Maguire Properties Commercial Debt Troubles Are Widespread Reality

The WSJ reported in this morning's paper that real estate investment trust Maguire Properties (MPG) has notified the holders of $1.06B worth of commercial debt that it faces "imminent default" on it's obligations.

Aside from the fact that Maguire's lenders are taking a bath on this one, this latest piece of news is a clear sign that commercial property is reaching a tipping point of sorts. Obviously, those REIT's whose assumptions were most favorable going into these deals are the ones getting burned right now. Maguire and many others examine a property from the front-end using a pro forma that includes future assumptions about market rents. Usually these assumptions end up as a linear, positive function; that is, rents are assumed to rise steadily and incrementally throughout the first 10 years of the building's life. The result is inevitably a model which indicates steadily higher levels of free cash flow, after paying for the building's management and dropping some maintenance dollars into the escrow of course. Obviously, the closer to the peak of the commercial real estate market a building was financed/modeled, the quicker it will approach the "danger zone". This is a term that I'm completely making up, but it refers to the point at which a commercial building's cash flow is insufficient to service it's debt. This ends up being a function of the severity of declines in market rents, the viability/solvency of the individual lessee's, and the level of financing secured for the property relative to it's value (LTV).

Once a property goes cash flow negative, the owner must weigh several factors, most importantly the likelihood of a rebound in the absolute level of rent supported by the local market, and in many cases the reputation of the entity which leveraged itself. I emphasize the use of the word entity in this case because most often an LLC or S-corp is responsible for the property's mortgage. These "shell" corporations can, in theory, default on their obligations without incurring liability for the "mother" company. Anyways, the REIT must make a judgment as to how long it will continue to feed the property before allowing it to fall into default. Maguire has apparently decided that this handful of So.Cal commercial properties will be a significant enough strain on cash flow that "punting" them is the best available option. Similar determinations are currently being made across the country with regards to income producing properties; this is what de-leveraging looks like.

*no position in MPG Sphere: Related Content

The Irrelevant Aspects of US Mortgage Woes

In its quarterly status report,  released today, the Mortgage Bankers Association presented data that, as expected, points to a continued deterioration in the quality of US mortgages. According to the Association, this report set all time records (to the beginning of record keeping for this sort of data) in the following categories:

• The percentage of first mortgages to have foreclosure proceedings initiated
  
• Quarter to quarter increase, in basis points, of percentage of first mortgages to have foreclosure proceedings initiated.
• The non-seasonally adjusted delinquency rate for mortgage loans on one to four unit residential properties.
• The combined percentage of loans in foreclosure and at least one payment past due.
• The percentage of loans in the foreclosure process.

Clearly, mortgages in the United States are performing poorly in virtually every aspect that it is possible for the instrument to fail. This information is all relevant insofar as assessments of future economic activity are concerned. What is quite irrelevant, in our opinion, is the fact that 46% of foreclosure starts are concentrated in a handful of states including Florida and California. Our reasoning is as follows: The nation does not exist in a vaccuum. We get the distinct impression that, when the MBA continually asserts the regional specificity of mortgage delinquincies/foreclosures/late payments, they are considering this aspect to be a mitigating factor within the carnage. This attitude belies certain realities.

First, California and Florida are major population centers within the United States-the two states together represent nearly 25% of the United States population. Hundreds of thousands of people migrate to and from these areas each year-under normal economic conditions. Housing markets across the country are adversely affected by the diminished pool of potential buyers that is the result of CA and FL residents being unable to sell their own home, or no longer credit worthy enough to receive financing.

Second, and obviously, woes within one region of the country can damage the ability of a financial institution, that is national in scope, to provide credit. Whether or not these bad loans are all located in one state, or evenly spread across the country, the majority of all loans are concentrated within a handful of financial institutions, rendering the actual loan location irrelevant. 

Perhaps the location of the mortgage meltdown epicenters is continually contained in these reports as a mere bit of trivia. Unfortunately, we feel that it is often cited as a means of assuring those lesser-affected states that everything will be allright.

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