Continuing my predictive analysis of a global real estate relapse, I bring you today's headlines followed by updated research of company that we see slated for probable bankruptcy. Professional and institutional subscribers should download the latest deliverable, which illustrates the likelihood of a bankruptcy in our most recent forensic analysis candidate if it were to go the foreclosure route -Foreclosure Scenario Analysis. This is the professional addendum to the general subscriber analysis released in the post I Present To You The First Probable US Commercial Real Estate Insolvency Of Many To Come. The next deliverable will outline distressed sales of properties, and after that I will make available valuation models on 27 properties in the company's portfolio to inequivocably demonstrate that this company has nowhere to go but down. Ain't math something else? Now on to the news of (yester)day, as reported by Bloomberg. 

BofA Plaza Goes for $235M in Auction

thumb_Reggie_Middleton_on_Street_Signs_FireReggie Middleton Sets CNBC on F.I.R.E.!!! - Reggie Middleton preaching the travails of commercial real estate in 2012/13 on CNBCBank of America Plaza, the tallest tower in the U.S. Southeast, was sold at a public auction today on the steps of the Fulton County Courthouse after landlord BentleyForbes missed mortgage payments.

The noteholder had a winning bid of $235 million, according to attorney Howard Walker of McGuire Woods LLP, who ran the auction. Holders of commercial mortgage bonds took ownership through a “credit bid” placed by LNR Partners, David Levin said in an e-mailed statement. Levin is vice chairman of Miami Beach, Florida-based LNR Property LLC, the parent company of LNR Partners, the tower’s special servicer.

BentleyForbes, based in Los Angeles, paid $436 million to acquire the 55-story Atlanta skyscraper in 2006 from Bank of America Corp. (BAC) and Cousins Properties Inc. (CUZ) in the city’s biggest property deal. Since the property market peaked a year after the purchase, the 1.25 million-square-foot (116,000-square-meter) building’s value has tumbled with tenants, including namesake Bank of America, reducing space.

Atlanta has the highest rate of late payments for loans on offices bundled into bonds among the largest U.S. metropolitan areas, at 25.3 percent, according to data compiled by Bloomberg. That’s an increase from 10.4 percent a year ago and is more than triple the 7 percent national rate.

The $363 million Bank of America Plaza loan became delinquent in December after BentleyForbes stopped making payments. The loan was partly packaged inside JPMCC 2006-LDP9, which was downgraded by Fitch Ratings in December because of expected losses. 

As I've been warning in many of my previous posts, ie. (must reads if you have not already done so):

1. I Present To You The First Probable US Commercial Real Estate Insolvency Of Many To Come
2. The Real Estate Recession/Depression is Here, Eurocalypse Style
3. An Overview of a US REIT Headed Towards Distress
4. The Greatest Risk To Retail Commercial Real Estate Is? Sovereign Debt! Macro Headwinds! Popping Bubbles! Busted Banks! No, It's The Internet!
5. Prepare For CRE Crash And Burn Marks At A Shopping Mall Near You

The can kicking of the last 3 years will come to a head once those 5 year debt instruments issued in 2007 come due in 2012 and 2013. Do banks roll over what is an obviously losing proposition or do they take the money and run. Here is an excerpt of the professional/institutional subscriber document Foreclosure Scenario Analysis showing what happens when you get to the end of the road in the neighborhood Can-Kick! Click to enlarge...

 thumb_REIT_bankruptcy_candidate_copy

We have culled the portfolio of nearly 30 properties which we individually valued and found who was due for mortgage/loan maturity in the next year. It didn't look pretty...

REIT_bankruptcy_candidate1 

 Of course, this is not just an "American" thing. The CRE crush will be felt word-wide, particularly in the EU, UK, and China.

•  We're At Step 2 Of The Global Real Estate
•  The Swiss Real Estate Bubble?!
•  The First Major Real Estate Collapse In Europe? I've Found The EU Equivalent Of GGP, The Largest Real Estate Failure In US History

What many do not understand is that the real estate crash of the previous decade is far from over, because The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. This is true for not only the US, but the EU countries as well. Unlike our European and Asian counterparts, many US investors are much too detached to what occurs overseas, quite possibly from a hubristic, apathetic or even ignorant stance that what happens over there has littel effect on us stateside. Unfortunately, that is not the case. What do you think, pray tell, happens when the liquidity starved, capital deprived, overleveraged banks fail to roll over all of that underwater Eu mortgage debt?

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Investors seeking safety in Germany, the UK and France may truly be in for a rude awakening!

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I recieved this email from a reader and thought I would toss it out to the community for comment...

Hi Reggie,

I'm curious to know your thoughts on the Swiss Real Estate Market and current bubble occurring (as the disparity between income growth and rental growth continues to widen for commercial and residential property).

Residential is protected by the Lex-Koller law, meaning that (with the exception of a few mountian resort towns) foreigner cannot buy and own residential real estate. However, commercial RE is open to foreign investment.

This growth in income vs. rent disparity has continued for quite some time and I'm curious to hear your thoughts on why you think Switzerland's economic environment has been able to sustain a bubble like this for so  long compared to other bubbles in other countries.

It has come to my attention that rents in the prime areas of Geneva and Zurich are just now beginning to trend downward (despite what Wuest & Partner, Colliers and the lot of them publish in their reports).

However there has also been an interesting "flight to quality", as I like to call it, by various REITs caused by EU fears. Yields (on NOI) in downtown Geneva and Zurich are between 3% and 4% at the moment.

Foreign govt pressure on banking secrecy is causing banks to leave, but trading companies are flowing into Switzerland to take advantage of 0% capital gains on shares.

I find it interesting to look at Switzerland because when economic indicators signal the nearing of a CRE bubble burst, other economic factors suggest such a burst might be unlikely to happen.

I'd love to read your thoughts on this apparent economic anomaly of a country.

In this post I will present to BoomBustBlog subscribers evidence of the next GGP. For those who don't know the GGP story, it was the nation's 2nd largest

mall REIT whom I went short on in 11/07 while it had:

• an investment grade rating (What Is More Valuable, The Opinion Of A Major Rating Agency Or The Opinion Of A Blog?),
• buy recommendations from all the major investment banks that covered it (Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?),
• a CFO issuing nonsense press releases contradicting my research (BoomBustBlog.com's answer to GGP's latest press release). This press release and my response to it outlines a situation that is eerily similar to that of the subject company that I'm presenting to my subscriberstoday, to wit:

  • We analyzed GGP's financial position and its expected funds from operations (FFO) to check the company's ability to meet its debt obligations -

    With GGP's optimistic assumptions of a cap rate of 7.5% and NOI of $365 mn and $415 mn for 2008 and 2009, respectively, (based on its historical growth rate of 5%) valuation for GGP's specific properties (on which debt is due for repayment in 2008 and 2009) comes to around $4.9 bn and $5.5 bn for 2008 and 2009, respectively. Based on LTV of 50% (which looks quite reasonable amid the current turbulence in the global credit markets) GGP should be able to raise $2.4 bn and $2.8 bn in 2008 and 2009, respectively. However, GGP's debt due for repayment in 2008 and 2009, respectively, is approximately $2.6 bn and $3.3 bn, translating into respective short-falls of about $188 mn and $577 mn (as shown below), even under the over-optimistic case presented by the company. Surprisingly, the company's financing requirement (as included in its press release) totally ignores the funding requirement for capital improvement and redevelopment programs required for sustained and long-term growth.

    $ million	GGP's Assumptions		Reggie's Assumptions
    	2008	2009	2008	2009
    Property specific NOI	$365	$415	$244	$369
    Cap Rate	7.50%	7.50%	7.50%	7.50%	Overly optimistic Cap Rate, but I'l give them this to prove a point
    Value of Properties	$4,867	$5,533	$4,589	$4,919
    LTV	50%	50%	50%	50%
    Maximum re-fi available	$2,433	$2,767	$2,294	$2,460
    Debt due at maturity	$2,621	$3,344	$2,621	$3,344
    EMI on prior year financing			$861	$1,246
    Capital Improvements			$542	$195	GGP's press release failed to allocate any funds for growth, development, and expansion
    New Developments			$1,040	$466
    Total Financing Required	$2,621	$3,344	$5,063	$5,251
    Shortfall from Re-financing	$188	$577	$2,769	$2,792	Even using the extremely optimistic numbers of the press release, GGP falls short of the mark!!!

    However, we believe that GGP's assumption of NOI growth of 5% for 2008 and 2009 is unrealistic in view of the softness in the U.S
    commercial real estate market, which has already started to experience the ripple impacts of sub-prime crisis. The (now) highly probable US
    recession, along with deteriorating macro-economic conditions, would make operating environment extremely difficult for commercial real
    estate companies like GGP.

Well, I outlined the fall of commercial real estate in general (September of 2007) and the collapse of General Growth Properties in particular (November 2007) in illustrative detail for both subscribers and the general public:

1. Will the commercial real estate market fall? Of course it will.
2. Do you remember when I said Commercial Real Estate was sure to fall?
3. The Commercial Real Estate Crash Cometh, and I know who is leading the way!
4. Generally Negative Growth in General Growth Properties - GGP Part II
5. General Growth Properties & the Commercial Real Estate Crash, pt III - The Story Gets Worse
6. BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming… (among over 700 pages of analysis, review the January 2008 archives or search for “GGP” for more research).

You see, we had an obvious and evident CRE bubble, particularly in retail and mall properties...

This bubble popped, as most may remember, but we never had the opportunity to have the economic cycle complete itself for the powers that be tried their darndest to defy gravity. How, you ask?

1. A public-private partnership of misdirection allowed the popping bubble to be disguised. See The Conundrum of Commercial Real Estate Stocks: In a CRE "Near Depression", Why Are REIT Shares Still So High and Which Ones to Short?

2. Money follows an economic "Circle of Life". This Circle Was Purposely Disrupted By Multiple Central Banks Worldwide!!!

3. Even with the "kicking the can down the road mentality", fundamental and macro realities are bound to rear their heads. See The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance and then see Reggie Middleton ON CNBC's Fast Money Discussing Hopium in Real Estate

 Reggie Middleton on CNBC's Fast Money Discussing Hopium in Real Estate

For those of you who desire a long form explanation of the matters at hand in video form... Reggie Middleton discusses the fall of commercial real estate in the US

Yes, I see portions of CRE on FIRE...

 In regards to the subject company at hand and proffered to my subscribers as a dramatically distressed concern, I offer you the following excerpts the document recently posted for download...

Valuation of properties

Observation  of Company Reported Valuations

BoomBustBlog Valuation of Properties

Key Observations:

• Properties acquired in 2003 have negative valuation (after deduction of loan)
• These properties have lower rentals and lesser operating margins against assumed operating expense of $13.99 per square feet. In other words, they are running negative cash flow, which upon capitalization actually gives them a negative valuation once sales expenses, mortgages and encumbrances are taken into consideration.
• The properties acquired in 2003 have valuations that are DRAMATICALLY OVERSTATED on the company’s balance sheet. The subject company carries the first property listed on its books at $78,195,000 with a Loan to Net Value of 55%. We have the property valued at ZERO (actually, it has a negative valuation). The 3rd property listed is carried at $92,082,000 where we valued it at significantly less than half of that.
• Needless to say, these properties' mortgages are substantially underwater.

Extensive portfolio analysis and online valuation models will be available to professional and institutional BoomBustBlog subscribers in order to assist in calculating timing and severity in regards to insolvency. Other BoomBustBlog links of interest to those interest in the weakening of the CRE space...

 The Greatest Risk To Retail Commercial Real Estate Is? Sovereign Debt! Macro Headwinds! Popping Bubbles! Busted Banks! No, It's The Internet!

 Prepare For CRE Crash And Burn Marks At A Shopping Mall Near You

Real Estate Cap Rate (Yield) Expanision in Europe

Reggie Middleton Featured in Property EU, one of Europes leading real estate publications

Those who wish to download the full article in PDF format can do so here: Reggie Middleton on Stagflation, Sovereign Debt and the Potential for bank Failure at the ING ACADEMY-v2.

Are The Ultra Conservative Dutch Immune To Pan-European Pandemic Contagion? Are You Safe During An Earthquake Because You Keep Your Shoes Tied Snugly?

I have made available the latest find in our "REIT at Risk" search. This one has the makings of a grand slam. Subscribers, see Cashflows and Debt Preliminary Analysis (as usual, the latest downloads are listed in the left margin of the homepage). As excerpted from said report:

The shortfall indicates that it is virtually impossible for the company to retire the debt, thus it will have to refinance it at a higher rate or default. If the debt is refinanced in full, it will most likely breach covenants. Even if just the shortfall is refinanced, current credit facilities will be maxed out leaving no room for error and still possibly tripping covenants.

The Company has been meeting its debt obligations through credit facilities in the past 2 years. Its operating cash flows have not been enough to fund its debt repayments and we forecast the retail CRE market to take a material and structural downturn from here. Reference:

1. 1. The Greatest Risk To Retail Commercial Real Estate Is? Sovereign Debt! Macro Headwinds! Popping Bubbles! Busted Banks! No, It's The Internet!
   2. The Conundrum of Commercial Real Estate Stocks: In a CRE "Near Depression", Why Are REIT Shares Still So High and Which Ones to Short?
   3. Reggie Middleton ON CNBC's Fast Money Discussing Hopium in Real Estate

   image001_copy_copy_copy_copy_copy_copy

In addition...

• 18% of its rents will likely be reduced in 2012 and an additional 21% will be reduced in 2012, unless we see a material firming in lease prices, an occurrence which we not only see happening but to the contrary we anticipate additional softening as demand dwindles.
• More than 75% of the property portfolio was purchased during the period 2003-2005. This was very close to the apex of the bubble, meaning the there is a very material chance that most (if not all) of these properties have declined significantly in value.

We are in the process of valuing this trust’s portfolio of properties on an individual basis in order to ascertain an accurate enterprise value and gauge both the likelihood and potential scenarios for default and/or fire sale of assets.

I explain why Apple carries in excess of $80 billion in cash, competition with Google, Samsung, Microsoft, housing and commercial real estate.

Relevant reading:

The Evidence Of Android Dominance Continues To Roll In - iOS Looks To Have Stopped Growing Market Share

Reggie_Middleton_Says_Real_Estate_on_FIRE_on_CNBC

This is a post for paying subscribers to update them on my search for prospective casualties in the real estate sector of the FIRE collapse (new subscription content available below and as always in the most recent downloads section in the right hand margin of the home page once you have signed in as paid subscriber). Below is an overview of my opinion the FIRE (Finance, Insurance & Real Estate) sector for 2012

• Reggie Middleton on CNBC StreetSigns Sees 2012 As Reluctant/Manipulated Continuation of Q1 2009
• Reggie Middleton Sets CNBC on F.I.R.E.!!!
• First I set CNBC on F.I.R.E., Now It Appears I've Set Sell Side Wall Street on F.I.R.E. As Well!!! 

thumb_Reggie_Middleton_on_Street_Signs_Fire

Last week I offered my susbscribers examples of the 2nd and 3rd sectors of the FIRE (Finance, Insurance & Real Estate) group that we see getting burned. I spent much of last year on the "F"portion of FIRE. Subscribers should reference  the last 5 or so documents in the Commercial & Investment Banks section of the subscription content area. I then illustrated a Dutch real estate company facing the FIRE (again subscribers reference the latest submissions in Commercial Real Estate), and I will be offering US REIT entities at risk in the next day or two. Of particular interest was my explicit warning on the insurance industry two weeks ago, both publicly and to subscribers, which included a full forensic analysis of the company we thought would be make the best short candidate as the feces hits the fan blades. See You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses! and Our Next Forensic Analysis Subject Is In The Insurance Industry for more on my opinion on such. I even appeared on CNBC yesterday, apparently the only investor/analyst/pundit warning on the FIRE sector for 2012. I outlined my summary outlook for 2012 here: Reggie Middleton on CNBC StreetSigns Sees 2012 As Reluctant/Manipulated Continuation of Q1 2009… The actual CNBC appearance is available below...

From this point on, start this YouTube video and let it play in the background as you go through the balance of this post. It''ll help set the mood...

So, the day following the CNBC appearance warning of the risks to the FIRE sector, and specific risks to the insurance industry in the guise of combined ratios bumping heads with massive investment losses on sovereign and financial entity debt, guess what appears in the headlines of those very same media outlets??? Insurers’ 2011 Catastrophe Losses Hit Record:

Japan’s earthquake and U.S. storms helped make 2011 the costliest year on record for insurance companies in terms of natural-disaster losses, according to Munich Re (ARN).

Several “devastating” earthquakes and a large number of weather-related catastrophes cost insurers $105 billion, more than double the natural-disaster figure for 2010 and exceeding the 2005 record of $101 billion, the world’s biggest reinsurer said in an e-mailed statement today. Competitor Swiss Re earlier estimated that the industry’s claims from natural catastrophes reached $103 billion.

Global economic losses jumped to $380 billion last year, surpassing the previous record of $220 billion in 2005, with the quakes in New Zealand in February and Japan in March accounting for almost two-thirds of the losses, Munich Re said.

“We had to contend with events with return periods of once every 1,000 years or even higher at the locations concerned,” Torsten Jeworrek, Munich Re’s board member responsible for global reinsurance, said in the statement. “We are prepared for such extreme situations.”

In Beware Even Those "Safe" Insurer's Portfolios I illustrated to my susbscribers the risks that insurance investors face. Munich Re said 2011 was the costliest year on record, but they failed to state how difficult it would be to handle said record losses with additional and potentially greater losses on bond and FI porfolios. Munich Re's net exposure to sovereign debt of PIIGS as % of tangible equity at the end of 2009 = 41.2%. Damn! Many compmanies are worse than that (and I'll delve into those a little later). Now, by revisiting the insurance primer that I offered in You Can Rest Assured That The Insurance Industry Is In For Guaranteed Losses! you can see that combined ratios may very well break 100 while investment losses spike. Somebody may not get their claims funded, eh?

Professional Subscribers, reference the addendum to the  Sovereign Debt Exposure of European Insurers and Reinsurers (439.61 kB 2010-05-19 01:56:52) whcih can be found online here: Insurer and Reinsurer Sovereign Debt Exposure Worksheets - Professional

Here's the rub upfront for those who desire quick summaries:

1. We had a massive CRE bubble which bust - See The Commercial Real Estate Crash Cometh, and I know who is leading the way.
2. The CRE bubble bust, even as disguised and manipulated as it was, claimed some serious retail casualties. See GGP and the type of investigative analysis you will not get from your brokerage house.
3. A public-private partnership of misdirection allowed the popping bubble to be disguised. See The Conundrum of Commercial Real Estate Stocks: In a CRE "Near Depression", Why Are REIT Shares Still So High and Which Ones to Short?
4. Even with the "kicking the can down the road mentality", fundamental and macro realities are bound to rear their heads. See The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance and then see Reggie Middleton ON CNBC's Fast Money Discussing Hopium in Real Estate 
5. ... and will do so both in the US and abroad, see The "American Realist" Says: Past as Prologue - Re-blown Bubble to Pop Before the Previous Bubble Finishes Popping!!!!
6. Those who truly believe that the more conservative EU nations will skate past this are sorely mistaken. See "Are The Ultra Conservative Dutch Immune To Pan-European Pandemic Contagion? Are You Safe During An Earthquake Because You Keep Your Shoes Tied Snugly?" Then see The First Major Real Estate Collapse In Europe? I've Found The EU Equivalent Of GGP, The Largest Real Estate Failure In US History

 

Exactly! Fu@ked! Professional subcribers can see the rapid growth of online retailing in Europe via this document - Online Retail Sales Penetration, as excerpted...

image005

In December of 2009, I posted and article and accompanying research titled, "A Granular Look Into a $6 Billion REIT: Is This the Next GGP?" The following are excerpts from it:

The results of these activities have been congealed in our analysis of Macerich’s entire portfolio of properties (118+ properties), including wholly owned, joint ventures, new developments, unconsolidated and off balance sheet properties. Below is an excerpt of the full analysis that I am including in the updated Macerich forensic analysis. This sampling illustrates the damage done to equity upon the bursting of an credit binging bubble. Click any chart to enlarge (you may need to click the graphic again with your mouse to enlarge further).image001.pngimage001.pngimage001.png

Notice the loan to value ratios of the properties acquired between 2002 and 2007. What you see is the result of the CMBS bubble, with LTVs as high as 158%. At least 17 of the properties listed above with LTV’s above 100% should (and probably will, in due time) be totally written off, for they have significant negative equity. We are talking about wiping out properties with an acquisition cost of nearly $3 BILLION, and we are just getting started for this ia very small sampling of the property analysis. There are dozens of additional properties with LTVs considerably above the high watermark for feasible refinancing, thus implying significant equity infusions needed to rollover debt and/or highly punitive refinancing rates. Now, if you recall my congratulatory post on Goldman Sachs (please see Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off), the WSJ reported that the market will now willingingly refinance mall portfolio properties 50% LTV, considerably down from the 70% LTV level that was seen in the heyday of this Asset Securitization Crisis. Even if we were to assume that we are still in the midst of the credit bubble and REITs can still refi at 70LTV (both assumptions patently wrong), rents, net operating income and cap rates have moved so far to the adverse direction that MAC STILL would not be able to rollover the debt in roughly 37 properties (31% of the portfolio) whose LTVs are above the 70% mark – and that’s assuming the credit bubble returns and banks go all out on risk and CMBS trading. Rather wishful thinking, I believe we can all agree.

For those of you who didn't catch it in the table above, I'll blow it up for you...

Notice anything familiar??? There is a very strong chance that every single property on the list detailed in the forensic reports will be taken over by the lenders, that's a lot of properties. Subscribers should reference  MAC Report Consolidated 051209 Retail 2009-12-07 03:46:49 580.11 Kb ,  MAC Report Consolidated 051209 Professional 2009-12-07 03:48:11 1.03 Mb, those who don't subscribe should download my   CRE 2010 Overview 2009-12-15 02:39:04 2.72 Mb. For those who want access, click here to subscribe!

So, why has Macerich and the entire REIT sector defied gravity despite the fact they are getting foreclosed upon faster than a no-doc, subprime, NINJA loan candidate who just lost his minimum wage job amongst all of these “Green Shoots”??? Well, I took the time to answer that in explicit detail... I urge all to read The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?

More hard hitting BoomBustBlog commercial real estate commentary and research from Reggie Middleton:

Archived retail research and opininion from BoomBustBlog...

This is an example of exactly what we were talking about in our subscription documents regarding the ridiculous run up in consumer discretionary shares when taken in context of  the American consumer and the stress born from the Pan-European Sovereign Debt Crisis (click the link for our detailed analysis). You can find the earlier articles in this consumer mini-series as follows:

1. What We’re Looking For To Go Splat! Part 1: macro arguments against the spike in retail stocks
2. What We’re Looking For To Go Splat! Part 2: A list of 147 retail stocks with attributes that causes on to question their gain in prices, with a shortlist of companies who may very well go “splat”!
3. Is the Consumer Really Back? Well, It Depends On If You Believe What the Government Tells You or Whether You’re An Indendent Thinker – The American Recovery and the North American Economic Outlook.
4. The American Recovery and the North American Economic Outlook

I've been renown for calling the housing crash in 2006-7 and the commercial real estate crash in 2007. Late in 2007, I penned a piece titled "The Commercial Real Estate Crash Cometh, and I know who is leading the way!" wherein I made it clear that the CRE party was over, the music stopped and the DJ was packing up. Part and parcel of this general CRE warning (the first of which was the introductory post to BoomBustBlog in September of 2007) was the identification of a particular short candidate whose profligate spending and excessive leverage made for what ultimately was one of our most profitable and thoroughly analyzed shorts - Generally Negative Growth in General Growth Properties - GGP Part II. This company was investment grade (AA) rated and it's common equity traded in the $65 range when I initiated my short position. Roughly twelve months later it filed for bankruptcy. It was the 2nd largest mall REIT in the US and the largest real estate bankruptcy ever although the CFO explicitly called my research and opinion "trash"! The entire story can be followed via: GGP and the type of investigative analysis you will not get from your brokerage house.

Unfortunately, many investors, the equity market, commercial, investment and morgtage banks failed to heed my admonitions. The result of which was the literal pillaging of investors by investment bank private equity and asset management arms. For those who think I'm being rather bombastic and dramatic, reference "Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!", to wit:

 Oh, yeah! About them Fees!

Last year I felt compelled to comment on Wall Street private fund fees after getting into a debate with a Morgan Stanley employee about the performance of the CRE funds. He had the nerve to brag about the fact that MS made money despite the fact they lost abuot 2/3rds of thier clients money. I though to myself, "Damn, now that's some bold, hubristic s@$t". So, I decided to attempt to lay it out for everybody in the blog, see "

The example below illustrates the impact of change in the value of real estate investments on the returns of the various stakeholders - lenders, investors (LPs) and fund sponsor (GP), for a real estate fund with an initial investment of $9 billion, 60% leverage and a life of 6 years. The model used to generate this example is freely available for download to prospective Reggie Middleton, LLC clients and BoomBustBlog subscribers by clicking here: Real estate fund illustration. All are invited to run your own scenario analysis using your individual circumstances and metrics.

realestate_fund.png

To depict a varying impact on the potential returns via a change in value of property and operating cash flows in each year, we have constructed three different scenarios. Under our base case assumptions, to emulate the performance of real estate fund floated during the real estate bubble phase,  the purchased property records moderate appreciation in the early years, while the middle years witness steep declines (similar to the current CRE price corrections) with little recovery seen in the later years.  The following table summarizes the assumptions under the base case.

re_scenarios.png

Under the base case assumptions, the steep price declines not only wipes out the positive returns from the operating cash flows but also shaves off a portion of invested capital resulting in negative cumulated total returns earned for the real estate fund over the life of six years. However, owing to 60% leverage, the capital losses are magnified for the equity investors leading to massive erosion of equity capital. However, it is noteworthy that the returns vary substantially for LPs (contributing 90% of equity) and GP (contributing 10% of equity). It can be observed that the money collected in the form of management fees and acquisition fees more than compensates for the lost capital of the GP, eventually emerging with a net positive cash flow. On the other hand, steep declines in the value of real estate investments strip the LPs (investors) of their capital. The huge difference between the returns of GP and LPs and the factors behind this disconnect reinforces the conflict of interest between the fund managers and the investors in the fund.

re_fund_returns.png

re_fund_returns_tables.png

re_fund_returns_tables.png

Under the base case assumptions, the cumulated return of the fund and LPs is -6.75% and -55.86, respectively while the GP manages a positive return of 17.64%. Under a relatively optimistic case where some mild recovery is assumed in the later years (3% annual increase in year 5 and year 6), LP still loses a over a quarter of its capital invested while GP earns a phenomenal return. Under a relatively adverse case with 10% annual decline in year 5 and year 6, the LP loses most of its capital while GP still manages to breakeven by recovering most of the capital losses from the management and acquisition fees..

re_fund_returns_tables3.png

Anybody who is wondering who these investors are who are getting shafted should look no further than grandma and her pension fund or your local endowment funds...

http://www.zerohedge.com/sites/default/files/images/user5/imageroot/volcker/MSREF%20V%202.jpg

What many do not understand is that the real estate crash of the previous decade is far from over, because The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance. This is true for not only the US, but the EU countries as well. Unlike our European and Asian counterparts, many US investors are much too detached to what occurs overses, quite possibly from a hubristic, apathetic or even ignorant stance that what happens over there has littel effect on us stateside. Unfortunately, that is not the case. What do you think, pray tell, happens when the liquidity starved, capital deprived, overleveraged banks faile to roll over all of that underwater Eu mortgage debt?

Slide21Slide21

Investors seeking safety in Germany, the UK and France may truly be in for a rude awakening!

Slide22

Do you really think they will rollover the US debt anyway? How about the result  of the guaranteed losses that both bank and investor will take as said debt either fails to get rolled over or is forced to do equity cramdowns? Then think about EU banks going down and American banks being called to pay CDS!

image015.png

Then think about those sovereign states that truly cannot afford to bail out their banks.

image009.png

I made this perfectly clear as the keynote speaker at ING's CRE Valuation Confeence in Amsterdam this past April.