Lehman Bankruptcy Creates More Uncertainty

Lehman Brothers’ bankruptcy filing has created more uneasiness for the commercial real estate sector, which has already been forced to mark down assets on balance sheets due to a lack of liquidity in the marketplace. Lehman's troubles, say industry experts, could result in a downward spiral of pricing.

According to Christopher Hoeffel, president of the Commercial Mortgage Securities Association (CMSA) and a managing director at JP Morgan Chase, Lehman’s portfolio is valued at about $33 billion. Hoeffel spoke during an emerging trends conference in New York this week.

“At no time in commercial real estate have emerging trends been more difficult to nail down,” said Hoeffel in his opening remarks at the conference. “We are seeing massive repricing of debt and equity. We’re seeing three of the five bulge-bracket investment banks go away in one form or the other.”

“We are seeing a marketplace that is influenced more by fear and panic than by underlying real estate fundamentals. This is a really challenging time,” continued Hoeffel. “Commercial real estate is being impacted by things happening across the capital markets spectrum and the broader liquidity crisis.”

Of the $33 billion in commercial real estate that Lehman has in its portfolio, only $17 billion is in the United States. And only $600 million of the exposure is in commercial mortgage-backed securities, said Hoeffel.

Lehman’s portfolio is one of the largest commercial real estate portfolios on Wall Street, according to James Glasgow Jr., a managing director and portfolio manager with Stamford, Conn.-based Five Mile Capital Partners. “There’s going to be an orderly liquidation of assets, which is what the bankruptcy gives Lehman the opportunity to do,” he predicts. “That’s better for the market than if they didn’t file for bankruptcy and their creditors were going after them and they were forced to do a firesale of the assets on their books.”

The Lehman portfolio includes a diverse pool of assets, such as bridge loans, mezzanine loans, senior loans and loans with loan-to-values as high as 95%. If the riskier assets don’t find any takers, Lehman may have to liquidate at substantially discounted prices, which could lead to a downward price spiral, Glasgow says. Most lenders, however, were not as aggressive as Lehman and the sale of the companies’ assets — even at deep discounts — is unlikely to impact the broader commercial real estate market.

Tim Mazetti, a partner and executive vice president with Chicago-based Cohen Financial, pointed out that Lehman was overleveraged and had taken on too much debt relative to its equity base. In addition, a lot of the company’s commercial real estate exposure is in overseas markets and includes high-yield and mezzanine loans.

“Whenever you sell into an illiquid market, you’re going to have to reduce price,” Mazetti maintains. “So that’s going to have an effect. There is obviously going to be a negative impact, a short-term widening of spreads in CMBS over the next three to six months.”

He pointed to a widening of spreads on the CMBX index in the last week. The index is made up of a group of indexes that track seven tranches of CMBS and is used to price the securities in today’s illiquid market environment. “The real issues might be more to do with the accounting and the financial marking-to-market than the fundamentals. The fact that you have to write down these assets is creating even further illiquidity,” Mazetti says.

And this has a negative impact on investors who are looking to buy commercial real estate assets and are put off by the prospect of having to mark them down, creating more illiquidity and perpetuating downward pressure on prices.

Mazetti expects that the CMBS sector will face these sorts of issues until the economy runs through a course of recession and hits bottom, probably by 2009. While investors have earmarked more than $50 billion for commercial real estate investments, they will not commit the money until they feel comfortable about a bottoming out in prices, he says.

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