Why Are So Few Properties for Sale?

Ever since the financial markets of the world were overwhelmed by the credit crisis in late 2007, many analysts have speculated that a tremendous problem was about to develop in the US commercial real estate market. The general expectation has been that with the collapse of the commercial mortgage-backed securities (CMBS) market and with the reluctance of most banks to make new mortgage loans, there would be a flood of foreclosed and distressed real estate that would engulf the market. That this did not happen in 2008 or 2009 has surprised many observers. And it was not just that the number of transactions in the commercial market was at a record low level in 2009, it has been even more surprising that so few properties are being offered for sale.

Two questions arise from this situation: first, why have so few properties come to market following the collapse of the mortgage market, and second, is this situation likely to change in 2010? There have been many reasons both the banks and the special servicers for CMBS loans have been slow to foreclose on loans that are in default. And both groups have actually resorted to various strategies to keep from having to foreclose on such loans. In Falcon Real Estate’s view, conditions may be changing in 2010 to bring more properties to the market, but this will be a gradual process, and we do not believe that the market is about to be overwhelmed by property offerings, as has so often been predicted.

The Banks’ Situation

With few exceptions, most banks in the United States, both large and small, were heavily invested in assets that depended, directly or indirectly, on the US residential real estate market. And most of those investments had been leveraged to extraordinary levels. As a result, when the residential market collapsed, the banks were faced with the huge problem of writing down all of these assets and attempting to restore their balance sheets. Given the magnitude of the problem in the residential market, the banks were not anxious to face up to the much less serious problems that have begun to arise in the commercial market. Therefore, the banks have had little or no motivation to foreclose on assets that will only add to the problems with their balance sheets.

As a result, the banks have in many cases been willing to grant short-term extensions of maturing loans. Some have labeled this policy “lend and pretend” since the extensions are frequently being granted without recognizing the decline in value that has occurred and in the hope that the market will improve before the loan matures again. This enables the bank to avoid taking a write-down on its balance sheet. The expectation is that the economy will improve during the next two years and the mortgage market will revive so that the distressed borrower will be able to refinance and remove the problem loan from the bank’s balance sheet. The banks have also been reluctant to foreclose since they have not wanted to assume management responsibility for a large number of properties. They generally do not have the asset management capabilities that would be necessary for them to do this.

The banks also face a problem with contentious borrowers. In many cases, borrowers are facing foreclosure since they are unable to refinance solely due to conditions in the mortgage market, even though the underlying property is fully leased and is performing exactly on budget. And there is frequently equity remaining in the property even at current depressed prices. As a result, many borrowers are resorting to the courts seeking the protection of the bankruptcy laws. If nothing else, these tactics have succeeded in delaying those situations where the banks have attempted to foreclose.

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