Troubled Assets Radar

Throughout 2008, the commercial real estate market deteriorated, but foreclosures were rare and distressed situations, while large and very public, were relatively few. As opportunistic funds proliferated, potential investors grew concerned that there would be too much capital competing for the small number of distressed situations that had emerged. Since September, though, a wave of defaults and foreclosures has hit the commercial property market and the magnitude of the situation is becoming clear; there is no lack of opportunities for the distressed property investors.

RCA has initiated a program to identify distressed and potentially troubled assets. The inventory already tops $106b and is growing rapidly. Truly distressed situations, where the mortgage is in default, the owner is bankrupt or the property has already been foreclosed, total approximately $25.7b, encompassing well over 1,000 significant assets. Of this total, approximately 200 properties valued at $4.5b have reverted back to the lender to become Real Estate Owned (REO). Thus, the majority of the distressed assets have only recently fallen into default and a foreclosure process commenced. The analysis also ignores approximately $11b of distressed situations that have emerged and already been resolved over the past year.

The volume of properties that are potentially troubled is even more significant totaling $80.9b in volume and 3,736 individual properties. Potentially Troubled assets are largely those with an upcoming mortgage maturity in 2009 or those where the owner is in some financial duress, often caused by maturing loans. In these situations, the properties involved may be free of problems or issues. However, certain property issues, such as a major tenant bankruptcy or a development that has stalled or failed to live up to expectations, will qualify it to fall into the Potentially Troubled category. Distressed and Potentially Troubled assets are distributed across virtually all markets and regions. The West has the largest value of both Distressed and Potentially Troubled properties. However, the Southeast contains the highest number of properties in these categories.

Trouble by Property Type

Distress exists across all property types due to maturing loans or financially challenged owners, although each sector faces specific issues as well. It is no surprise that trouble has emerged first and is currently the greatest for development projects, where an estimated $7b in construction financing is in default or already foreclosed. The quantity of potentially troubled developments currently identified is roughly $5b, a low estimate. The retail sector has the largest pipeline of potentially troubled properties, with many large retail owners such as Centro and General Growth facing significant financing hurdles plus a growing number of retail tenants filing for bankruptcy protection. The hotel sector, already seeing its fair share of distress, could see that grow sharply as both business and leisure travel have been severely curtailed in recent months. The apartment sector, which includes failed condo conversions, has the highest number of properties in peril. While this analysis includes only those property types that RCA traditionally tracks, information on other major commercial properties in distress is available online.

Types of Trouble

A vast array of troubles at the property, ownership, or financing level can cause a property to become distressed. RCA has grouped these factors in this fashion. Property issues can occur when a sole tenant goes bankrupt or a development or redevelopment falls behind, goes over budget, or fails to achieve leasing or sales goals. At the ownership level, bankruptcy of the general partner or other financial pressures of an over-levered owner often lead to distressed situations. Ownership may change as well if a mezzanine lender assumes control from equity providers, a sure sign of trouble. Financing issues occur when the mortgage is facing a near-term maturity or is already past maturity. In this tough credit environment, many borrowers are having difficulty refinancing their mortgages even though the mortgage may be current and the property has no problems. None of the property, ownership, or financing issues are mutually exclusive and often some combination of issues is present in a distressed situation.

Trouble by Metropolitan Market

In this downturn, no market is immune to troubled commercial property. At least 20 metropolitan areas in the US are facing $1b or more of distressed or potentially troubled commercial property. Metro New York and Los Angeles, the locations of many highly leveraged acquisitions in 2006 and 2007, account for $23b of possible and actual problem loans. Distress has also emerged first in the once high-flying development markets in South Florida and Las Vegas. Markets such as Phoenix, Houston and Atlanta have the most number of properties at risk although most are not yet formally classified as distressed. Chicago is another market to watch because of its concentration of properties and developments at risk.

Where the Trouble Lies

Distressed assets have already appeared in almost every significant commercial property market in the United States. The potentially Troubled map is a rude awakening of what to expect in 2009.

Troubled Asset Methodology

Real Capital Analytics has established methodology outlining the Troubled Assets Radar (TAR) which it will continually update and expand as this downturn evolves and new situations emerge. A complete version of the TAR methodology is available for download at www.rcanalytics.com and relevant portions are provided below.

RCA endeavors to maintain the most current tracking of distressed and potentially troubled properties as possible, and it is the largest compilation known to be available, but it is far from complete. In addition, RCA may not be aware of all the issues regarding a property or mortgage nor is it fully informed if a troubled situation is resolved.

TAR Value Estimates: RCA uses the mortgage balance, when known, or a conservative approximation of the property value based on recent sales or offering prices to assign a value to each property. These estimates are utilized for analysis and quantification of the data, but are not displayed on an individual asset basis.

TAR Sourcing: RCA uses existing public and proprietary sources thought to be reliable. A record is maintained for each property to log each source, its date and the nature of the information.

Property Types: This analysis includes only office, industrial, retail, apartment/condo, hotel, land and commercial developments generally valued $2.5 million or greater. However, the TAR program will track a broader array of commercial property types than most of RCA’s core products.

Distressed Asset Categories

Troubled: Includes mortgages that are in default or delinquent, usually evidenced by a recorded Notice of Default or the mortgage being assigned to special servicer. Also includes situations where a foreclosure notice has been filed or the property is placed in administration or receivership. Includes situations where the owning entity or general partner has filed bankruptcy or the sole tenant is in liquidation. Other indications of a troubled mortgage may be actions taken by the mezzanine lender to secure its position.

Lender REO: Signifies the completion of a foreclosure process where the ownership of the property transfers back to the lender. This can occur through a deed-in-lieu, action process, or court order.

Non-Distressed Asset Categories

Potentially Troubled: Includes properties where the ownership is known to be in financial distress although often, there is no direct knowledge of property level distress. Potentially Troubled also includes mortgage loans that are known to be facing maturity deadlines in 2009 or that have previously been extended on a short-term basis.

Delayed/Abandoned Developments: Although not included in this analysis, RCA offers information on commercial and residential development projects that have been deferred or abandoned which are often the source of troubled assets, but not all are or will ever be troubled. However, in a number of situations there is likely a development site no longer needed or land loan that could be at risk.

Troubled Asset Search

With this report, RCA announces another industry first: the largest compilation of commercial mortgages and properties that are troubled or likely to be. Subscribers to our online tools can search for investment opportunities, evaluate the volume of distressed assets in any market, view the sales and refinancing history of specific properties, and track new situations as they arise. RCA provides all the information needed to know, now that the boom has bust. RCA has synthesized data from a vast array of sources including our own transaction data, title records and CMBS files into a simple, but powerful online tool. The database has information on both securitized and non-securitized mortgages as well as additional property types that RCA has not traditionally tracked. In addition to this US data, RCA will be introducing distressed property and loan information for global markets in early 2009. For more information about Real Capital Analytics’ new Troubled Asset Search tool, visit http://www.rcanalytics.com/aboutTAS.aspx.