And while LNR has yet to make a formal announcement of its plans, industry observers believe any decision may have far reaching implications for commercial real estate. After all, the company’s special servicing arm, LNR Partners, manages a quarter of all loans in special servicing.

LNR’s booming special servicing business, which according to Fitch Ratings has more than doubled in the past year, may indeed be contributing to its current woes.

“They may be attempting to get out from underneath their obligations to advance interest payments to the unsubordinated senior tranches,” says Greg E. Schecher, managing member of Lexington Capital Advisors LLC in Boca Raton, FL.

LNR’s land and residential holdings may also be sinking the company. “They are, unfortunately, involved in one of the most volatile property niches in the market, land,” says Dan Fasulo, managing director of Real Capital Analytics. “Given the property value decline in that sector, it’s not surprising at this point that they are looking at bankruptcy protection as a way to move forward.”

In January, Bloomberg reported that LNR enlisted Lazard Ltd. and law firm Dewey LeBoeuf LLP to help restructure nearly $1 billion of debt and prepare for a possible bankruptcy filing. Calls placed to Dewey LeBoeuf were not returned, while representatives from Lazard and LNR declined to comment.

According to Bloomberg, Oaktree Capital Management, LNR’s largest creditor, is also seeking advice on restructuring the firm’s debt. Oaktree Capital and a handful of LNR’s other bondholders are considering a takeover, sources tell GlobeSt.com. Those same sources, who wish to remain anonymous, say LNR’s majority stakeholder, Cerberus Capital Management LP, is now running its operations. Calls to Cerberus were not returned.

Some observers suspect an investor will snap up LNR’s special servicing branch much like Warren Buffett’s Berkshire Hathaway Inc. and Leucadia National Corp. did with Capmark’s servicing business, back in December. Since September 2009, Centerline Holding Co. has been in discussions with Island Capital Group LLC to recapitalize its special servicing arm, Centerline Capital Group.

LNR’s troubles came to light last November, when Moody’s Investors Service downgraded the firm’s credit rating to Ca from B3 because of the “rapid deterioration in LNR’s liquidity profile.” This affected some $900 million of the firm’s debt. LNR, the ratings agency said, is under mounting pressure from declines in cash interest income from its devalued CMBS investments. What’s more, the protracted credit crunch in the commercial real estate market has delayed collection of its special servicing resolution fees.

“Every time a property comes back to the special servicer it creates a liquidity issue because the servicer doesn’t have any real method to create liquidity, except through the disposition of assets,” Schecher says. A series of asset sales may seem like the obvious solution, but with a fiduciary duty to protect bondholders in the capital stack, it’s not that simple.

“Special servicers are hired just like an independent contractor and they have to work in the best interest of the trust,” says William Campbell, a partner at Strook & Strook & Lavan LLP in New York City. “Many investors feel, however, that because specials are conflicted they’ll seek to just take action to prevent their affiliates from taking losses. So they’ll extend loans rather than foreclose them. However, this concern may be exaggerated.”

Indeed, some wary observers of this practice question whether there is an inherent conflict of interest in having a B-piece buyer service its own loan. “There have been allegations toward some special servicers that they’ve been over zealous in their servicing of mortgages,” says Anthony Sanders, professor of finance in the School of Management at George Mason University in Virginia.

But Campbell observes, “The value of special servicing has risen as their affiliates’ investments have fallen, and to avoid lawsuits and rating agency downgrades, specials may be more vigilant in upholding their duties to the trust then some predict.”

Still, Sanders points out that special servicers have been accused of unduly calling performing loans or collecting fraudulent fees. Senior bondholders have also been known to sue special servicers if they are unhappy with the servicer’s course of action.

Appaloosa Management, for example, filed a motion on Tuesday alleging CWCapital Management, the special servicer for Stuyvesant Town/Peter Cooper Village, violated its fiduciary duty by seeking to foreclose on the property—exposing the trust to “wholly avoidable losses, risks and injuries,” like double transfer taxes.

Like many of its competitors, LNR Partners has been brought to court for breech of contract, though there are no recorded judgments against the special servicer. With LNR’s current crisis, some question how a bankruptcy filing may affect the trusts to which the company must answer.

Stephanie Petosa, a senior analyst at Fitch, says bankruptcy courts generally protect the interests of the filing entity with regard to its special servicing business. Including the special servicing arm in bankruptcy could jeopardize its agency ratings.

A reorganization of LNR may result in a surge of distressed commercial assets sales. “If LNR files for bankruptcy, it is going to need cash and liquidity. So it sounds to me that it would probably want to be auctioning some of loans in the portfolio,” says John Garth, partner and managing director of originations for the East Coast for the Pembrook Group.

Recovery rates for resolved CMBS loans are lower than the historical average, according to Fitch. But the agency’s most recent data show that LNR had a 90.7% recovery rate as of the end of Q3 2009. That number, however, may be a bit deceiving since LNR has the largest portfolio of loans in special servicing, and at the time had resolved just 119 of its 1,000-plus loans.

Loan extensions may be too costly an endeavor for LNR to continue in earnest. A torrent of asset transfers, like LNR has experienced, can be a crushing expense if monthly base fees or resolution fees are only trickling in. Special servicers may handle appraisal costs, legal fees and other expenses, with the hopes of reimbursement.

To cover operating expenses, Schecher points out special servicers typically borrow money from line lenders, which require haircut equity. But he says, “The amount of foreclosed properties that are coming into the CMBS default arena creates a liquidity crisis for the special servicer.”

He continues, “You can’t continue bringing in bad assets and not sell them and continue to borrow to pay the advances on real estate taxes, insurance and interest payments; this is a losing proposition.”

LNR’s $1-billion senior credit facility is set to mature in 2011. Moody’s suspects the company, likely unable to refinance, will default on its credit obligations. Schecher suggests this line lender turmoil may create problems for other special servicers, if LNR defaults.

“You are going to see line lenders getting nervous about their position with lesser servicers,” he says. “The uncertainty of this could cast a pall on the industry for some time, and that means the velocity of transactions will remain static.”

A month after Moody’s took action, Fitch Ratings downgraded the special servicing entity, LNR Partners, because of its parent company’s financial trials. With 1,107 loans valued at $18.6 billion as of January, LNR has been named special servicer for the largest amount of CMBS debt, according to Trepp.

Were LNR Property to file for bankruptcy, those loans would continue to be serviced, says Sanders. “Even if the worst happens and they start moving toward a process of liquidation, the servicing rights will just be sold to other servicers out there. And there are still plenty of players out there,” he says.

What’s more concerning, he adds, is how this situation reflects on the state of commercial real estate. “It’s sending a signal out that there are some serious structural issues going on in the commercial market.” Sanders stresses that the skyrocketing level of defaults and delinquencies in the commercial real estate space continues to be largely ignored by the public.

Petosa says, “All servicers are stressed and most of them are under financial pressure. The whole special servicing landscape is going to change this year, whether that’s through consolidation or the purchase of existing servicers.”

“We have no comment other than to confirm we have satisfied The Related Group’s lender obligations, and we have sold the two projects (Trump II and Trump III at Sunny Isles) to former partners in these developments,” Betsy McCoy, Related’s vice president and associate general counsel, said in an e-mail.

This comes after Related and its lenders—likely to take title soon to the Icon Brickell towers—slashed prices on the nearly vacant Miami project. And Related no longer owns a site in Downtown Miami where Perez planned another condo tower.

“In an economy like this, when developers like Related became so big, they actually contract,” says Michael Cannon, executive director of Integra Realty Resources in Miami. “What [Perez] is going through is a contraction rather than an expansion, and this is what a lot of developers are doing.”

Related was one of the most prominent condo developers in South Florida over the past decade. The company built Murano at Portofino, Icon South Beach and Apogee in Miami Beach, plus 50 Biscayne, 900 Brickell and Loft Downtown in Miami.

But when the housing market and economy collapsed in 2007, Related and its joint venture partners were left owning thousands of new luxury condos.

Perez’s personal net worth has also declined. He was ranked at No. 197 on the Forbes 400 list of the wealthiest people in 2006, when his net worth was estimated at $1.8 billion. Last year, he fell off the list when his net worth dipped below $900 million, according to Forbes.

One of Related’s partners was the Dezer family. Related and the Dezers co-developed the Trump Towers, but the relationship ended Dec. 31, according to four people familiar with the project who declined to be identified.

“It wouldn’t surprise me, unless he had a major stake in the [Trump Tower] project, that he would terminate the agreement and move on,” says Cannon, who has no direct knowledge of the deal.

Related had a 50% share in TRG Sunny Isles VII, the company behind the oceanfront project, until Jan. 13 when the Dezers took full control, according to the Florida Division of Corporations. Related and the Dezers joined forces more than five years ago to build the three-tower oceanfront Trump project on Collins Avenue and 160th Street. Each 45-story tower has 271 condos.

In 2007, TRG Sunny Isles obtained a $345.7-million construction loan from Wachovia Bank, now owned by Wells Fargo. On Dec. 31, Wachovia modified the loan and extended its maturity date. A mortgage filed with Miami-Dade County did not disclose the due date.

One tower is sold out, another has a few units sold, and the third is vacant. The unit prices have dropped nearly 40% since pre-sales started five years ago.

Trump Towers condos are selling from $350 to $400 per square foot, down from about $550 to $650 per square foot a few years ago, said Craig Studnicky, president of the International Sales Group in Aventura, whose company represents buyers of Trump Towers units. “At $350 a foot,” he says, “there is not going to be any profit realized by the developer.”

Related also took a big loss on the sale of a Downtown Miami parcel where the company planned to build condos. It sold a 28,500-square-foot lot at Northeast Third Street and Second Avenue for $4.4 million on Dec. 29 to Miami investor Rafael Kapustin, who had sold the land to Related for $12 million in 2007, as the condo market was beginning to deteriorate.

After reacquiring the site, Kapustin sold it to Miami-Dade College for $5.5 million. Related paid off a $5 million mortgage with HSBC Realty Credit Corp. at the time of the sale.

Now Related is working to resolve its problems at Icon Brickell. The company has nearly 1,500 condos to sell and is delinquent on construction loans totaling nearly $700 million.

Related’s McCoy says the developer was negotiating to hand over Icon’s three towers to the lenders with the condition that the company continues to run the project. “We are in a workout process so we would continue to manage [Icon],” she says.

The Miami builder’s shares surged nearly 9% on Thursday after it announced late Wednesday winning an auction for a portfolio of about 5,500 residential and commercial real estate loans from 22 failed banks. Lennar agreed to pay $243 million for a 40% stake in the portfolio. The rest will be held by the Federal Deposit Insurance Corp.

A subsidiary of Icahn’s company, Icahn Enterprises LP, emerged as the only qualified bidder this week after two competing bids were deemed unqualified, an examiner appointed by the US Bankruptcy Court in Miami said in documents filed with the court, the WSJ says. Icahn has pledged $106 million for the project, plus $50 million in financing during bankruptcy proceedings.

Hotel consultant Sumner Baye, president and partner of International Hotel Network LLC, who has worked with Icahn many times in the past, tells GlobeSt.com that Icahn “certainly has a taste for the gaming industry.”

Baye explains that Icahn’s “past gaming investments have turned out very well for him” and that Icahn continues to be on the lookout for more gaming opportunities ahead.

One of the “past gaming investments” that Baye is referring to includes the Stratosphere, which Icahn sold for $1.3 billion to Whitehall Street Real Estate Funds, an affiliate of Goldman, Sachs & Co. Icahn started investing in the Stratosphere in 1997 when he purchased $82 million of the property’s $203 million in mortgage debt. Another gaming investment Baye mentioned in support of Icahn’s “taste for the gaming industry” includes the Tropicana Atlantic City, which he, along with creditors, claimed ownership of in 2009 in exchange for $200 million worth of debt.

As GlobeSt.com previously reported, the deadline for submitting a qualified bid for the stalled $3-billion, 3,800-room Las Vegas Strip resort development was set at 5 p.m. PST on Friday, Jan. 15, 2010. The last bid supposedly topped Carl Icahn’s $156.2-million “stalking horse” bid by at least $1 million.

Several hedge funds looked closely at the Fontainebleau in the past few weeks but ultimately decided not to bid, a person close to the situation told the WSJ. Penn National Gaming, a regional casino company, scouted the project for months but dropped out last week after determining that the market couldn’t support the $1.3 billion to $1.5 billion the company believes it would take to finish the Fontainebleau.

In other Icahn news, as GlobeSt.com recently reported, through Icahn Partners LP and certain affiliates, the billionaire investor acquired 51% of the first-lien debt owed by Trump Entertainment Resorts to Beal Bank for $229 million in cash and has the option to purchase the rest for around $220 million, according to papers filed on Dec. 11 with the US Bankruptcy Court for the District of New Jersey in Camden. The deal was part of a bankruptcy reorganization plan Icahn negotiated to help the troubled casino company emerge from Chapter 11.

As many as 110,000 rooms in Miami-Dade, Broward and Palm Beach Counties are expected to be filled during the 10-day buildup to Super Bowl XLIV on Feb. 7, including the Jan. 31 Pro Bowl. It’s the first time the National Football League has held both its marquee events in the same stadium.

“For this year, it’s the perfect situation,” Bill Talbert, president and CEO of the Greater Miami Convention & Visitors Bureau, tells GlobeSt.com. “That will bring in more fans and more media earlier than it normally would.”

While South Florida has had plenty of experience as a Super Bowl site, and will bid to host the game again in 2014, the region is treating this one like it is the first. That means rounding up hundreds of local volunteers and, for hotel owners’ part, treating their properties like they are game central.

Besides 25 miles of contiguous beaches, unlimited golf possibilities and even eco-tours of the Everglades, the region’s biggest selling point is what it has always been in winter: warm weather. “It’s doubtful anyone can challenge it at this time,” says Talbert, who also serves on the South Florida Super Bowl Host Committee.

Miami and surrounding areas could certainly use a boost during an overall tough market for the US hotel industry. Occupancy at local hotels earlier this month averaged at least 75% with daily room rates averaging $173, according to Hendersonville, TN-based Smith Travel Research. That’s well ahead of national average occupancy close to 40% and ADR just under $92.

To understand how area hotels can benefit from a national football championship, check out Los Angeles, where the Bowl Championship Series college title game was held Jan. 7. Occupancy in the market rose to 62% for the week, while ADR reached nearly $128, STR reports.

The NFL estimates a $400-million economic benefit to South Florida from hosting both the Super Bowl and the Pro Bowl, which is traditionally played in Hawaii the weekend after the Vince Lombardi Trophy has been awarded. The Pro Bowl will return to the islands the next two years, though Talbert believes more such games could be staged stateside if this year proves successful.

In the meantime, the region will undoubtedly benefit from having two signature NFL events during a global recession, he says. “Timing is everything, and our timing is great.”

For insight on this issue, CoStar interviewed Greg Maloney, president and CEO of Jones Lang LaSalle Retail, whose firm has been appointed as a receiver or is dealing with several retail properties in foreclosure. In December 2008, Jones Lang LaSalle announced it had been appointed as the receiver for 10 retail properties. Today, the firm has 25 properties in receivership status that it is managing while it either tries to sell or reposition foreclosed properties.

Most of 2009 was marked by lenders and special servicers trying to get their arms around properties struggling with their loans, sorting out the most pressing problems, and attempting to tackle those in a “very thoughtful and hopefully profitable way,” said Maloney. He said the timing of foreclosures and receivership announcements occurring at the end of the year was largely driven by year-end decisions by their lenders. “Servicers and banks were saying, ‘if we’re going to close these things out in 2010, lets foreclose on what we can by the end of the year.’ ”

Maloney expects this activity to continue well into the first part of this year as lenders that have decided to foreclose will want to do so “sooner rather than later.” In an effort to keep costs down and speed the process along, Maloney expects many lenders and servicers will opt to “bypass receivership, foreclose on the subject property, put it in their REO portfolio, hire somebody to come in and secure the asset, and then turn it over to their investment sales people to get rid of it.”

The exceptions that are more likely to first go into receivership, said Maloney, will be the very distressed assets, such as unfinished properties caught in disputes between the borrower and lender, and retail properties hit hard by a large number of vacancies.

With the caveat that there can be many circumstances affecting the strategy lenders and servicers decide to take, Maloney said, “Receivership is generally a very expensive process that [lenders] usually put a very troubled asset that has lost a lot of its value and they don’t want to take on the liability risk at this time.”

However, if the property is simply under-performing without a great deal of liability exposure, the lender might as well just foreclose on it, he added.

Regarding retail loan default trends, Fitch Ratings recently reported that the CMBS loan delinquency rate rose again in November — reaching 4.29%, which is up 43 basis points from the month prior. While delinquency rates were up in November among all property types, the retail delinquency rate rose only slightly, from 3.55% in October to 3.81% in November, accounting for $5.2 billion in delinquent retail CMBS loans. This rate is up from only .63% delinquency in November 2008.

However, Maloney said the CMBS loan default rate is no longer the key driver of shopping center foreclosures and receiverships. “The majority of the troubled retail CMBS loans have already been turned over to the special servicer or lender. There will still be more. However, the real traunch is the non-CMBS stuff, which is really starting to come up in 2010 and 2011. These are loans that are just going to mature and the lenders are very concerned because most of the properties have lost value. The property is worth less than what they loaned on it two to five years ago. That is what’s really going to take place in 2010 — a lot of borrowers and lenders, even more than before, trying to come to some sort of agreement to extend the loans and keep things going,” or turn over the keys, said Maloney.

In the receivership process, Maloney said that in most cases, a lender hopes the receiver will stabilize the property, finding tenants for vacancies and keeping current tenants in place, so that it ultimately can be sold out of receivership, rather than taking it through the foreclosure process.

But that is easier said than done in today’s market as potential buyers are still reluctant to execute sales at current pricing levels, said Maloney. “We have them in the market and I think we’re very close to it. I think in the first quarter you’re going to see a lot of the assets starting to trade hands — especially out of receivership and foreclosure.”

In most cases, especially in the first half of this year, Maloney said he expects sale prices to be low — in many cases well below their previous purchase prices.

“I think the properties we’re going to see sell first are the ones that have lost a lot of occupancy and NOI,” said Maloney, adding that he expects a large number of distressed properties brought to market in the beginning of this year with the hope of making a quick sale and reposition for recovery by the end of 2010.

According to CoStar information, the fact that the number of retail properties in distress continues to rise supports Maloney’s expectation. In the Sept. 24 CoStar article, ”

                                                                                      
If, as Maloney expects, the industry sees more retail receivership work and foreclosures this year, is this work a good replacement for the lack of transaction income?

“I think we all thought we were going to get a lot more of this work, especially in retail, than we have,” Maloney said, adding that fees from receivership and management services of these properties “is not enough to make a difference.”

From a brokerage standpoint, Maloney said the transactions in receivership typically are renegotiations, not new lease deals. And given the difficult sales environment, the small number of sales that do go don’t generate a great deal of commissions.

“It has not been a windfall,” he explained. “The amount of business has not been big enough to spin off and make into a separate division, for example,” adding that JLL simply treats the work as an added client service.

Bank of America, representing a commercial mortgage-backed securities (CMBS) fund, filed the foreclosure action on Dec. 21 against PMAT Cocowalk, according to Miami-Dade County Circuit Court records. It targets the four-story, 200,000-square-foot complex at 3015 Grand Ave.

New Orleans-based PMAT Real Estate Investments bought Cocowalk for $87 million in 2006 and pledged $5 million to redevelop it. PMAT Principal Robert A. Whelan couldn’t immediately be reached for comment.

Adam Greenberg, managing director of Miami-based Baybridge Real Estate Group, said the price per square foot paid for Cocowalk was way too high. The loan-to-value ratio, based on the $80 million mortgage PMAT obtained after buying Cocowalk, was extremely aggressive, he added.

“You’ve got to wonder what investor signed off on something like that,” Greenberg said.

Cocowalk is a popular destination for dining, movies and shopping, especially for students at the nearby University of Miami. Its restaurants include the Cheesecake Factory, Chili’s, Fat Tuesday, Hooters and Starbucks. Cocowalk boasts retailers such as GAP, Victoria’s Secret, FYE Music, and White House/Black Market.

While the Cheesecake Factory and the ground floor retailers get a lot of visitors, the retailers on the higher floors struggle to get customers, Greenberg said. Tenants on the second and third floors have rotated in and out for years.

Since shoppers at Cocowalk tend to be young and budget-conscious, the landlord shouldn’t charge tenants there such a high rent, he added. But with the high debt servicing costs, rental rates in Cocowalk are fairly steep.

Greenberg said Cocowalk shouldn’t sell for more than $50 million. The buyer must make concessions on rental rates in some cases, he added.

In September, Cocowalk terminated its lease with Kansas City, Mo.-based American Multi-Cinema (AMC) to operate a 16-screen theater. AMC had been there since Cocowalk opened in 1990.

Mike Whalen, CEO of Jupiter-based Paragon Entertainment, said he plans to open a Muvico-branded theater in Cocowalk on April 15. It will have 12 screens, reserved seating, a bar and a restaurant in about 50,000 square feet.

“We think it’s a great site for a movie theater,” Whalen said. “The foot traffic of a theater coming through there will help all the restaurants.”

Whalen declined to comment on the foreclosure.

Since its debut, Cocowalk has lost traffic to the newer Shops at Sunset Place in South Miami and the Village of Merrick Park in Coral Gables.

“So you’ve got an all right business plan and retail center at Cocowalk and then three other retail centers come that are drawing from that market,” Greenberg said. “The night life wasn’t such a draw that it could support everything else. Traffic is a mess. A lot of people don’t’ want to pay for garage parking.”

Miami attorney Oscar Sanchez, who represents Bank of America and the CMBS fund, could not immediately be reached for comment.

With “normal attrition” in the industry typically about 1%, “the closures represent the worst on record and reflect a 7.3% loss in the nation’s dealer count,” said Urban Science. The firm said the closures are primarily the result of General Motors and Chrysler consolidating dealership locations, with the two automakers accounting for 90% of the closures.

“While OEM bankruptcies and bad economic times drove the closures, all dealers have to deal with a market that has dropped from several years of 17 million in sales to somewhere around 11 million,” said John Frith, vice president of retail channel solutions, Urban Science.

In an April 2009 article published by CoStar,

Two years ago, almost everyone was discussing, and looking forward to, a tsunami of distressed assets which would be coming to market based upon the sub-prime mortgage crisis and the stresses it would exert on the credit markets in general. In September of 2008, when Lehman failed and Wall Street as we knew it was structurally transformed from an investment banking platform to one of bank holding companies, the “almost everyone” mentioned above was changed to “everyone”. But the tsunami has not arrived, not even close.

The fact that only a few distressed assets have been put in play is not because they aren’t out there. The pipeline is chock full of them.

Let’s use the New York City marketplace as an example. In the 2005-2007 period, there were $109 billion of investment sales in New York City. Based upon reductions in revenue (rent levels) across all product types including residential, office, retail and industrial and cap rate expansion, values have declined by 32%, on average, year to date. If we eliminate multifamily properties from this analysis, values have fallen from peak levels approximately 48%. Based upon these reductions, we estimate that, of the $109 billion spent on investment properties, $80 billion of that was spent on properties which now are in a negative equity position. This relates to about 6,000 properties.

If we include properties which were refinanced during the 2005-2007 period, the number of properties having negative equity jumps to 15,000. We estimate that there is about $165 billion in debt on these properties and, based upon today’s underwriting standards, there should only be about $65 billion in debt on them. This means that in order to have a conservatively leveraged marketplace, we would need to extract $100 billion in debt.

Clearly, this will not happen. Many investors have the ability to feed their properties and, based upon a desire to own them on a long-term basis, will do so. Other transactions will be worked out utilizing any of our favorite terms which have become commonplace in today’s vernacular including, “extend and pretend”, “delay and pray”, “a rolling loan gathers no loss” or “kicking the can down the road”. We do believe, however, that $30 to $40 billion will ultimately be extracted from the market in the form of losses.

So where are those distressed assets now? Some have not come to the market because they aren’t even in default yet due to mortgages which are still in interest only periods or are operating on an interest reserve set up by the lender when the loan was originated. Others have loans floating over 30-day LIBOR which closed on friday at 23 basis points (3-month LIBOR is only at 26 basis points). At 150 over LIBOR, the rate being paid on those loans would only be 1.73% and they can cash flow at those levels of debt service. While some properties are fundamentally under water, they are not yet in default, but likely will be when these advantageous terms expire.

Other distressed assets haven’t come to market because everything that has happened legislatively has allowed lenders to hide bad assets on their balance sheets. The FASB mark-to-market accounting rules have been modified to allow loss avoidance. Similarly, bank regulators will now allow lenders to hold a loan on their balance sheet at 100 even if they know that the underlying collateral for that loan is only worth 60. Additionally, modifications to the REMIC regulations have made it easier for CMBS loans to be kicked down the street.

Any of these delaying tactics will only be beneficial if appreciation is anticipated in the short-run. Given the massive deleveraging the market must experience and unemployment rates which are anticipated to remain elevated for at least another year to 18 months, we do not see support for the short-run appreciation argument.

We really don’t understand the reluctance of lenders to deal with these problem properties. Many of those that are in default are currently in the foreclosure process. This is a frustrating process, especially in New York, as it can take years to get through the process and obtain the title to the collateral. Many borrowers further complicate things by going into bankruptcy, which, based upon backlogs in the bankruptcy courts, adds additional time to the process.

It is very difficult to say this without sounding completely self-serving ( After all, I do sell buildings and notes for a living) but, if a lender wants out of a bad deal, selling a note today is likely to lead to a better recovery than waiting a year or two.

We believe this because the lack of product on the market toady has created a dynamic in which many investors are fighting over relatively few opportunities. Because of this, particularly on our income producing properties for sale, we are generally receiving 25 to 35 offers for each. Furthermore, on each note we have sold this year, we have received over 50 offers. This is due to the fact that buyers today would rather purchase from a lender than a private seller, believing they will get a better deal. “Believing” is the key word in the last sentence.

Due to the excessive demand for distressed assets, buyers are currently paying aggressive prices for anything banks are selling.  In many cases this year, we have obtained prices for notes that, we believe, are at or very near the value of the underlying collateral.

Some lenders are taking advantage of these dynamics to rid their balance sheets of underwater loans and are using the proceeds to make good loans today. Consider that two years ago, bank spreads, based upon all of the competition to put money out, were as low as 30 or 40 basis points. Those spreads can be 300-400 over corresponding treasuries today. Additionally, today’s loans have less risk associated with them as, rather than a loan to value ratio of 75%-85%, LTVs today are generally in the 60%-65% range. These loans are also significantly less on a price per square foot basis than they were two years ago.

If your business was 10 times as profitable as it used to be and there was much less risk involved, wouldn’t you be trying to do as much business as you could?

“Out with the bad, in with the good”, should be the mantra of lenders today. Until now, this has been slow to develop. To illustrate this, consider the following very telling statistics: Massey Knakal is asked by potential sellers to provide opinion of value reports and provide an explanation of our marketing program and we exclusively list about 31% of the properties that we are asked to analyze. It is just like a batting average in baseball, if we are hitting .300, we feel pretty good. With lenders and special servicers we are working with, we have completed just over 1,000 valuations and have exclusively listed just 12 properties/notes. That is a batting average of just .012. Many of these opportunities have simply not come to the market in any form. Perhaps the lender/servicer is waiting to see what the future will bring; perhaps they are simply making deals with the borrowers.

We have, however, seen this freeze thawing slightly as 2009 comes to a close. We expect to be coming to market with several distressed notes from lenders and special servicers right after the holidays and remain optimistic that we will be able to continue to achieve pricing at levels where the recovery versus collateral value is significant. There are also some foreclosures which should be concluding shortly which will lead to some REO which should be placed on the market shortly thereafter.

Let’s hope that 2010 sees a significant rise in these opportunities coming to market. It appears that the year will, at least, start out that way.

By Q4 of this year, commercial mortgage defaults are expected to rise to 4%, nosing up further to 5.2% by the end of 2010, and then finally topping out at 5.3% in 2011. The report says that by ’11 and 2012, the larger share of commercial mortgages originated at the peak of the asset cycle in 2006 and 2007 will mature. Ultimately, that means those mortgages will require balance adjustments in larger numbers as a consequence of high loan-to-value ratios and weak debt service coverage that fails to meet prevailing criteria.

Simply put, Sam Chandan, president and chief economist at REEcon, tells GlobeSt.com, “We continue to observe increases in default rates, consistent with projections from one year ago.” And Chandan says that in part, at least so far, policy interventions have not stemmed the increase in distress among bank-held portfolios.

REEcon’s analysis says that 211 institutions, or 4.6%, are homes to commercial mortgage default rates of 10% or higher, with 1% of the analyzed banks having default rates of 16.5% or higher.

It was just this past June that commercial real estate mortgages started coming home to roost in droves and default levels reached the highest levels seen in 15 years. Add to that recent Federal Reserve data from Q3 showing delinquency and writeoff rates for commercial real estate loans at all banks in the US at 8.74%, nearly double the number for the same quarter in 2008 at 4.74%. By all indications, it could be headed beyond a 1991 peak of 12.06%.

Thus far this year, 124 FDIC-insured banks have failed. On Nov. 24, the agency’s insurance fund sunk into negative territory, with an $18.6-billion deficit.

Despite those grim sounding numbers, Chandan says it’s only been in recent weeks that new policy initiatives promulgated and intended to directly support banks’ management of the commercial loans have been enacted. He says the primary focus has been on encouraging securitization activity. In fact, he says the TALF program has only encouraged the minimalist contribution to the commercial real estate market.

“The Q3 results underline that a shift in policy attention to the challenges of banks is warranted,” says Chandan. As a good example, he says, “the loan workout guidance released by the FFIEC some weeks ago is an initial step in addressing some of the banks’ issues.”

Digging deeper, Chandan says there’s been a tendency to paint a broad stroke over the entire regional bank sector, creating the perception that they are a significant problem area. For example, it’s been widely reported that among 36 banks Fitch Ratings evaluated with less than $20 billion in assets, commercial property exceeded 25% of total loans, compared with 10% or less at the nation’s four biggest lenders.

Still, Chandan says “it’s important to evaluate each bank’s performance individually,” and point out there is significant variation. In fact, the REEcon report says default rates for institutions in larger asset size groups are higher, despite having significantly commercial real estate concentrations.

“Some banks that have similar concentrations may have, as a result of institutional factors, made less aggressive loans and underwritten loans differently,” Chandan says. “In many cases, the capacity of these banks to manage risks in their portfolios as we go forward is tempering the rate of defaults and loss severity.” He adds that after examining actual data, he finds that “some regional banks that have large CRE exposures are managing them really well.”

And therein lies today’s lesson for the future, according to Chandan, who says “risk management culture, management and accountability structure within an organization as well as data collection practices” all figure into his preliminary analysis. “If some banks are managing this well, and doing a reasonably good job, let’s study what they are doing and try to tease out what those practices are, so they can be replicated elsewhere at institutions less prepared to deal with increased levels of distress.”