Good Times

The recent paper published by Harvard regarding multifamily reminds of the well-intentioned JJ in Good Times who had admirable goals but bungled the delivery every time. The ultimate goal of the Harvard paper is admirable, and some of the recommendations are tenable and realistic, but they bungled some of the facts.

Lending has dropped, significantly, across all sectors, and no one would dispute even after looking at the actual numbers. You want to build a new apartment? Good luck getting a loan, it'll be tougher than it was two years ago. Want to rehab some apartments or convert them to condos? The hurdle gets set significantly higher. Want to refinance a 10-year old loan on a performing multifamily asset? - much more realistic. I've seen lists of closed multifamily loans from the last 2 or 3 months and the average weekly volume was around $1 billion.

Most CMBS loans, and loans from other sectors too, on stabilized properties (there are no construction or rehab loans in CMBS, except for in a handful of deals that are considered esoteric), are 10-year balloon loans, fixed-rate, and have 30-year amortization periods. Obviously there are variations, but that is 75% or more of the market.

Multifamily loan performance remains quite strong and underwriting standards appear to have remained prudent, unlike in the
single-family market.

MF has the highest delinquency rate amongst the various property types in CMBS at year-end 2008, and had the largest increase during the 4th quarter. Regarding the 'prudent' underwriting standards, I give you Peter Cooper Village/Stuy Town.

Let's pretend we have a loan called Manor Apartments, it's fictitious but based on an actual portfolio of 1999 originated loans that are coming due this year. These loans had an average LTV of 64.5%, coupons of 7.5% (or 170 bps over Treasuries at the time), and have an average 58% appreciation embedded in them since origination (based on NCREIF appreciation indices). It's also performing. Even in today's stressed lending environment, with coupons several hundred basis points above Treasuries, borrower's are likely to get a comparable or lower debt service, and can leverage up even in the face of expected 30+% price declines in CRE.

Instead, Fannie Mae and Freddie Mac simply lost market share to the CMBS market channel

They didn't lose market share, they changed their model just like the insurance companies did. Do you keep a department in place to manage a loan portfolio? or do you buy one that is prepackaged in a CMBS that by nature is diverse and pays a good yield? The Agencies got a sweet deal - CMBS market created a tranche just for them, all the multifamily loans provide cashflows to the A1A tranche, while losses on foreclosed loans hit the lower rated tranches in a deal along with losses from other property types. Frankly, historically, multifamily is a more volatile sector and without the Agencies supporting them in the CMBS world, financing would have been much more expensive the last couple of decades.

A good point made is that the Agencies will shortly have to reduce their portfolio holdings, and this will be disastrous for the multifamily market. Currently there is not enough demand in the CMBS secondary market and spreads continue to widen - imagine adding another 30% in supply (about the size of the Agency's holdings of Multifamily CMBS via the A1A tranche)...

many believe that underwriting standards have been looser in the CMBS market channel, though it is difficult to judge whether this is true.

*cough* *cough* *Riverton* I could name names, but the list is too long.

There are some good points made in the paper, but its overshadowed by the apparent lack of knowledge of the author. There are several points that feel wrong, but I frankly just don't have my arms around it. Case in point, investors will likely demand the kind of uniform
standards and transparency in underwriting more associated with the GSEs than CMBS. I think with your typical GNMA deal you know the weighted average stats of a pool - compared to the transparency you get with a CMBS deal (property level financials) this seems wrong, but again, I'm not that familiar with the GNMA deals. I do not think transparency when I think GSE, though... at all.

Peter Cooper Village Stuyvesant Town - Fitch's View

The rating agencies and journalists/bloggers continue to fail to do their homework. Peter Cooper Village/Stuyvesant Town (PCV/ST) was bought at the height of the market with more leverage than your average deal, and the likelihood of it failing is above 50% in my opinion. However, I have yet to see an article that correctly identifies the winners, losers, and timeline.

If it fails, the losers are:

• Equity Investors (BlackRock and TishSpey)
• $1.5 billion of Mezz debt holders - especially the bottom $200 million

Winners/Unaffected Parties:

• Tenants - what is done is done, to this point. The tenants want the investors out. Heck, the tenants bid on actually buying the building (for more than the current senior note value, mind you).
• Senior Mortgage holders (4 CMBS trusts) - The proforma appraisal had an LTV of 56%. Assuming that is wrong, you still have a lot wiggle room. I wouldn't want to own the B piece necessarily, but at the AAA level you are in an OK position - you have a back bid from the tenant group, even the misguided rating agencies (Moody's and Fitch) agree the servicer is likely to advance in full, and you have a slew of mezz lenders who are likely to take a stab at operating the property at a loss for some period of time.

Timing:

• The outstanding debt service reserve, according to the Fitch report being referenced, as of 1/15/09 is $127.5 million. That is consistent with my September 2008 analysis, here, indicating that they are drawing $10 - 11 million a month from the reserve. Again, $127.5, divided by $11 million, I get about 11.5 months of reserve remaining - I can't figure out where Fitch is getting their 6 month estimate, but I'm sure there is something I am missing.

Long Holiday Hiatus

We found ourselves on a much longer than intended holiday hiatus the last couple of months. But we're back, and now our favorite little market is front page news every single week - so, we plan to comment on a regular basis. We'll start today with the piece about Hancock Tower (Boston) that was in last week's early close WSJ, and the authors Ling Ling Wei and Alex Frangos botched beyond repair.

John Hancock Tower was appraised at nearly $1.3 billion in 2006, and acquired by Broadway Partners with a $640 million senior mortgage (5.599% coupon, in GG9, matures in 2019), a $723 million mezzanine loan (with an average coupon of L+395, matures 12/2009 but has extension options).

In interesting sidenote, the prior owners, Beacon, had a short-term senior mortgage with Lehman and securitized in LBFRC 2006-LLFA, when the property changed hands, Lehman provided some of the mezz debt in the current transaction. Later, when Lehman failed, State Street took the mezz debt back.

NONE of the mezz debt is in a CMBS deal. The outstanding size of the CMBS market according to the FRB is $940 billion, not $700 (although that is about the size of Conduit deals). The most subordinate mezz debt chunk of $300 million at L+500, and it's held by someone who does not really want to own the property - many mezz lenders use the loan-to-own model. So, Broadway misses a payment on their mezz loan, and the mezzanine model kicks into play - everyone argues whether to provide extensions or defaults, with different parties wanting different outcomes; appraisals are ordered, occasionally lawsuits are filed, and the process keeps rolling along as it always has. There is not really anything new to report here - of course the parties disagree, they have different interest and millions of dollars are at stake.

The senior mezz guy is in a good position though. Even if you think the 2006 appraisal that resulted in a 50% LTV loan maturing in 10 years is bunk, the senior mezz holder is still sitting pretty. If he defaults on the sponsor and everyone junior to him in the mezzanine debt stack, then he owns the property and no longer makes payments to the junior mezz holders because they get taken out. If he votes on an extension, then he still receives his coupon on the mezz debt he holds and can take the other holders out later as they default.

Your CMBS holder is also in a good position, relatively speaking. You have a 50% LTV loan, that is cashflowing at 1.33x DSCR with a 99% occupancy rate (at least that is the publicly available number - 21% of the leases did rolle in 2008, but at the end of 1H 2008, they hadn't lost any - I can't verify the WSJ numbers. Maybe they lost Hill Holiday? 7.7% of NRA).