Strategic Default Double Standard

Business Decisions,
Big and Small

What happens to a homeowner who strategically defaults? (that is, they walk away from their home because it's worth less than what they owe).

Their credit is damaged -- if not wrecked -- for as long as seven years.

What happens to a commercial property owner who strategically defaults?

If it's a REIT, its stock goes up, due to its improved cash flow -- and hence greater appeal to investors:

In the business world, there is less of a stigma [associated with strategic default] even though lenders, including individual investors, get stuck holding a depressed property in a down market. Indeed, investors are rewarding public companies for ditching profit-draining investments. Deutsche Bank AG's RREEF, which manages $56 billion in real-estate investments, now favors companies that jettison cash-draining properties with nonrecourse debt, loans that don't allow banks to hold landlords personally responsible if they default. The theory is that those companies fare better by diverting money to shareholders or more lucrative projects.

"To the extent that they give back assets or are able to rework the [mortgage] terms, it just accrues to the benefit" of the real-estate investment trust, says Jerry Ehlinger, RREEF's co-chief of real-estate securities.

--"Commercial Property Owners Choose to Default"; The Wall Street Journal (8/25/2010)

Good luck getting Joe and Jane Homeowner to honor their underwater, $300,000 mortgages when Corporate America is ditching their $30 million (or $3 billion) mortgages.

What's that line about "what's sauce for the goose is sauce for the gander?"

Endangered Species: the Phoenix (Building) Crane

Arizona Travelogue:
Recession Catches Up to Phoenix

What a difference 2 years makes.

The last time I visited Phoenix, "the Valley of the Sun," all you saw were cranes, cranes, cranes.

That, despite the fact by February, 2008, real estate was very much on the downside of its record run, and the nation was already in recession (not that it really matters, but the official start date was retroactively determined by the National Bureau of Economic Research to be December, '07).

Now, the only in-progress construction I noted locally was road construction (your tax dollars at work!); a handful of cranes on the south side of downtown Phoenix; and a huge, new hotel going up on an Indian Reservation near Scottsdale (you'd think the term would be banned as not sufficiently PC, but that doesn't appear to be the case here).

Real Estate 101

The explanation for those cranes, then and now, is why real estate -- especially commercial -- is inherently cyclical: big, commercial projects take years to come to fruition.

Once developers break ground, the only way to recoup their investment is to "see it through," and finish the project.

In good times, this leads to overdevelopment.

In lean times, it means too few projects are conceived, assuring that commercial real estate supply will initially lag demand when things eventually rebound -- and setting the stage for the next boom (and overshoot).

Grandparent and Grandchild Bubbles

A 30 Year Overview of Commercial Real Estate

Did you know that bubbles can have progeny?

That's John Carney's take, in his treatise-length (but extremely worthwhile) post, "How A Government Bailout Created Today's Commercial Real Estate Catastrophe" (Clusterstock; 11/16/2009).

According to Carney, today's commercial real estate bubble is actually a "grandchild" bubble; the "grandparent" was the bubble that resulted from letting commercial banks branch out into commercial real estate loans in the early '80's.

Carney does a remarkable job of presenting three decades of government policy toward banks -- and tracing the consequences of same.

One of his (not so surprising) insights is the extent to which commercial real estate the last three decades has been driven by financing (or the lack thereof) -- vs., say, fundamentals like supply and demand.

One other nugget: the securitization phenomemon that ended up wreaking so much havoc with residential real estate the last few years dates back to government clean-up efforts following the S&L bust in the early '90's.

In essence, securitization acted like a giant sponge, allowing the Resolution Trust Corporation -- the government entity charged with overseeing the S&L cleanup -- to expeditiously sell off thousands of mortgages at a time, in literally millions of tiny slices.

Sound familiar?