Here Come the Accounting Changes

When the Senate passed its version of the financial overhaul Brendan Reilly, SVP of government relations for the Commercial Real Estate Financial Council told he was relieved that the provisions were basically in line with what the real estate industry needed for CMBS to restart. But he couldn’t help adding that the financial legislation is only one piece to a larger recovery, with other regulatory and accounting reforms also playing a role.
Indeed, it could be said that the accounting reforms coming the industry’s way will have almost as big an impact as the financial services bill. There are several moving parts to this story – one is the push to converge global and U.S. accounting regulations, which will deliver both benefits and risks. The day of reckoning for that is a bit off – the SEC has yet to make some crucial decisions about deadlines.
More immediate though are two proposals from Federal Accounting Standards Board – one that has grabbed the attention of real estate firms and one that is just as steadily moving towards resolution but with little notice.
Yesterday FASB put forth its proposal that banks report the fair value of loans on their books and accelerate recognition of credit losses. If that rule was in force now you know what it would mean: no more pretend and extend, a lot more distress. For borrowers the former would have made a painful period a lot worse; for opportunistic funds, it would led to more buying opportunities. Indeed the Wall Street Journal reported this week that many of these funds are returning money to investors as their commitment periods end because they haven’t found anything in which to invest.
The other proposal on which FASB and International Accounting Standards Board are working has to do with lease accounting standards. Like the banking proposal, this will have a big impact on a wide range of industries – basically anyone who leases anything, from equipment to property will have new business decisions to make once this rule goes into affect. Property owners are just now beginning to realize that as tenants are becoming even less willing to sign long-term leases until the ramifications of the new standard are completely clear.

Life’s Appetite for Real Estate, CMBS Grows

Insurance companies have never been ones to spell out their allocations for commercial real estate. Usually real estate developers and investment managers are left to make their best guesses at the start of the year as to what insurance companies will be doing, both in terms of lending and in what they will be investing. By now it’s pretty clear that life insurance are not just lending defensively to real estate this year — that is, lending just to keep their existing portfolios solvent — but are actively expanding their business.

The latest proof point: Bernard Winograd, Prudential Financial’s executive vice president for U.S. businesses. According to comments he made in a conference call, the insurance company is happy to be a lender to real estate again. “We feel good about the upside opportunity for valuations relative to the downside risk.”

It’s not just Prudential. As Bloomberg reports, MetLife said last month that prices have bottomed out while valuations are starting to rise. “Smart capital is starting to queue up,” Principal Chief Executive Officer Larry Zimpleman said in an April 27 interview. “There are a lot of new funds being formed by investors who are looking to invest and buy either loan portfolios or buildings.”

Perhaps of even greater interest are the comments made by Primerica CFO Alison Rand in another interview with Bloomberg.
The insurer is planning to invest at least some of its portfolio in CMBS, she says.

Supply of new CMBS, that is, has been sparse for obvious reasons, one of which is lack of demand. Whether Rand was discussing new or existing CMBS is unclear, but either way it signals growing intereste by the buy side for these securities.

What does Freddie Mac’s Loss Mean on Capitol Hill ?

Freddie Mac has posted an eye-popping $8 billion first-quarter loss — an amount higher than the $7.8 billion that Freddie lost in Q4 2009.

The GSE will be seeking more funding from the government. In the short run it will likely get it. The Obama Administration has all but said the sky’s the limit for keeping Fannie and Freddie solvent. There is a case to be made for that – certainly multifamily companies like that position.

However the numbers also bolster a case being made by some Republicans that it is time to cut the cord for Fannie and Freddie. Unfortunately, they may be the right — the government’s support of the two GSEs in the long run is not sustainable. It is also hindering private market solutions, such as a multifamily CMBS.

Given the strong constituency that wants to keep the status quo with the GSEs – at least, again for multifamily – the situation is not likely to change any time soon. Including the GSE’s bleeding red ink.

4 Signs of Life in the Past Week

It has become a cliche to say the economy is showing signs of life — but, then, there it is. The economy IS showing signs of life — as well as the commercial real estate industry, which all but had its final rites time last year.

To be sure, there are several challenges including the yet-to-be-resolved question of where billions of dollars of commercial property debt will find refinancing, the record high CMBS default rates and several legislative initiatives that are worrying the industry.

But never mind those for the moment. Instead consider what has happened in just the last several days:

  • Citigroup is bringing a $222M RMBS to market — a private-label RMBS — according to the Financial Times. The bonds are expected to be AAA-rated, backed by 255 residential loans originated by CitiMortgage.
  • REITs — at least the publicly traded ones and even many unlisted REITs — are going gangbusters. Last year they raised a record amount of equity, primarily used to shore up balance sheets. This year they are on track to match that or more. Better yet, at least some of this war chest is expected to be used to make acquisitions. This week alone saw five REIT IPOs or stock offerings including Kilroy Realty, Chatham Lodging Trust and Macerich Co. which raised an eye-popping $1.23 billion.
  • The reviving CMBS market is pushing out more transactions. Glimcher Realty Trust CEO Michael Gilmcher, for example, told USA Today that the company just acquired $100 million in loans will be sold into the CMBS market in order to refinance loans for shopping centers in Tennessee and Ohio.
  • Europe’s structured finance market is getting back to its feet as well too. Property investment fund Vesteda launched a $471 million CMBS this week, the first in Europe for almost a year.

International accounting standards and the political process

There are a lot of potential accounting changes facing commercial real estate firms as U.S. and global authorities remake standards. There is, as Real Estate Roundtable’s Jeff DeBoer recently pointed out at a Realshare conference, the matter of lease accounting, which depending on how the rules are redone, will have a dramatic impact on how leases are accounted for. There is the question of how long banks will be able to carry non-performing assets on their books.
Then there is the convergence of international standards, which will usher in an entirely new chapter of accounting regulations for real estate firms and REITs. For instance, in a video on NAREIT’s home page,  George Yungman, SVP of Financial Standards, notes that under International Financing Reporting Standards, REITs will have the choice of opting for fair value standards – as many international firms already do.
Getting to the point where developed and developing countries have reached a consensus – much less adoption – of one set of standards is clearly not easy. Assuming it is done correctly, the payoff could be significant for both firms and their shareholders. (One only has to look at the lessons learned from Lehman Bros.’ global shuffling of $50 billion in assets to understand that). Hearing, then, about the potential of undue political pressure placed on the process can be maddening. I am not going to claim the U.S. is an innocent in such matters, but a news report from the Financial Times on Monday illustrates how far some officials are willing to go with this.  According to the FT, European Union’s new internal market commissioner has suggesting linking the future funding of the International Accounting Standards Board to whether it goes along with suggestions from the European Commission.

Another win for CMBS – and REITs

Another sign has emerged that the CMBS market is starting to come back. REIT Ramco-Gershenson Properties Trust  just closed on a new $31.3 million CMBS loan with J.P. Morgan. It’s not the much-longed for multi-borrower conduit type deal, but still. Ramco-Gershenson secured a loan at 60% LTV for two retail properties at a ten-year term at a fixed rate of 6.5%.

The deal is also a nod to REITs, the publicly-traded ones, that is, which have become de facto kingmakers in the commercial real estate debt and equity markets. The biggest boost to CMBS, it must be noted, came from another REIT – Developers Diversified Realty – last year with its $400 million CMBS.

DDR then disappointed the market by declining to go back for a second pass. Instead, it has recently priced a $300 million  stock offering. That move wasn’t so much a commentary on the still-nascent CMBS market, but rather an illustration that REITs basically have all sorts of capital raising avenues open to them these days.

Does FDIC think about the impact it’s having on commercial real estate

Let me start off by saying that of course FDIC’s main mission is to get the best deal it can for taxpayers. The agency is trying to sell off a huge number of assets that it has seized from failed banks. Of course it is going to do what it can to get the best price.

But it would be nice if it gave some thought to the US commercial real estate market and the impact its actions could have there. Two recent news items suggest that CRE is not at the forefront of FDIC’s thinking as it goes about dispersing the assets now under its control.

The most blatant example is news reported by Bloomberg that FDIC is holding a $1 billion auction in which it is selling off loans – including a loan to the build a W Hotel in Atlanta – that may trigger write downs among other banks as well. Half of the loans were originated by Silverton Bank, according to Bloomberg – but several other banks joined Silverton in providing the $80 million W construction loan. These banks will have to take write-downs as the Silverton loan goes to auction, and possibly push many to the edge of insolvency. It’s not just this auction: reportedly of the $50 billion or so in loans seized by FDIC, 63% involve other lenders.

The other news item – again, reported by Bloomberg- also points to future woes for CRE, thanks to FDIC actions. Reportedly FDIC is seeking pension fund money to invest in failed banks. It’s a smart move for FDIC, which sees this is a good way to lower fees, according to Bloomberg. But the CRE industry should wonder if these funds will re-allocate money slotted for acquisitions or other investment into FDIC deals.

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May 2020

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