Crisis Hits Values of Commercial Mortgages
Investors Leery of Real Estate Bonds

By Heather Landy and Dana Hedgpeth
Washington Post Staff Writers
Friday, November 21, 2008

NEW YORK, Nov. 20 -- Another levee in the financial markets is crumbling.

Fears about rising default rates and declining property values, which engulfed the home mortgage market at the start of the credit crisis, are spreading to the commercial real estate market, hammering the value of bonds backed by loans made to office buildings, shopping centers and apartment complexes.

With the slowing economy threatening the health of commercial borrowers, investors are wary of scooping up the bonds, even though some cash-strapped banks, hedge funds and money managers are willing to part with them at steep discounts.

As a result, the market for commercial-mortgage-backed securities has been sent into a tailspin by the now-familiar combination of forced selling and bleak economic forecasts.

Until recently, investors had presumed that commercial-mortgage bonds were relatively safe. They avoided taking a direct hit from the subprime meltdown, which derailed the market for bonds backed by residential mortgages, and the the bonds' default rate, while climbing, has stayed below 1 percent.

But a report this week about delinquent payments on two high-profile loans -- one for a California shopping center and the other for two Westin resorts in Arizona and South Carolina -- stirred fears about whether an era of rosy business projections and loose lending standards will, like the residential market, give way to missed mortgage payments and a tough refinancing environment.

"A lot of very foolish loans were originated between 2005 and 2007, and many of those loans begin to mature in 2010," said Mike Kirby, director of research at Green Street Advisors, a commercial real estate research firm. "You have a significant amount of debt maturing at that time and yet you don't have a market to replace that debt."

Atlanta, Detroit, New York and Tampa are among the markets showing signs of rising defaults on commercial mortgages that have been packaged into bonds. So far in the District, Maryland, Virginia and West Virginia, the percentage of loans that are 30, 60 or 90 days overdue are well below national averages.

Herb Miller, who has helped developed major retail properties in Georgetown and downtown, said he has some loans coming due in the coming years, though none have been packaged into securities. He is closely watching the market.

"We're in pretty good shape, but everybody's nervous," he said. "There's no money out there for real estate refinancing. The market is awful."

Skittish investors are demanding higher premiums to hold commercial-mortgage bonds. Yields on the safest-rated category of commercial-mortgage-backed debt are now 15 percent above benchmark interest rates, traders said. At the start of the week, that spread was just 8.5 percent.

Investors buying at the current yields would have all of their principle protected even if all of the loans pooled into the bonds defaulted and offered only modest recovery values, said Lisa Pendergast, an analyst at RBS Greenwich Capital Markets.

"It's gotten to the point where I believe it's more about fear than anything else," she said. "But at some point if borrowers and real estate [investors] cannot get capital, then you really do start to have fundamental issues."

Some investors were banking on the Treasury Department's financial industry bailout plan to keep the commercial-mortgage-backed securities market propped up. They hoped that cash-strapped banks would either be able to sell those assets to the federal government or get more breathing room to sit on their holdings by offloading other assets onto the government.

But late last week, the Treasury Department announced that it wouldn't buy any assets from banks under its Troubled Asset Relief Program, and instead would use TARP funds to buy stock in banks.

"That was the last hope for a lot of people," said Sean Kirk, a trader at the Seaport Group in Miami Beach. "After two months of holding out for some sort of miracle bid, the market realized it was not going to be there, and now these things are trading at liquidation levels."

Adding to the panic is a spate of recent bankruptcy filings by high-profile merchants such as Circuit City. Dimming prospects for consumer spending in a slowing economy has stirred concern about the value of commercial-mortgage bonds tied to properties dependent on retail tenants.

General Growth Properties, which owns shopping malls around the country and acquired the developer of Columbia, Md., in 2004, is trying to stave off filing for bankruptcy protection as it struggles to refinance more than $27 billion of debt. The Chicago-based company, which took on debt when it bought the Rouse Co., announced yesterday that it has hired law firm Sidley Austin as a financial advisor.

Hedgpeth reported from Washington.

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