I came across this article by Preston Howard on Broker Agent Social Network (http://brokeragentsocial.com/article.php?article_id=901) and found it very interesting. Let me know what you think…
Lately, I’m hearing about homeowners committing strategic defaults for over a year. These are the homeowners who have cash in the bank, FICO scores above 720, and stable employment that can cover the mortgage, but choose to walk away.
In this instance, they find a new home at a lower price tag (which may even be on the same block as their current home), close escrow, move into it, and then walk away from the first house and their original mortgage loan, never to pay on the underwater mortgage ever again.
These homeowners have no interest in trying to modify, negotiate or do a short sale. They’ve bought the replacement that they wanted, and the home with negative equity is no longer their issue. Accordingly, they “give the keys back” to the bank and wash their hands of the entire thing. Surprisingly, some of the largest landlords in the world are doing the same thing because it makes pragmatic sense for them to just walk away from properties that are underwater and will never be worth what they owe.
For example, the Simon Property Group, the largest mall owner in the United States, with over 388 properties in 41 states and the countries of China, Poland, Japan, South Korea and Italy decided to walk away from its Palm Beach Mall project in West Palm Beach, FL. Taubman Centers, the owner of the Dolphin Mall in Miami, and the Beverly Center in Los Angeles, made the pragmatic decision to stop making payments on its $135 million mortgage on the Pier Shops at Caesar’s in Atlantic City, NJ. Additionally, Vornado Realty Trust, owner of the Kings Plaza Shopping Center in Brooklyn and the Montehiedra Town Center in San Juan, Puerto Rico recently decided to discontinue making payments on its $18 million loan on its Cannery at Del Monte Square project in San Francisco.
These are not the John Does and Susie Smiths who are down on their luck. Instead, these are large corporations, which in many cases are flush with cash. Their properties are making money. Many of them have recently refinanced their portfolios with lower rates and better terms. The Simon Group had $3.8 billion in revenue and has been actively trying to buy its biggest competitor, General Growth Properties. Taubman has eight projects currently being developed around the world, including one in Macau, China and another in Incheon, South Korea. In spite of the fact that Vornado walked away from its San Francisco loan, the company just obtained $660 million of 10-year mortgage notes in a single issuer securitization. How is this possible?
Banks are calling individuals who embrace this practice “morally unethical.” Strategic defaulters should know that Fannie Mae is considering a seven-year lockout for those who default on a residential loan and then try to purchase another property. However, the same cloud of shame and ostracism doesn’t necessarily apply to commercial landlords. Many of them have non-recourse debt, meaning that the bank can only take the property and not go after the individuals behind the corporations for judgment deficiencies. Furthermore, since a significant number of properties were financed by mortgage backed securities, with literally hundreds of investors behind them, restructuring and/or enforcing provisions in the mortgage documents is extremely difficult.
Some of these corporate defaulters have to stick with their properties in spite of desire to just walk away, as they can’t burn a bridge or bite the hand of the bank that supplies them with their cash to build and expand their portfolios. Nevertheless, many of the alternative financial institutions that have been burned include the regional banks, hedge funds, and high net worth investors who sought a higher yield. With the advent of the new strategic defaulter, these sources of alternate funds may dry up, whereby the source of funds is gun shy of investing in future projects. Many real estate investors got their start using alternative monies until they “graduated” to bank financing. Funds for their projects came from angel investors, mom and dad, hard money lenders, and/or regional banks with an expertise in lending to a particular locale.
As our industry starts its nascent recovery, many commercial defaulters may create rippling effects down the financing food chain, thus making it harder for any and all persons/entities interested in buying investment real estate to obtain financing. Lending institutions of all sorts will be hesitant to lend due to the belief that if a giant like Simon Property Group will walk away from a property because it makes practical sense for them to do so, likewise, a smaller investment group trying to capitalize on a once in a lifetime opportunity will most definitely hand back the keys at the first sign of trouble. I anticipate that ironclad personal guarantees will be common place at all levels of the financing food chain. Non-recourse money will be available for only the largest of borrowers with the most impeccable Dun and Bradstreet reports, while cross-collateralizations on a borrower’s other properties (including the family home) will be necessary to hold borrower’s feet to the fire when nothing else will.
We are living through some of the most interesting times, where the decisions of others, both large and small are creating rippling waves that will affect all of us. Susie Smith defaults at the lower rung, while corporations like The Simon Property Group default at the top. Those of us in the middle who remain are left to face the repercussions of these “strategic” decisions by having to endure the new difficulties of obtaining needed financing from lenders who are less than motivated to make new loans.
Posted in Commercial Real Estate
