords playing the deregulation game The game was mostly played in NYC, but also in San Francisco (The owner of Riverton actually has a similar project in SF) and other cities with rent-regulation.

Either way - you know you have problems when 96-year old women (see image from NYTimes to the right) are gathering in the streets protesting with signs disparaging Private Equity - I mean really...