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?"

Toll Bros. & the Twin Cities Housing Market

Cleaning Up After the Elephants; or,
"Love 'em and Leave 'em"

It was fun -- sort of -- while it lasted. But what a hangover!

In 2004, when local land went for $120k an acre, national home builder Toll Brothers swept into the Twin Cities paying . . . $200k an acre.

Why?

Because it could.

Just like the commercial REIT's ("Real Estate Investment Trusts"), large, publicly traded builders such as Toll and Pulte had access to cheap capital, allowing them to bid up local land prices 50% - 75% practically overnight.

While providing a windfall for the first wave of land sellers, the bubble created many more casualties than winners.

They include:

--Local builders, whose land acquisition costs got driven sky-high;
--New home buyers, who the builders passed their costs on to, and who were left holding the bag when prices collapsed;
--Municipalities also left holding the "foreclosure bag" when underwater homeowners defaulted, leaving decimated, half-built subdivisions in their wake.
--Banks whose balance sheets were left in tatters.

At least Toll hung around to help clean up their mess, right?

Wrong.

The 3 subdivisions Toll built in the last 5 years still have many unsold units (surprise!), but Toll appears to have exited the Twin Cities new construction market about two years ago (Note: if anyone's heard otherwise -- please let me know!).