RISMEDIA, January 26, 2010—That is a line from a 1983 Bruce Springsteen song, “My Hometown.”
As I drive around my town, I can’t get the lyrics or somber melody out of my head. It is like witnessing old friends drop dead one by one.
Last week I went into town to buy some guitar strings. Band Central Station, a friend of 30 years, was gone. In its place? Nothing. A halfhearted “for lease” sign hangs in the front window.
It was more than just a place to buy sheet music or a Bach LT36 Stradivarius Trombone, it was a musical hub where professional musicians, teachers, and students all came together, found each other, and furthered our local musical heritage. The Internet can’t replace that.
Peto’s Feed and Grain was way more than the name implied, also offering a large number of hard-to-find things for the home gardener. Put out of business by a misguided redevelopment plan that saw more potential revenue from a soulless, big box tilt-up. For a while, there was a Linens ‘n Things inside, now its empty hulk sits dark and foreboding with no future in sight.
And, it isn’t just small enterprises. We lost a Circuit City, a Chevrolet dealership, tried-and-true franchises like Dairy Queen and Arby’s. Last week Sam’s Club announced it will close its local big box bulk store. Then came news that Wal-Mart, the parent company, intends to lay off 10,000 Sam’s Club Employees. Even the ubiquitous 99 cent stores have been cut in half.
The story is the same in surrounding towns. Nor has the regional mall been spared. Until this past Christmas Eve, I hadn’t been to the mall in about two years. Wow! It looked more like a Gypsy Bazaar than a suburban mall. I couldn’t find some of the stores; other papered up spaces reading “coming soon” offered little assurance when the yellowing of the paper and the fading of the ink suggest otherwise.
Some bays had what appeared to be either seasonal or limited commitment type operations, as evidenced by the scarcity of their tenant improvements and absence of furniture or what might loosely be referred to as décor.
So, the businesses that provided jobs are gone, the office and retail space sits vacant, likely in default. The windows get broken, the walls get tagged, the weeds grow, trash blows, and, with no one to stop it, nature begins the process of permanent destruction. The value of those businesses and real estate is now gone.
Each of these failed enterprises is a sad testament to the times we live in, but taken in their entirety, they foretell an even grimmer future. It will be a longtime before the jobs return.
The failure of Linen’s and Things is a prime example of how Wall Street plundered Main Street, robbing retailers, big and small, and leaving a trail of failure, unemployment and boarded up buildings behind.
Once Wall Street realized that success can only be so profitable but failure has unlimited potential, the race was on to loan money and securitize the debt.
Just like sub-prime residential mortgages, commercial real estate financing and corporate raiding offer opportunities on many fronts. Private-equity groups bought up large retailers and buried them in debt. Leveraged buyouts, as their name implies, are exactly that, leveraged, in that most if not all of the purchase price is borrowed money. The buyer has little, if any, skin in the game.
The nearby Mervyn’s sits empty, another casualty of a leveraged buyout. In 2004, investors, including Cerberus Capital Management, Sun Capital Management and Lubert-Adler purchased Mervyn’s with $800 million secured by Mervyn’s own real estate. Then the stores were leased back to Mervyn’s at substantially increased rates. Dow Jones reported that investors took $400 million out of the company before filing for bankruptcy.
You might be familiar with the mall-based, teen-focused, accessories chain, Claire’s Stores. It was taken over in 2007 by Apollo Management LP for $3.1 billion. At the time, the chain had over $245 million in cash on hand. Today, the cash is gone. Struggling under the weight of $2.3 billion in debt, sales continue to decline.
Underlying all of this are the same activities that led to losses in sub-prime residential equities. Money was looking for a home, and some investors saw that cash could be leveraged out of these enterprises by buying them with someone else’s money and looting the assets.
It isn’t likely that the U.S. will see any big box expansion, retail, and office space or hotel development for years to come. With more retailers expected to fail in the next few years, it is difficult to imagine who will need these structures.
According to Moody’s Real Commercial Property Price Index, prices have already plunged 41% from their peak in 2007. The housing market, by comparison, has fallen 30.5% since 2006.
“We’ve never seen this extreme a correction as far back as the data go, which is the late 1960s,” says Neal Elkin, president of Real Estate Analytics, the research firm that created the index.
It wasn’t that we didn’t need them so we can’t really blame overbuilding for the problems we are experiencing today. An oversupply of money was the engine driving prices upward.
“There was a bubble in private equity just as there was a bubble in hedge funds,” said Howard Davidowitz, chairman of Davidowitz & Associates, a national retail consulting and investment banking firm in New York. “And, it’s all built on leverage. Leverage doesn’t work when things are collapsing. Leverage magnifies your winnings when things are going up, but it also exaggerates your losses when things are going down.”
The making of more and bigger loans was driven by the fees and bonuses Wall Street could earn by finding a home for private equity. They didn’t care about the quality of loans because, just like sub prime mortgages, these loans were being pooled into securities and sold.
As the market overheated, it became a breeding ground for fraud. A flurry of new court cases reveals the disturbing extent to which commercial mortgage borrowers may have doctored loan documents.
U.S. office vacancies hit a five-year high of almost 17 percent in the third quarter of 2009, while shopping center vacancies climbed to their highest since 1992, according to the property research firm Reis, Inc.
According to Matt Anderson, partner with Foresight Analytics, an Oakland, California real estate research and forecasting firm, 2.5 million office jobs will have been lost by the end of the year.
Jeffrey Rogers, president of Integra Resources, a Manhattan-based commercial real estate appraiser, says that $2 trillion worth of commercial mortgages will mature over the next 15 months.
Rents are falling while vacancies continue to rise. With property values still declining, lenders face rising default rates likely to trigger new write-offs. Many banks have yet to bite the bullet and address the problem, although many of the large banks are walking away from their devalued real estate.
“Recent loans were designed to lure borrowers who otherwise could not have qualified. Interest only was paid for the first few years, but a balloon payment of principal would come due after three to seven years”, notes Anderson. “Those balloon payments are now coming due.”
At highest risk, are loans done in 2006 and 2007, says Anderson. These were based on hyper-inflated property values and Anderson questions if they can be refinanced now that values have tumbled. Just over $50 billion of the 2006-07 loans mature this year and next. But, the real flood of maturities follows closely behind. From 2011 to 2013, $300 billion of these loans, many already problematic, are due for full repayment, Anderson estimates.
In all, banks stand to lose $200 billion to $300 billion on commercial real estate loans, estimates Richard Parkus, head of commercial real estate debt research at Deutsche Bank Securities. In reality, these are only paper losses to the bank. The off balance sheet credit default swaps will actually make them a tidy profit.
The counter parties who sold the default swaps, but only have fractional reserves to offset losses will have to turn to the government for further bailouts or not pay the banks. That is why AIG was bailed out in 2007. Should we do it again?
The investors in these commercial properties, pension funds, hedge funds, etc. will bear the losses, and will probably bring numerous class action law suits against the originators of the investment pools, further tying up vacant commercial property until the case makes it’s way through court.
But, as these were mostly Special Purpose Vehicles, registered in the Cayman Islands, the enormous profits are not only unrecoverable but cannot be taxed.
Everyone says it’s the economy and that we are “coming out of it” as though it were all a drug-induced haze. But, we aren’t coming out of anything, we are going deeper. Nothing has improved except Wall Street compensation. We still
