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December 10, 2009

Reggie Middleton vs Goldman Sachs, Pt. Deux: Buy into a Collapsing Market to Fund Bonuses, PLEASE!!!
by Reggie Middleton

As a quick recap: I pointed out the illogical, self destructive, circular relationship between Goldman and its clients/customers as significant monies are lost following bad advice and purchasing trash in the form of financial and investment products. See "Reggie Middleton vs Goldman Sachs, Round 1". Goldman has recently issued a buy rating on the commercial REIT sector (of course, Goldman has started underwriting and selling REIT securities), something that I consider to be suicidal at best. Let's take some anecdotal glances into the commercial real estate world to see exactly what it is that Goldman would have us buy, and why.

In December of 2007, I wrote an article "Will the commercial real estate market fall? Of course it will", which I will excerpt from...

Sam Zell, one of the most successful real estate investors of our time, sold his Equity Office Properties Trust of Class A and B buildings to Blackrock for what I assuredly thought was a fools price. When I saw the numbers, I said easy money or not, there is an ass for every seat. Well, little do I know. Blackrock found someone to pass the cherry on to, and in near real time at that - and they paid even lower cap rates than Blackrock did. Hats off to the Blackrock folk. You found the guys at the very tip top of the market to drop those cap rates off on.

Now, the problem for the last guys to buy these properties (as Sam Zell sits there smiling on his $21 billion pile of cash) is that it is going to be nigh impossible to find someone who will pay a ZERO cap rate, and try as you might it will be damn hard to raise lease rates amongst an economic hard landing and negative trending earnings... And thus, this is the fate of commercial real estate. The many guys who overpaid, will get burnt as values tumble from their peak bubble highs. Old school real estate guys email me and say they never even heard of 5, 6 and 7 percent cap rates until recently (after 30 years in the biz). Well, some of these guys are pushing zero (literally 1.5% to 3 and 4%).

Let's fastforward to today, where we may learn the fate of those guys who bought that CRE flip from Blackrock. From Crain's Chicago Business, "Zombie fears stalk Tishman in the Loop"

A venture led by Tishman Speyer Properties L.P. has defaulted on part of a package of loans used to finance the $1.72-billion purchase of six prime downtown office towers during the frenzied real estate market of 2007, sources familiar with the deal say.

The New York developer bought the 5.7-million-square-foot portfolio from Blackstone Group, which flipped them as part of the New York private-equity firm's $39-billion leveraged buyout earlier that year of Sam Zell's Equity Office Properties Trust. [Anybody reading my blog in 2007 or even knew me in 2006 could have seen this coming a mile away!]

The buildings, including such Loop landmarks as the Civic Opera Building and the 10 & 30 S. Wacker Drive complex, have lost much of their value amid the broad decline in the commercial real estate market...

Tishman Speyer, led by longtime developer Jerry Speyer, is in hard-nosed negotiations with officials of the Federal Reserve Bank of New York to rework an estimated $1.4 billion in loans. The Fed inherited the mortgages as part of the 2008 collapse and sale of Wall Street investment bank Bear Stearns Cos. With the talks at a stalemate, the Fed is taking an aggressive tack, cutting off a key source of capital for leasing costs.

The portfolio, which also includes 161 N. Clark St., 30 N. LaSalle St. and 1 N. Franklin St., already illustrates several recent real estate trends, such as rapidly falling property values after prices peaked thanks to large amounts of cheap debt. With credit now virtually gone, defaults on downtown buildings are likely to rise, forcing them into foreclosure or onto the market at big discounts that will put more downward pressure on prices in a spiral similar to the struggles of residential real estate across the country.

"Virtually all the assets bought between '05 and '07 cannot be refinanced today without a significant capital infusion," says Shawn Mobley, executive vice-president at real estate firm Grubb & Ellis Co. "These buildings need to be recapitalized to get back in the business of being active real estate."

Without a financial restructuring, the properties are likely to join a new trend -- "zombie buildings," which can't compete for new tenants because they lack the money to cover brokers' commissions and interior office reconstruction.
...
Many tenants won't consider zombie buildings because they need landlords' cash [for tenant improvements].

Avoiding a "Night of the Living Dead" scenario could be tough even for an established firm like Tishman Speyer, whose local portfolio totals 12.2 million square feet.

A company-led venture is in default on a mezzanine loan of undetermined size, part of an estimated $1.4-billion package of mortgages, sources say. The loans come due next year but can be extended until 2012, sources say [when prices have corrected even farther, put your head in the sand].

... The number of zombie buildings in the Chicago area is likely to grow in 2010, according to a forecast by California-based Grubb & Ellis. For landlords, the trend means even top-quality office properties are likely to divide themselves into "haves" and "have-nots," with the latter seeing their vacancy rates worsen because of the lack of financing. [SHHHH! You Freakin' Idiots! You didn't get the memo?!?! Goldman just upgraded the sector! Goldman needs to underwrite REIT securities to fund the 2010 $23 billion, 500% of the dividend payout bonus pool]

Even landlords that may have cash are hoarding it. Dallas-based Behringer Harvard REIT I Inc., which owns five downtown office buildings, says it is avoiding upfront costs by cutting rents on existing leases in exchange for lengthening the agreements.

From NYC's local real estate rags:

Midtown Manhattan sees double-digit drop in office rents, London's West End still world's most expensive office market
As commercial real estate floundered across the globe, the cost of renting office space plummeted in some of the world's most prominent financial centers. On average, office markets saw a 7.7 percent decline in rental expenses, according to a CB Richard Ellis report released this week, but several dozen markets experienced drops in the double-digits. Midtown Manhattan slipped to 24th on that list, at $68.93 per square foot, down from its 15th-place ranking last year, though it is still the most expensive office market in the U.S. Nearly three-quarters of the 179 markets surveyed saw declines, and Singapore, Hong Kong's Central Business District, and Downtown New York City were among those hit hardest. Those markets ranked second, fourth and ninth for largest rental cost decreases with roughly 53 percent, 41 percent, and 30 percent, respectively. Kiev, Ukraine came in first with a crushing 65 percent drop. Meanwhile, the West End district in London clung to its title as the world's most expensive office market, with costs averaging $184.85 per square foot. "While there are signs that commercial real estate values are stabilizing in some markets in Asia and parts of London, underlying property fundamentals are still weak," Raymond Torto, global chief economist at CBRE, said in a statement.

Stuyvesant Town ruling post-mortem report examines which properties are in danger
New York City multi-family landlords who took advantage of the same J-51 tax abatement program that got Stuyvesant Town into legal trouble are facing legal battles of their own, according to a Deutsche Bank report released this week. The report, a culmination of an analysis of hundreds of these tax break recipients whose loans are secured by commercial mortgage-backed securities, said landlords of properties like the tony Belnord and the Ansonia on the Upper West Side, as well as the Meyberry House on the Upper East Side, would have to make due with decreased operating income as a result of the October Stuyvesant Town ruling, which stipulated that rents cannot be destabilized while J-51 is being utilized. "In the longer term, owners may face decreased investor demand for rent-stabilized properties since the growth rate of cash flow is now severely limited," the report said. Many rent-stabilized buildings will not be able to increase tenants' monthly payments until 2017, according to the report. The Belnord, which has a loan balance of $375 million, topped Deutsche Bank's list of largest CMBS loans on properties affected by the ruling. [WSJ]

Experts see steep rise in deadbeat renters
The percent of residential apartment dwellers in the city who are not paying their rent has as much as quadrupled since the market weakened last year, industry leaders on a panel discussing multi-family properties said earlier this week. "Collections, especially in New York City, have become more of an issue," said Mark Stern, senior vice president at Waterton Residential, a Chicago-based building owner and operator. His firm is planning on making acquisitions in New York City. "[They are] going from the 5 percent range to now 10 or 20 percent in collections, which makes a difference on the bottom line," he said. Mason Sleeper, a principal with the real estate investment firm Praedium Group, said he has seen a similar distress in the market. "You have your collection issue which is increasingly creeping up to becoming a little bit of a problem," he said. They were speaking on a panel that also included Kevin Davis, partner of Area Property Partners; Tim Wang, vice president at ING Clarion and Max Herzog, senior vice president at CB Richard Ellis. The panel, moderated by Mike Kelly, president of Caldera Asset Management, was part of a day-long forum covering multi-family real estate organized by GreenPearl.

NYC real estate pounded with layoffs
The New York City real estate industry shed 600 broker-related jobs in October, bringing the 2009 tally thus far to 5,700, or 4.7 percent of that sector's labor force, according to a new employment report from Eastern Consolidated. Nationwide, brokerage firms cut 2,200 employees during the month, for a current total of 105,500 job losses, or 5.1 percent, since December 2008. The construction industry alone, however, is weathering a more serious fallout. A whopping 16,300 New York City construction jobs -- 12.3 percent -- were lost during the month, though that was only a fraction of the nearly 1.6 million construction employees terminated across the country, who comprised 20.7 percent of the industry. TRD

Michael Stoler -- "Extend and pretend," the new rule for commercial real estate loans
As the fall of 2009 comes to a close, many of the commercial real estate lenders continue to limit their exposure to financing for real estate. The buzzword for 2009 is "extend and pretend," whereby a bank extends the term of a loan to a later date. The legendary Samuel Zell, chairman of Equity Group Investments, the keynote speaker at the NYU Capital Markets conference Nov. 19, stated that "our government has become the bailout city. If a loan is kept current, banks will 'pretend and extend.'" No one is surprised by the "pretend and extend concept," especially if you had the opportunity to gain insight from the Federal Reserve's October 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices and hear the comments made by Ben Bernanke, chairman of the Federal Reserve, in a speech at the Economic Club of New York Nov. 16

Dubai impact on NYC limited to distressed hotels, but signals end to sovereign wealth rescue
As the international credit crisis spread into the kingdom of the United Arab Emirates, real estate experts said that while any direct impact on New York would be limited, it may signal the inability of sovereign wealth funds to bail out distressed assets here. The financial world briefly shuddered last week after Dubai World, the main investment arm of the powerful Gulf region city-state, asked lenders for a six-month suspension of nearly $60 billion in debt payments. Analysts say the suspension may force Dubai to sell many of its trophy assets around the world, including several high-profile buildings in New York, like the Jumeriah Essex House, the former Knickerbocker Hotel and the flagship W New York-Union Square hotel, whose mezzanine debt is scheduled for a Dec. 8 foreclosure auction. "Dubai got drunk with debt just like we did here in New York," said Dan Fasulo, managing director of research at Manhattan-based investment research firm Real Capital Analytics. "A lot of people think Dubai [was financing its deals with] oil. In actuality, it was very much of a debt-fueled building boom."

So, hopefully, between my link-dense introductory post and this anecdotal 'semblage of newsbytes you can fathom that there may be a rather selfish motive to

Goldman's CRE sector update. Let's suppose you are an institutional investor that may have doubts that Goldman has been/is/will act in your best interests. What should you do? Well, for one, I would unplug my ass from the Matrix and shake that dizzying spell of "Goldman is the best in the world-itis", and pay more attention to the smaller, independent, and considerably less non-conflicted sources of analysis, data and opinion. This does NOT include the major rating agencies. As I have stated in the past, if your research sources benefits from transactions in the marketplace and/or sales, you had most asuredely best be on the same side of the trade that they are on. Goldman clients cannot say this!

Lets revisit Goldman's sector upgrade - "Goldman Sachs Upgraded US REITS to Neutral; Ups BKD, AVB, GGWPQ, Downgrades KIM" in which they probably don't have anything on the underwriting calendar for KIM (hence the downgrade), and they have upgraded GGP from sell to neutral (after it has fallen from $60 to pennies and has filed for bankruptcy, thanks fellas - I would have done better reading a blog). Notice that they have also upgraded Taubman, whom I have done a decent amount of analysis on for my subscribers (The Taubman Properties Research is Now Available). What are the odds that a Taubman underwriting is in the pipeline? Did you know that Goldman packaged Taubman mortgages into CMBS already? Let's take a look at how those mortgaged properties are faring (keeping in mind how well [horribly] investors fared in that RMBS offering illustrated in my last vs GS post, see graphic)...

In 2006, Goldman issued CMBS to institutional investors (mostly insurance companies and asset managers) under the moniker GSMS 2006 - GG6, with 19 tranches from junk to AAA rated under both Fitch and S&P (Uh Oh! See the sidebar below for what is happening to S&P rated CMBS debt). This included the mortgages financing the Northlake Mall and the Mall at Wellington GreenTaubman properties - one of which is just about at the underwater mark, and the other that is already past the refinanceable LTV limit imposed by the newly prudent, risk averse CRE financing market. When the CMBS was sold to the investors, the max LTV could not have been more than 70, and was probably less. As you can see, things can get much worse, quite quickly. I anticipate one these properties to be completely underwater by 2010 year end and the other to need a significant equity infusion by suckers, victims future Goldman clients.

What the investors should be concerned about is that although the properties are not quite under water yet, the macro and fundamental trends are heading sharply downward and the debt behind them currently cannot be rolled over without a significant equity infusion. I would assume mezz debt would be out of the question. Now, of course there is a diversity of properties other than Taubman behind these derivatives (just as thier was in the GSAMP Trust RMBS offering graphic above, hint, hint!), but if GS recommends Taubman, one must assume that GS considers Taubman to be one of the better players (or GS is preparing to do another Taubman offering, which is the wager I'd put my money on).

As in the RBMS scenario above, as the underlying properties decrease in value, the lower tranches of the CMBS face the possibility of a total wipeout, and even the higher rated ones fave the possiblity of material risk. Is this the AAA comfort and complacency that you had in mind when you reached for that measly blip of several basis points in additional yield over treasuries??? When dealing with the big name brand banks that need to fund $19 billion bonus pools, it is not necessarily return on your capital that you need to be concerned with. Its the return OF your capital, lest it wind up in the GS bonus pool!!!

The German Reinsurance Company, the Japanese and American asset managers, and the US life insurer that bought heavily into this "bound to make your career" CMBS offering from Goldman are welcome to contact me. Believe it or not, there are CMBS offerings floated by other "name brand" banks that have done even worse in terms of the properties that are backing them. I will get into that in my next post, and give Goldman Sachs a break, after all, they are about to lose half of their (very hard to conceive that they deserved) bonsues. See Darling Places 50% Levy on U.K. Bank Bonuses, Will Raise Wage Taxes in '11. Can you believe it. The capital goes from GS clients who followed GS advice and bought GS products to GS's bonus pool, just to end up in the hand of the UK taxing authority. I'll bet your left nipple that congress is weighing their options as I type this. I warned my readers for months that GS upper management was pushing their luck much, much too hard. One would think they actually started drinking their own Kool-Aid marketing in believing that "Masters of the Universe" stuff. They strutted and dared, and taunted and just very well might have created a precedent that would prove most difficult to unwind.

Darling actually had darling of a soundbite that I just couldn't resist posting:

"There are some banks who still believe their priority is to pay substantial bonuses," Darling said in Parliament. [Nawwww!!! Say it ain't true!] "I am giving them a choice. They can use their profits to build up their capital base. If they insist on paying substantial rewards, I am determined to claw money back for the taxpayer."

What are the chances that the bankers would rather take shareholder capital and increase the bonus amount to compensate for the tax increase than do something a little more,, umm,,, shareholder friendly with it? What are the chances the sheepish shareholders would just sit back and let them do it? After all, the lion's share of net revenue ALREADY goes to the bonus pool as it is, right???

S&P Looks to be Taken Seriously???

As per our analysis S&P has, of late, been very aggressive in reducing its ratings for the CMBS tranches in the last six months as it changed its rating methodology in May 2009, which had the impact of downgrading most of 2005-2008 CMBS classes. Note the reporting from ZeroHedge.

Moreover, we believe that a large percentage of the downward revision in the ratings must have been done by now as S&P initially intended to roll out its results from new methodology over the next 3-6 months, after it had launched the new methodology in May 2009.

Below is the comparative S&P rating for most MSC 2007-HQ12 CMBS tranches issued for Deptford Mall from MAC's portfolio, for your reference:

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

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