REIT Wrecks on the Proposed Bailout

REIT Wrecks has penned an excellent breakdown of the issues plaguing commercial real estate in a way of explaining why industry leaders have extended their hand to Washington in search of a rescue.

Here's a taste. But you should go read the whole thing.

Clearly, huge demand for CMBS led to a decrease in underwriting standards, including (among other things), a relaxing of traditional loan-to-value criteria. Moody's estimated that the gap between the Moodys LTV and underwritten LTVs reached record in the first quarter of 2007 (nearly 45%). The Moody's estimate of actual LTV also reached a record of 106.5%.

These poorly underwritten loans are still out there and in a few of short years, many of them will start to mature. Unfortunately, no lender will touch them now because they are practically radioactive. At the same time that a huge source of capital has disappeared from the market, borrowing costs have soared, making whatever capital there is out there relatively expensive. You can enlarge the chart a bit by clicking on it. Nevertheless, the lines going up and to the right tell the story: money is more much more expensive.

This is happening at the same time that cap rates, which were compressed down around that 6% mark, are now correcting. Cap rates averaged 8.3% between 1986 and 2008, but they fell below 6% in the first quarter of 2007.

This is a toxic mix for those New York City real estate tycoons, and the reason they made the trip to see Chuck Schumer from Brooklyn is simple: they are all about to lose a TON of money.

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