Grim Update on Real Estate Market

Tom Lindmark sent me a link to a post on his blog, a write-up of the main things he learned at the IMN Distressed Real Estate Conference in Las Vegas. Remember, this event is for those in the industry who LIKE messy, ugly situations. But it gives the impression that the industry is close to free fall.

Tom intends to write a more extensive version of what he heard at the conference, so those who are interested should check back at his site early next week

You should read his post, but let me give some excerpts to highlight how bad things are:

Aside from say multi-family and really solid income producing properties (producing solid verifiable income now, not projected income) there is no debt available. There is lots of equity looking for 20% and up returns. Since these will have to be largely unleveraged, the asset price required to deliver the return is abysmally low. Further driving down implied valuations is the fact that the equity is Wall Street money with 3 to 5 year time horizons. No one thought that was achievable (with the exception of the Wall Street boys in the audience, of course)….

Appraisals are good for no more than a month as values are deteriorating so rapidly…

The Indy Mac performing loan sale that was reported to have been done at about 60% of asking price has fallen apart. Most of the bids at the 60% level were withdrawn after further due diligence. The actual prices the stuff went for is between 20% and 45%. By the way Indy Mac had current appraisals supporting their asking price.

In his note to me, Tom asked what my take was.

I don’t have any reason to doubt the information presented at the conference, as grim as it is. My reaction is this is the result of building a credit system that was so dependent on securitization. But giving investors the exposure profile they wanted required credit enhancement. The three ways to achieve credit enhancement were monoline guarantees (which were sometimes in the form of credit default swaps, although monoline CDS has some differences from typical CDS), credit default swaps from banks and hedge funds, and overcollateralization. Monoline guarantees have gone the way of the dodo bird, and CDS are now too pricey for them to work.

Now a reader may object and say that the sort of deals under discussion often would be done by a local bank and not securitized. Yes, but that local bank is up to its eyeballs in real estate already (this is from memory, but I believe Nouriel Roubini has said that 29% of the regional and community have construction loan books that exceed their equity) and for the most part much cannot on-sell any mortgages (a core product) unless they are government guaranteed.

That is a long-winded way of saying that a big chunk of the real estate industry which benefitted from securitization has suddenly gone back to the old model of depending on bank balance sheets at the time when banks are badly impaired. And limited access to debt means very depressed values.

Since the regulators expect on-balance sheet intermedation to be far more important going forward, the revival of real estate may depend on bank recapitalization. Not a pretty thought.