June 2nd, 2010 |

New Distress Climbs as CMBS Restructurings Shift - Borrowers are moving current assets into special servicing

posted by Carlton Dean, CCIM | Senior Investment Real Estate Advisor - all posts by Carlton Dean, CCIM | Senior Investment Real Estate Advisor

Monthly Distress Overview

I found the recent article and report from Real Capital Analytics very enlightening about the current distress happening in the commercial real estate markets. The following is an overview of that article.

After several months of relatively flat growth in the total dollar volume of troubled property, new distress spiked in April by almost 41%, adding $12.8 billion. It was the largest increase so far this year, and brought total outstanding distress to $184.6 billion; altogether, cumulative distress this cycle has reached $239.0 billion.

The climb in April was due largely to the office and hotel sectors, both of which saw major assets and portfolios fall into distress. Also contributing heavily to the spike in new distress was Morgan Stanley’s default on its $2.0 billion Revel casino-hotel development in Atlantic City. Additions to trouble in other sectors, however, either declined or were on par with recent levels. The nearly $13.0 billion in new distress in April is likely not an aberration: already, new distress in May is approaching $10.0 billion.

April’s distress totals reflect, in part, the emerging effects of a changed approach to the restructuring of troubled CMBS debt that began last September. At that time, the IRS issued guidance that afforded special servicers greater flexibility in modifying loans prior to an imminent default. A stellar example of this is the 17-property office portfolio that Beacon Capital Partners, though current on its obligations, placed into special servicing ahead of any default (see Office). Since borrowers and special servicers can restructure assets that are not yet troubled, more borrowers have been moving to secure modifications before losing control of an asset. The restructuring pipeline is almost certain to increase across almost all property types going forward. Indeed, in late May, an affiliate of bankrupt Lehman Brothers Holdings won court approval to restructure $5.2 billion in CMBS debt on its 2007 acquisition of REIT Archstone Smith, made with Tishman Speyer.

Reflecting this trend, 60% of the new trouble was tied to assets backed by CMBS, up 5% from March. Additionally, there was significant growth in the number of new CMBS-backed properties that fell into distress. This not only reflects the changes wrought by last fall’s IRS guidance, but also could point to a step-up in new trouble on larger assets backed by bank loans.

Given this, the lower level of restructurings during April seems surprising. However, it is more likely that, while many borrowers have recently begun restructuring talks with their special servicers, those discussions have not yet resulted in agreements, in part because special servicers may be overwhelmed by the volume. In addition, large corporate restructurings, such as that of General Growth Properties, can skew data in a particular month or period of time. GGP’s debt restructuring accounted for a large portion of the spike earlier this year, and the restructuring of Extended Stay Hotels will create a similar spike in coming months.

Borrowers have also worked to restructure loans held by banks ahead of a potential default. For example, Blackstone used this pre-emptive means to restructure the mezzanine debt on its huge privatization of Hilton Hotels.

One corollary to the ongoing wave of restructurings is the somewhat lethargic pace at which lenders are reluctantly reclaiming assets as real estate owned (REO); that may be even more pertinent for resolutions involving sales out of distress: April’s $1.3 billion of resolutions was the lowest since October 2009. Both of these trends continue to frustrate waiting opportunistic capital.

The vast majority of assets taken by lenders as REO are being seized by non-CMBS lenders, who dominated this activity both in dollar volume terms (92%) and by number of properties (85%) in April. This imbalance reflects the larger share of the CRE debt market in general held by these lenders, which also backed a larger proportion of non-income-producing properties that are resistant to workouts.