Real Estate Financing in '98 :  A Recycling of Recent Events ?

By: Wilhelm A. Rosenberg - Mega Funding International Corp., NY
Date: 1998

Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.

The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances.

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My former partner was also an adjunct professor for Business and Finance. He used to say that history was like a Genoa salami sandwich, as it kept repeating on you until it was finally digested. Students of real estate trends over the past 15 years will see a great similarity between events of the mid-Eighties and some contemporary real estate lending practices. Rather than see my colleagues experience the trauma and difficulty in arranging even creditworthy transactions which paralyzed the industry's lenders during that period, and at the risk of being accused of writing a needless jeremiad, I shall point out some disturbing trends that have emerged over the past few months, in the hope that we will collectively reflect on these matters. Timely prudence may still allow the current real estate recovery to proceed without the need for a correction in the form of a Big Bang that occurred at the end of the Eighties.

With the increasing sophistication and activity of the conduits, permanent mortgages on a non-recourse basis are now being offered on most property types with razor-thin spreads. The conduits have muscled into the markets of the life insurers and the large thrifts, and have forced them to choose between shaven yields or yielded market share. While the conduits have expanded the market by offering limited amounts of financing on hospitality structures, the bulk of their activities have been in the home courts of the competition, in the form of mortgages for A and B-grade multi-family dwellings, office buildings, and retail assemblages. Though the insurance companies have a fairly strong source of low-cost premiums that are used to fund these deals, the same cannot be said of the thrifts. New money continues to pour into mutual funds that earn more than deposits, and the thrifts appear to be spread-gapping in order to continue to offer ten-year, fixed-rate mortgages.

Although the only ones who now see real inflation on the financial radar-screens are bond-traders lusting for the trade opportunities that volatility brings, a Nobel Prize is not required to comprehend that even a gradual run-up in rates over the next 10 years might cause portions of thrift commercial mortgage portfolios to have negative yields. Some thrift executives might counter that their response, were this to occur, would be to sell these pools of assets in the secondary market, and use the proceeds to book new, higher-yielding loans. However, notwithstanding Wall Street's pronouncements that it is into securitization for the long-term, the history of the Street only confirms its trader's mentality. The investment banking houses have always moved quickly to exploit profit opportunities and cut losses wherever they might be, and a big drop in earnings from conduit deals can easily cause real estate finance divisions to get closed almost overnight. Were the secondary market's current liquidity to be altered, the thrifts would be hard-pressed to find buyers for their low-yielding, fixed-rate commercial mortgages. A primary cause of the debacle of the Eighties was the pumping of money into the construction sector, which resulted in massive over-building in most major markets.

We are concerned that the commercial banks, who are still in a merger frenzy of their own, and who have still not seen major increases in Commercial and Industrial lending since the beginning of the Clinton presidency, will look for new ways to boost profits and the value of their shares. One all-too-logical strategy will attempt to increase bookings for new and rehabbed construction. In many markets, this will likely take the form of commitments to build new retail and office space without substantial pre-leasing. We have seen greater interest in these proposals since the beginning of the summer not only from the commercial banks, but also from some of the thrifts. To quote the sports historian Lawrence J. (Yogi) Berra: "It's déjà-vu all over again."

Human nature encourages an attitude of letting the good times roll. One can enjoy a bottle of fine single-malt scotch one shot at a time over a period of days, or by emptying the whole flask in one woozy session, which will result in a minimum of a massive hangover. The analogy to real estate lending is clear. If we now ask the question of where we're going, we won't have to figure out how we got there in a few years.

EDITOR'S NOTE: Mr. Rosenberg's firm has contributed this article in the public interest. It is not intended as legal advice. Nor is any professional relationship intended or established with the reader by virtue of browsing this article. Neither Mr. Rosenberg nor Mega Funding International Corp., NY are affiliated with Hollander and Company LLC. The information contained in the article is believed to be accurate but should not be relied on without independent advice of an appropriate professional.

Copyright © Jay Hollander, 1998. All Rights Reserved.