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The Vultures are Looking at Credit Card Debt and Commercial Real Estate Loans


 
22.10.2008

The Vultures are Looking at Credit Card Debt and Commercial Real Estate Loans


 

This article might be entitled that the sharks have figured out where the food is. As has been noted before, groups and syndicates of large well financed investors have and are being assembled to cash in on the over leveraging of credit within the US and elsewhere. The problem is that they cannot and could not figure out where to go.

Dow Jones Private Equity Analyst has noted that at least 18 “distress funds” have raised $37.9 billion so far this year.

As I noted in prior writings, efforts to stabilize the residential real estate market pre-foreclosure is very difficult to do because of the securitization process.

And, as I noted, it is very difficult for even the most sophisticated private investors to buy mortgage backed securities because no one knows the value of the assets and who owns what and who owes what to whom.

As a result, for those instruments – to the extent that they are purchased – are being bought up by the Government which has the time and expertise to figure this out.

In addition, to the extent that these syndicates or groups are buying residential properties, they are doing so at foreclosure sales where the banks would rather have cash than a credit bid and ownership of the house.

Bloomberg noted today that Southern California home sales rose 65% in September as buyers took advantage of foreclosures to buy properties at discounted prices.

A total of 20,497 new and existing houses and condominiums sold last month in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties.

As such, with these bargain prices, syndicates can purchase the houses at very below market rates and then sell them for a profit.

However, where you will see much more activities pre creditor direct action is in terms of credit card debt and commercial real estate loans.

The reason for that is that given the way the Rescue Law has been implemented, there is only $100 billion allocated now to asset purchases and banks need cash to recapitalize.

In that situation – where cash is king – the banks can choose to transfer recurring potentially income for hard cash now. It is important to remember as to credit card debt that most people are paying their bills and as to commercial real estate that by definition is an income producing asset in almost all cases.

As has been noted in a number of venues, there is a concern that credit card debt is the next problem area. However, most people are paying their bills and credit card debt is difficult to discharge in bankruptcy.

Moreover, very little of this securitized so it is very easy to identify who owns what to who without all the legal issues associated with mortgage backed securities. As a result, companies are being formed to purchase that debt from the banks at a discount.

The second area is commercial real estate. That is an area overlooked with a lot of over leveraging. Unlike mortgage backed securities, in this state at least, this is an easy area to figure out. Unlike residential real estate, there are individual trust deeds/mortgages on identifiable property which are individually purchasable from banks that need cash.

 In the commercial area, moreover, the over valuation results from the property being is over liened but the first lien holder knows that there is substantial equity in the property beyond that first lien.

In addition, because these are income producing assets, under standard trust deed’s the trust deed holder has a right to “rents and profits” under the “rents and profits” clause of a deed of trust through judicial enforcement during foreclosure – this was the result of a statutory rewrite in the area enacted in 1996 triggered by the Real Property Law Section of the State Bar. [see Civil Code § 2938]

The 1996 legislation also made clear that a receiver per CCP § 564(b) (11) and (12) ] [in this case a court appointed rent collector] would take possession of the rents and profits during foreclosure and per CCP § 564(d) this is not an action for purposes of the “one right of action” rule set forth within the meaning of CCP § 726.

Any rents actually collected are credited against the amount of the debt but since default results in acceleration – if the foreclosure is done judicially – then it is really irrelevant. I should add that to avoid overbidding, there are ways that sales are conducted so that the lien holder can collect both the rents held by the receiver and still acquire the property.

Because these are identifiable properties which can be valued and the first lien rights are assignable, the amount of money to purchases these rights do not require the amount of outlays that would be required to purchase mortgage backed securities.

These commercial deals are typically deals in the $5 to $25 million range which are easily doable. I should add while it is counterintuitive for banks to take second and third positions on commercial properties, the legal implications of doing so are not necessarily disastrous.

In terms of the legal impacts, almost all of these foreclosures are done judicially for two reasons. One, if you are going to seek a “rents and profits” receiver, you are in court anyways. And, two, junior lien-holders must be joined in the action as this wipes out their rights. There being joined actually allows in one action or case number issues as to “marshaling of assets” as well as junior lien-holders asserting their own rights via cross-complaints.

First, as to “marshalling” it is a doctrine developed historically and traditionally used to prevent a junior lien holder with a security interest in a single property from being squeezed out by a senior lien-holder with a security interest not only in that property, but in one or more additional properties.

The doctrine requires the senior lien-holder to first resort to assets free of the junior lien to avoid the inequity which would otherwise result from the unnecessary elimination of the junior lien-holder's security with the increased likelihood the junior creditor will be unable to satisfy its claim.

Secondly, as to deficiency judgments, which is the bank getting its money, when a property is foreclosed on, the rights of junior lien holders depends on whether it gave a purchase money security interest on that very same property to that lien holder. If the money was purchase money for another property, then CCP 580b does not apply per the direct holding of Roseleaf Corp. v. Chierighino, (1963) 59 Cal.2d 35 and a deficiency judgment does not apply.

And, in many of these cases there are guaranties and as such “fair value” rules and 580b do not apply in any event which is why banks are willing to make junior lien loans because they are getting a lot more collateral. I should add that seriatim non judicial foreclosures against multiple pieces of property are not considered actions within the meaning of CCP § 726.

I should note that there are tax advantages and disadvantages in these transactions which require resort to CPA’s. However, the bottom, line is that because they are a lot easier to understand, the “vultures” are looking at commercial real estate and credit card debt.

Since the mid 1980's Irwin Nowick has worked for the California State Assembly and State Senate on a plethora of policy issues, most notably firearms legislation. He has been described as "The Assembly's resident genius" by a former Speaker of the Assembly and is seen frequently in the Capitol hallways and offices assisting legislators in drafting and amending pending legislation.

Comments

Ok, so it's easier to understand who owns the asset in Commercial Real Estate. However, as the economy continues to limp I'm curious how the small business will be able to meet its financial obligations. (Blood out of a turnip...etc.) The majority of commercial space is small users, under 5000sf.

How do they pay their rent if their sales are down, their services are not being utilized, government contracts are frozen or cut altogether, they can't get a line of credit at the bank, they've exhausted their personal life lines in the forms of rich friends, etc? Well, they can get a hard money loan...at 25% interest?

You bet, let's get in line to make these loans! But for how long will this small business be able to make the interest payments, much less the principle.

So, yes, commercial property paper is well leveraged, provided the assumptions are correct. I mean people always pay their lease obligations, don't they?

If we use the idea that 97% of the homeowners are making their mortgage payments what if we generalize and say that 97% of the leaseholders will make their lease payments? Well, depending on the type of lease...this could have a much larger effect than just the direct rent due...it also effects the common area maintenance charges that the owner will now be carrying.

So you tell me, what effect will economic conditions have on the value of the commercial real estate a lot of which was bought since 2003 on 1+ libor (or other financial instruments at 50 year lows), with incredibly low cap rates, based on the projections that we would at least have 3%cpi increases annually, plus (in the case of the effervescent retail) the excellent windfall of the percentage lease.

Buildings are now staying on the market longer. Prices are coming down. The End user is no longer able to extend themselves. We are seeing "creative financing" instruments to get sales to occur. Of course commercial brokers say “the market is righting itself,” “the bubble can’t last forever.” This should start to sound familiar to the residential market.

This is the next house of cards to fail. It may take about 18 months to two years (2010?) for the full impact of the lack of liquidity, consumer fears, and failure of large companies to be fully realized...but we are coming back to the days after the fall of the savings and loans with huge buildings empty, enormous signage advertising AVAILABLE and the deep pockets buying up distressed properties.

As I've stated before I am not-an-economist. But my intuitive awareness of boots on the ground is difficult to ignore. Even more, it's difficult to hear.

Êîìïàíèÿ "SV Development"