A Few More Thoughts from Tom Barrack

From Barrack's Chairman's Corner:

The disposition of distressed commercial mortgages has not happened at a scalable level as a result of relaxed mark-to-market regulations; untested special servicers and CMBS waterfalls; tranche warfare amongst holders of various classes of debt; zero interest rates; "pray and delay" and "extend and pretend" strategies. Consequently, the anticipated recycling profits from a massive macro correction in debt has been slow to come and many funds have been frustrated by the lack of product at what they believe to be attractive discount pricing. As a result, there are very few market clearing transactions for non-strategic, long-term buyers.

Many owners realize their equity value is gone but in many cases, due to historically low floating interest rates, can still make debt service if the term of the loan is extended. Everyone is playing for option value and it is a slow moving train, which becomes a bit "Japanese-esque," and the tea leaves tell me that this stage will be here for a while.

Commercial banks feel no pressure to mark the loans to market value because the regulatory requirements have provided a relaxation of LTV mark-to-market tests if sufficient debt service is still available. Consequently, a loan originated in 2007 on a $100 property at 70% LTV and 1.0x DSC with a 5.5% interest rate can still be "OK" at an LTV of 150% because artificially low interest rates are driving up coverage ratios to acceptable levels (see chart below); thus the dawning of "extend and pretend" and "delay and pray."

(1): Floating rate assumes L+100 bps with 30-year amortization

Real estate equity is moving slowly because a substantial disparity between most buyers and sellers still exists. Buyers have been anticipating price corrections as a result of the market downturn and continued deterioration in fundamentals while sellers who are not under bank or mortgage pressure are simply holding their ground. In most cases they have little incentive to sell, and due to their own debt issues, more likely than not, have lots of reasons to hold.

........In summary, solid risk-adjusted returns will be made by true real estate professionals with the tools and the teams to plow and hoe. By being in the marketplace, we will sense when that next repricing opportunity exists and will avail ourselves of it. The business is not about inventing the next iPad or launching the largest leverage buyout. It is about showing up, doing a good job, harvesting reasonable returns for our investors (which will look strong in hindsight against other asset classes), and waiting for the repricing moment.