Lending Is Back

Lending Is Back

Many groups raised funds to buy distressed loans or REO, but found there was almost nothing to buy. Having raised the funds they needed to do something with the money so they have now almost all become lenders/preferred equity providers. There is now a rush of money to loan and the race is on to put it out. Spreads have already started to come in and leverage levels are rising already. We already have competition between lending sources. On transactions I am personally doing, and others I am familiar with, there is funding for deals none of us would have imagined just 60 days ago. For example I am arranging funds for a brand new condo project at 75% of DPO cost. Another is a cash flowing portfolio of select service hotels some of which are still in the ramp up phase being brand new. Again a 75% LTV is apparently achievable through an A/B structure. Another transaction I am advising on is to raise a fund for hotel debt at similar LTV with a similar structure. These are all non-recourse, but underwritten on today values and today existing cash flows.

The banks are getting back in slowly and it depends on what condition the bank is in as to capital. The major banks are lending, although more conservatively than the funds. Insurance companies are lending to core properties. Spreads on the top quality loans with low LTV and top rated borrowers can be as low as 300-350 over with 30 year amortization. Some insurers are now lamenting that they did not act more aggressively late last year and early this year, as they are now having strong competition to put out dollars. One foreign bank is considering a construction loan in New York at fairly low spreads.

Several bankers I recently had dinner with this week were discussing how they are still working the old book of bad loans while the push is starting for new originations. They commented that originations are much more interesting and a lot more fun than modifications, which leads on to believe modifications are going to be accelerated to get them over with so the lending officers can get back to enjoying their work by making new loans.

A number of the grown ups in the business are already worried, including me. We can see where this is headed. We are astounded that any lending is happening at all this fast compared to the early nineties when it took until mid to late 1993 to restart having stopped in 1989-4 years. Now we see it stopped in late 2007 and here we are in spring 2010-2 ½ years later- and just past the worse collapse since 1932, and we are off to the races again. It will not take long before the amount of money chasing loans ramps up and spreads come in further and competition is underway for each good loan. While there is still hundreds of billions to refi over the next few years, the rush will be on by borrowers to lock in lower rates while they still exist.

Securitized lending is coming to your neighborhood sooner than we all expected. Treasury pulled a wonderful massive head fake with TALF making believe it was a real program, which it never was. The capital markets thought it was real and a few prime deals happened and securitization was jump started. TALF was never real and it was designed to do just what it did. Fool everyone into thinking it was real and to get securitization going again. It worked. Now we just need to wait to see what comes out of Congress as to the proposed 5% holdback and possibly other restraints to try to prevent the insanity of securitization of the past. They can regulate all they want, but unless stringent underwriting is adhered to and the rating agencies hold the line on subordination levels, we will be back to dumb lending a lot sooner than anyone would have believed. Here I personally think tying bonuses to long term success of a securitized pool is what is needed to make it clear there are real consequences to bad underwriting. Otherwise in several years we will be doing all the dumb things all over again. I have seen this picture show several times in my career.

Appraisals Are Causing Damage

Appraisals Are Causing Damage

It is clear from feedback from a variety of appraisers that there is great debate within the appraisal community as to the veracity of many appraisals and the methodology. It is very clear to me that the methodology is completely wrong and that some appraisers just did whatever they were instructed to do. Just because this is the way appraisers always did it and it proved totally wrong, is every reason to change it.

In discussions with friends who run banks and sit on boards of trustees of major pension funds, as well as many of my capital markets colleagues, it is clear that almost nobody believes appraised values any more. They are either too frothy in good times or overly negative in bad times, but rarely correct. For banks they are dangerous. In good times they lead to bad lending decisions, and in current times they lead regulators to require banks to foreclose even when the loan is current on interest and the borrower is a responsible owner. Pension funds revalue assets by appraised value in some cases and that undervalues assets currently. CMBS resolutions of defaults require appraisals and they are frequently wrong and lead to bad outcomes. As proof we know that each side gets its appraiser and the results are usually very different. As a former lender, I know that it is easy to get some appraiser to gin up whatever was needed to justify a loan, even when the value was known to be too high. The whole system and methodology is badly in need of new rules and procedures.

Appraisers who responded to my blog admitted that they merely reflect the current thinking of investors- as though there was some universal edict among all investors. How do they explain that some investors got out of the market in 2007, while others got in. Which set of investors were the appraisers reflecting. Why do a 10 year cash flow and projected terminal values and discount rates if at the start you are trying to reflect the current investor thinking. That just proves the projections have to be architected to fit the answer which was pre determined to reflect current market prices. It is all nonsense. That is why MAI stands for made as directed. The appraisers have actually admitted in several responses to my blog and my column in Hotel News Now, that they do make their appraisal fit what the borrowers or lenders demand.

It is time that the Appraisal Institute convene a roundtable to include bankers, investors, pension trustees and underwriters to set new methodology so that appraisals do what they should, provide a true, independent valuation with all the potential risks brought to the fore of future events. We had thought after 1990 and the new rules then, that things might change, but they only got worse. It is time for true resetting of the definition of what is an appraisal and how is it to be accomplished to give real ranges of values. I am not trying to eliminate appraisals, just to make them much more accurate and usable so they are not misused as they have been and continue to be.

Investment Time Horizons

Investment Time Horizons

While it appears the economy and real estate will improve over the next several years, subject to various geopolitical events which could disrupt everything, such as Israel attacking Iran which is a strong possibility in late fall 2010, or another major terror attack which is predicted by all of the intelligence agencies. These black swan events need to be closely watched as there are many in the world these days.

Leaving aside those unpredictable events, the real issue is what is a reasonable investment time horizon to work to. Given the direction of things in Washington under Obama and Pelosi, shorter is better than longer. The healthcare law is going to prove to be a fiscal disaster in about 7-10 years. We will have to have higher taxes at all levels of government. Unions are getting their payoff for pouring hundreds of millions into Democratic coffers. The general approach of this administration has been well stated to redistribute the wealth of all of us who created it and who create jobs.

It is my contention that in seven years it is time to be out of most major investments. By that time taxes will have risen, but the deficit will have risen even more.  By 2017 the deficit will be on a track to eat the ability of the country to grow the economy. By 2020 we will be at a point where the deficit will be approaching 85% of GDP and that is simply not sustainable nor consistent with a strong economy or strong dollar. Inflation will be higher, interest rates will of necessity be higher to try to sustain the dollar and to try to control inflation. The government expenditures for pensions to government workers, which are already crushing state and local governments, will cause services to be curtailed. The baby boomers will be in full retirement mode eating up social security and Medicare. Higher tax rates on the most productive people who are the high earners, will disincentivize people from making the extra effort or risk required to move the economy forward as fast as it otherwise might.

Many top economists are screaming about this coming crisis, but the administration and Pelosi seem deaf to it. As opposed to fixing the Medicare problem, they just made false accounting entries to make it look like they saved $500 billion. Social security will not get touched until it is too late so payroll taxes will rise even more than the new Medicare tax on capital investment income.

As a result of all of these trends, it is best to get in now and get out in 2015 or soon thereafter with the substantial profits I believe can be achieved over the next several years,and then take a look at where we are to decide to buy gold, invest in Brazil and China, or to reinvest in more traditional US based assets. Maybe things will change in time, but I have serious doubts. Washington has become so dysfunctional it is starting to look a lot like Albany and Sacramento. Just be very careful when investing to make sure your exit is realistically achievable in a timely manner, and don’t count on the long run to make it all OK. This time may really be different. It is very hard to know what the world will be in seven years, which is why investment horizons beyond then are too risky.

Appraisals Are Deeply Flawed

Appraisals Are Deeply Flawed

I recently wrote a column on HotelNewsNow stating that appraisal methodology was deeply flawed and that appraisals are essentially fairy tales based on a bunch of unsupported wild guesses by appraisers. They claim to be able to project cash flow, interest rates, discount rates, terminal value cap rates, and renovation requirements for 10 years and then they use some unsupportable discount rate to determine present value. It is all nothing more than wild guess compounded by more wild and unsupportable wild guesses. It short, appraisals to me, have no value, and were clearly proven to be nothing more than propaganda to support unrealistic loans in the 05-07 period.

In response to the column two appraisers commented that”appraisers are required by our standards and regulations to reflect the market. If the market is being optimistic we are required to reflect that. It is not the appraisers role to adjust projections or cap rates or values or opine if anticipated net income is not sustainable. We are merely reporters on the sidelines. If you want us to tell you what we really think then have us put our consulting hat on instead of asking us to do an appraisal.”  Another appraiser said “we are required to reflect the froth”.

That says it clearly. Even the appraisers say their appraisals are nothing more than make believe to reflect what the clients wants them to say. In fact one appraiser responded to my column by saying “who are we to question the view of the borrower or the lender”.  

Why do appraisers even bother with the make believe of 10 year cash flows, alleged terminal cap rates and all the rest. What they are admitting finally is they are merely making all that up in order to get the answer their client wanted in the first place. This is why when I created the first hotel CMBS programs in 1993 we refused in our underwriting to use any numbers or values the appraisers came with. We got appraisals just to fill the rating agency file folder.

Everyone would be much better to ask appraisers to provide real numbers and projections as the appraiser I quote above has suggested. Phony appraisals was one of the contributors to how we had the crash. They were used as excuses to make stupid loans. The rating agencies are the ones to drive this change. The servicers tell me they are relying much more on broker opinions of value than appraisals and they only get appraisals because they are required to by the PSA docs.

In 1993, our underwriting manual required the use of historic cash flows and then current cap rates to determine loan proceeds. Loan to value was only used to make sure we did not exceed a percent of the appraised value since we knew the appraised value was in excess of reality, we always wanted to below that test.

My intent here is to get the capital markets, the rating agencies, and the real estate industry to start to use appraisers properly, and to use their knowledge in a way that is helpful, and not to support excessive lending and stupidity.  If the truth hurts as to projections and value, then loan proceeds should reflect truth and not bull.  If we redo how loans are underwritten, and if we use the talents of the appraisers properly, we may just help save ourselves from the next crisis in the capital markets.  Excessive lending and over inflated values always lead to a crash-that is reality, so let’s not repeat this costly history.