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Waiting Game

Wary of Realizing Losses, Lenders “Pretend and Extend”

Two phrases have entered the commercial real estate industry lexicon in recent months: “Pretend and extend” and “A rolling loan gathers no loss.” Both witticisms describe an ongoing phenomenon in real estate finance: as the level of distress mounts, lenders have been loath to seize properties from troubled borrowers. Instead, in many cases banks are granting extensions or modifications even in situations where borrowers are unlikely to pay back the loans.

To date, $60.5 billion in commercial real estate assets have entered default or delinquency, reports Real Capital Analytics (RCA), a New York City-based research firm. (Overall, the firm counts $108 billion of assets in default, foreclosure and bankruptcy, including some $31.1 billion worth retail assets worth.) In contrast, only $4.1 billion in troubled assets have been resolved this year.

Many banks hope that if they stave off foreclosure for a year or two, even if a distressed sale becomes inevitable, they will be able to recover more capital than they would if they sold now. With multi-family or office buildings, that could be true, says Christopher Grey, managing partner with Third Wave Partners LLC, an advisory firm in El Segundo, Calif. But the likelihood of a significant increase in the value of retail properties, he says, remains low.

Distressed assets are trading at steep discounts to peak market prices, says Gerard V. Mason, executive managing director with Savills US, a New York City-based real estate services provider that is currently involved in up to five off-market extension transactions. If banks were to take back these assets now and try to sell them, they would fetch prices as much as 35 percent off pricing peaks.

Lenders are not treating all borrowers equally, however. They are making distinctions based on the quality of borrowers and assets. In cases where properties boast healthy cash flows and owners with proven track records, lenders see little reason to foreclose, notes Dan Fasulo, managing director with RCA. In these cases, the delinquencies are more the result of the poor financial climate than they are of mismanagement.

On the flip side, on properties left in the hands of owners who hold little to no equity in them, cash flows might erode further. Managing a successful retail center takes money, starting from leasing commissions and ending with tenant improvement dollars, Grey says. He and other market watchers hope the current logjam will start to unwind by the first quarter of 2010. If their predictions are on target, it will be another three to five years before all the bad commercial loans out there get resolved. But if lenders continue to postpone dealing with troubled assets, the resolution of this crisis might take as long as 10 years.

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