• The Economy – GDP grew at an annual rate of 3% last quarter.  This growth is predominately based on the government’s various stimulus programs, many of which have or will soon end.  The private sector is continuing to go through a deleveraging process and we need continuing monetary stimulus for support or there could be another bear market in 2012.  Unemployment may not revert back to the 7% range until 2013-14, resulting in only modest growth over the next two years.  The U.S will probably not experience significant inflation or deflation.  With the Fed having printed some $1.3 trillion in new money, most of which was used to buy commercial mortgage bonds, that program ceased on 03/31/10.  The Fed may come back to inject more liquidity, but at this time, its intent is unknown.  A market bottom won’t be clear until the jobs picture stabilizes and lending in all sectors becomes more widespread.

  • Carried Interest Legislation – The House of Representatives has just passed HR 4213, a bill that can double the tax treatment on carried interest income received by fund managers and investment partnerships.  There is concern by many that the resulting tax increases will discourage real estate ventures from making further investments and thereby negatively impact the commercial real estate recovery.  The Senate will consider this matter in the next few weeks.

  • Distressed Asset Pricing – There is a tremendous amount of investment capital that has been raised in a short period of time to buy distressed assets.  Much of this capital has been sitting in low yielding accounts, with fund managers paying out aggressive dividends.  In addition, the falling Euro has encouraged overseas investors to seek shelter in hard assets in a relatively more stable economic environment like the U.S.  With few quality assets available (loans or property), competition for these has been fierce, especially among institutional investors, resulting in cap rate compression and thus, higher prices.

Bigger banks have resolved many issues and are now able to accept more significant write-downs resulting in the availability of more truly distressed assets like undeveloped land and broken condo projects.  Many of the smaller and mid-size banks have been able to raise capital, allowing them broader flexibility with borrowers and the ability to work out or extend maturing loans.
  • Risks inherent in purchasing distressed loans – Many inexperienced investors don’t realize that when you purchase a distressed loan, you are NOT purchasing the collateral that guarantees the note.  Rather, you are buying a stack of loan documents which provide the borrower and the lender with certain rights, only one of which is to foreclose on the loan for nonpayment or other type of default.  As a result, it is imperative that the investor complete a comprehensive review of all of the loan documents for any material flaws that may provide the borrower with the right to contest a foreclosure.  Other issues to research include: borrower bankruptcy ramifications; liens and other title problems; lease modifications (known or unknown); tenant correspondence; and environmental, structural and local municipality violations or issues.  One should also fully underwrite the borrower and its capacity to make debt service payments.  Is the note guaranteed by a Special Purpose Entity (SPE), whose only assets consist of the property?  Do the leases have personal or corporate guarantees?  Always complete a net present value computation on prospective acquisitions, including the cost of carry for the period of time required to foreclose (which may be up to two years in some states).

-Jerry Monash
Gerald Monash, CCIM is Executive Vice President at NAI Global.  Jerry leads NAI’s Investment Services Group and is a loan sales specialist on NAI’s Special Asset Solutions team.