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Mark is a specialist in medical office
and national team leader for Sperry Van Ness |
Regardless of how you feel about the Affordable Care Act (ACA), the cloud of uncertainty has been removed. The ACA was passed by Congress and signed into Law by the President on March 23, 2010 and upheld by the Supreme Court on June 28, 2012. This new direction for health care will ensure dramatic change in demand for real estate used by hospitals and doctors. This is especially true locally given the large number of elderly Americans that retire in Florida, combined with our large proportion of poor uninsured and under-insured who will soon be added to the ranks of medically insured.
There are two main segments of medical office real estate: hospital-controlled buildings and doctor-controlled buildings. The problem over the past three uncertain years during health care reform debate was that neither hospitals nor doctors knew how health care reform was going to wind up. Well, now we know.
Hospitals
Health care (HC) systems have been more proactive regarding their real estate needs than doctors over the past three years while the debate raged. While not knowing for sure how reform was going to shake out, most hospitals felt change, was inevitable in one form or another, which would lead to more Americans becoming medically insured. Many HC systems have already taken steps to expand their real estate needs to accommodate this anticipated increased demand for care. Now that the Presidential election is over, eliminating any reasonable speculation about ACA repeal, many hospital systems across the U.S. are accelerating their expansion plans. HC systems are partnering with developers to construct new projects while others are using Sale/leaseback transactions involving existing facilities to self-fund their expansion.
Doctors
Most private practice physicians adopted a “maintain the status quo” attitude over the past three years while hoping for an eventual repeal of ACA. This MD uncertainty fueled today’s pent up demand for medical real estate that is now being released. This is a new environment for doctors and is causing them to change the way they manage their businesses. I find that doctors focus on the bottom line today more than ever before.
For example, over the past twenty years it had become common for doctors that owned their own medical buildings to have their medical practices pay themselves (as Landlord) rent that often exceeded fair market rental rates. This was a popular way for doctors to create exceptional “in-house investments” where their medical office building (MOB) investment returns where often quite remarkable. But this meant their practices often paid very high rental rates that sometimes exceeded fair market rental rates by as much as 200%. When many of these doctor/MOB owner’s decided to sell their buildings prior to retirement, they quickly learned that a sale/leaseback to an investor created much higher sale prices than selling to another doctor or even to their own practice.
The reason for this phenomenon is that owner occupied MOB’s get appraised as though vacant because the appraiser is not allowed to use the existing lease (that would normally drive value higher) because the lease is between related parties and not deemed “arm’s length”. This is great for the acquiring practice but it causes the seller to leave a lot of money on the table.
On the flip side, when the MOB is sold in an arm’s length transaction to an investor and the MOB is then leased back by the medical practice, the appraiser must use the lease to calculate value. The market rent lease steers price much higher and in some cases by as much as 40% higher compared to selling the same MOB to another doctor.
Consequently, over the past 20 years, doctors that understood these advantages employed the sale/leaseback approach, often choosing the highest rental rate possible to set the highest possible sales price. This “pushing the envelope to the top” of fair market rental rates created some eye-popping sale prices and saddled medical practice tenants with very high future rents. While this was not a significant issue under the old way of doing business for doctors over the past twenty years, it is today. Now that ACA is anticipated to bring lower reimbursement rates to doctors in the future, doctors are very concerned and look to keep overhead as low as possible.
Today I see doctors doing the opposite of the past two decades and are either choosing a moderate rental rate for their lease back future; or they pick a below market rent sufficient to retire debt so they can lock in the lowest possible rent to maximize future practice profitability. This is a sound business move as doctors’ incomes are expected to be reduced. This is the fiscally responsible approach, in my view, and it is one example where ACA is helping to reduce the overall cost of health care in America.
Since ACA rewards doctors who work in bigger groups or alliances, there is a trend for single practice doctors to merge with larger medical practices or switch employment to hospital systems. Since stronger tenants are preferred by MOB investors, this trend of smaller groups merging into bigger medical groups is helping the single practice MD get a better price for his MOB than he would have when he was a solo practitioner.
Some forward thinking medical groups were ahead of this curve and started alliances years ago. Others are just getting started. But the trend is clear. Large medical groups are becoming more prevalent.
The Affordable Care Act is not perfect, and most doctors don’t like it because it reduces their future income. But ACA will add millions of individuals to the roles of the medically insured, and this will create higher future demand for health care services. This, in turn, will create higher future demand for medical office space for doctors to treat patients. There are strong, long-term, underlying business fundamentals for medical office building investments.
On June 29, 2012, both the Senate and House passed the Biggert-Waters Flood Insurance Reform Act of 2012 as a part of H.R. 4348, the Surface Transportation Conference Report. The President will sign the measure in a few days. This is the culmination of a successful multi-year REALTOR campaign and a final push at NAR’s Midyear Legislative Rally and Meetings in May 2012. Congress had been extending the National Flood Insurance Program a few months at a time since 2008. Twice this led to shut downs, including one that stalled thousands of real estate sales in June 2010 alone. Passage of this 5-year reauthorization will bring certainty to real estate transactions in more than 21,000 communities nationwide where flood insurance is required for a mortgage. The bill ensures the program will continue long-term for more than 5.6 million business- and homeowners who rely on it, achieves one of NAR’s top priorities for the year, and means taxpayers will spend less on federal assistance for flood disasters over the long run.
The Federal Reserve Board of Governors met on June 7th to publicly discuss proposals for implementing the Basel III capital requirements and Dodd-Frank capital requirements in a simplified manner, as well as to vote on a final market risk capital rule (Basel 2.5).
The Board unanimously approved the release of three Notices of Proposed Rulemaking (NPRs) for Basel III and the final rule for Basel 2.5. Basel III requires that a bank hold 4.5% of its risk-weighted assets (RWA) as common equity (up from 2% in Basel II) and 6% as Tier 1 capital (up from 4% in Basel II). Total capital (Tier 1 plus Tier 2) must be at least 8% of RWA. Additionally, Basel III requires that banks hold another 2.5% capital buffer, made up of common equity. Restrictions are also to be imposed on what assets can be counted toward Tier 1 capital.
The Board is under the impression that most banks already meet these requirements at the present time (especially those under $10 B). The approach for calculating risk weighted assets would also change the treatment of residential mortgages, making it more risk-sensitive. Under the NPR, residential mortgages are divided into two categories and the risk weights would depend heavily on LTV and would range from 35%-200%, while High Volatility Commercial Real Estate Exposure (HVCRE) risk weights would jump to 150% from 100%. Governor Elizabeth Duke raised concerns about this portion of the proposed rule reducing the willingness of banks to make mortgage loans.
While the new capital rules won’t take effect until 2019, concerns have been expressed by both industry and some Fed governors, that such an increase in capital requirements would have negative economic effects, as there would be less capital available to lend. The Fed’s rule-writing staff said that these effects were likely to be modest and would largely be mitigated by having a long phase-in period. Furthermore, the staff said that banks could largely meet requirements via retained earnings, and would probably not have to issue more equity.
The Federal Reserve surprised the banking industry by forcing even the smallest lenders to comply with Basel III -- all 7,307 U.S. banks. Many bankers had expected regulators to exempt smaller, community bank lenders. While the core Basel III rules will apply to all banks, other aspects of the new regime single out the biggest, most complex banks for tougher treatment than their smaller peers. The banks will have more than six years to fully comply with the new rules, with the phase-in period starting next year.
Potential Impact on Credit Capacity
While the goal of the new regime is commendable, requiring banks to hold far more capital to prevent financial disaster could further exacerbate credit challenges for real estate and broader credit capacity. There is grave concern among many in the banking community that stricter capital rules may curb economic growth by making it more expensive to lend.
As proposed, there is concern that the measure is not appropriately calibrated and could lead to disproportionately higher borrowing costs for commercial real estate borrowers. Setting excessive capital requirements will limit the availability of funds that support new investments and job creation – particularly for commercial real estate.
The current risk weight under Basel II for commercial real estate loans, including acquisition, development and construction (ADC) loans, is generally 100%. However, the Accord permits regulators the discretion to assign mortgages on office and multi-purpose commercial properties, as well as multi-family residential properties, in the 50% basket subject to certain prudential limits. Under Basel I, commercial real estate was assigned to the 100% basket. The proposed Basel III measure would increase the risk weighting to 150% for High Volatility Commercial Real Estate Exposure (HVCRE) and, which could also deter banks from making real estate loans and reduce credit capacity.
Importantly, however, the NPR specifically permits regulators the discretion to exempt certain commercial real estate collateral from HVCRE treatment that fall under certain guidelines. Such collateral would generally be treated as corporate debt position, with a 100% risk weighting. These CRE exemptions would apply to:
(1) One- to four-family residential property; or
(2) Commercial real estate projects in which:
(i) The LTV ratio is less than or equal to the applicable maximum supervisory LTV ratio in the agencies’ real estate lending standards;
(ii) The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate's appraised “as completed” value; and
(iii) The borrower contributed the amount of capital required under paragraph 2(ii) of this definition before the banking organization advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project. The life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full. Permanent financing may be provided by the banking organization that provided the ADC facility as long as the permanent financing is subject to the banking organization's underwriting criteria for long-term mortgage loans.
Next Steps
The Federal Deposit Insurance Corporation (FDIC) and Office of the Comptroller of the Currency (OCC) must also review the proposed Basel rules before they take effect, and are expected to do so on June 12th. Comments on the three NPRs' will be due on September 7, 2012.
NAR is currently reviewing the measure and its potential impact on commercial and residential real estate credit capacity. We are already working with a number of industry groups to develop consensus viewpoints in an effort to begin raising concerns about the economic consequences of proposed rules in advance of the comment deadline.
The documents may be found at CLICK HERE
WASHINGTON, D.C. — President Obama unveiled several proposals this week aimed at helping small business owners. The proposals will expand two critical Small Business Administration (SBA) lending programs, one of which could help some in the commercial real estate industry. One of the new SBA initiatives will temporarily allow for the refinancing of owner-occupied properties under the SBA 504 program, which provides guarantees on loans for the development of real estate and other fixed assets but could not be used to refinance maturing debt up until this point. Under the new initiative, businesses with a loan maturing in the next year, and who are current on their loan payments, will be able to refinance up to 70 percent of the current property value, with the SBA helping with the remainder. For less established lenders, the SBA will take on up to 40 percent of the property's value for the refinancing. The program will be funded through additional fees for refinancing projects instead of through a Congressional appropriation. The refinancing proposal will help refinance up to $18.7 billion a year in commercial real estate that would otherwise be foreclosed on or liquidated. In a statement, SBA Administrator Karen Mills said, "Thousands of good, creditworthy businesses find themselves caught by declining real estate values as a result of the recession. With many of them now facing mortgages coming due in the next few years, the ability to refinance into SBA's 504 loan will give them the chance to lock in long-term, stable financing, as well as protect jobs by protecting small businesses from foreclosure."
A public adjuster is an insurance expert who is employed exclusively by a business or personal policy holder who has sustained an insured loss. Public adjusters handle every aspect of the claim and work closely with the insured to provide the most equitable and prompt settlement possible. A public adjuster inspects the loss site immediately, analyzes the damages, assembles data supporting the claim, reviews the insured's coverages, determines current replacement costs and negotiates with the insurance company. One of the best in the business is Richard Michaelson. He is a liscenced public adjuster in multiple states and is a sought after speaker on the topic. As a service to my clients I was able to garner some time from Rich and have him stop in Champaign on his way to the SEC conference in Las Vegas where he is to be a keynote speaker for the convention. In just the short time we had together Rich was able to share some very informative and extremely valuable information about how to deal with the myriad of insurance issues that we all face. Public Adjusters work for the commercial or residental property owner, not the insurance company. The highly stressful period following a loss is a difficult time for individuals and businesses. A professional public adjuster can reduce those major headaches, allowing you to get back to what is really important. Public Adjusters negotiate insurance settlements for the benefit and protection of the policy holder. Your insurance company has an adjuster representing them and their interests and so should you! A Public Adjuster can re-examine, re-open and negotiate settled claims for additional money. We had a great turn out in the second presentation in our CLIENT SERIES with Rich Michaelson. Stay tuned for new and continuing presentations for our clients.
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.
SVN's Asset Recovery Team provides immediate underwriting nationwide and disposition solutions to financial institutions and real estate clients with distressed portfolio assets.
Collaborative teaming with our Senior Accelerated Marketing Advisors and over 900 local market experts and professional brokers create, design, implement and execute customized marketing plans for the repositioning and disposition of assets to insure the maximum return for our clients.
The diverse services we offer include:
Market Research
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E-mail Alex Ruggieri to get connected with the appropriate SVN's Asset Recovery Team advisor for your area.
Our Value Proposition
The hundreds of years of experience represented by the Sperry Van Ness Asset Recovery Team includes successful disposition of assets as contractors for the Resolution Trust Corporation and private-sector disposition of distressed and recovered assets. That experienced team is part of a recognized national framework of real estate professionals unmatched in the industry for providing immediate and successful solutions. Time to market is vastly reduced through extensive technology facilitating the required underwriting, packaging and marketing of assets in a seamless process designed to maximize exposure resulting in maximum recovery value.
The Sperry Van Ness Asset Recovery Team consists of twenty real estate professionals that specialize in asset disposition solutions for distressed assets and portfolios across the United States.
The team designs and implements custom marketing initiatives for the disposition of assets that insure maximum return to our clients. We are able to provide our clients with national reach and local expertise through our network of over 900 Sperry Van Ness advisors located in 150 markets throughout the nation.
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