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Rx for the Economy, Extracting Equity from Debt

By Fred Cordova
Published: Wednesday, July 22, 2009, at 10:50AM

Fred Cordova is a Senior Vice President with Colliers International. He writes about capital markets and real estate on his blog, The New Nexus.

The stock market, which is up over 7% this week, seems to be signaling strong signs of economic recovery based on second quarter earnings numbers but don’t be fooled.

It's time to tackle the real evil: too much debt.

Mort Zuckerman, author of "The Economy is even Worse Than You Think," points out in that the real national unemployment rate is much closer to 16.7% (25 million workers) than the 9.6% being reported. The devastation of job loss that resulted from the massive and unprecedented meltdown in the financial sector is not going to go away soon and will continue to weigh heavily on the economy for several more years.

Nassim Taleb argues that the long term health of the economy can only be restored and sustained by turning debt into equity. That is precisely what Kennedy Wilson and LeFrak did with Mercury Rising and now is what is about to happen with several more downtown properties as a major Corus Bank loan portfolio is currently being shopped. With properties like the Concerto, Little Tokyo Lofts, Evo, G2 Lofts, Solair, and Wilshire Boulevard Condos in the portfolio it is a virtual certainty that a major portion of the debt on these properties will be converted into equity.

Specifically this means that they will either be sold at deep discounts to the existing debt and recapitalized or the lenders will have to write them down and hold onto them (which is the most likely case). Either way, the result is a substantially lower basis which allows the owner (who may be the original lender) to reduce rental rates or sales prices (for condos) to generate revenue.

Although there are some markets and specific properties presenting unusual resiliency in values, by and large there is overwhelming evidence in every market throughout the country that office, retail, industrial and multifamily are all down 40% to 50% in value. Hospitality is even worse.

If you are a buyer this is good news, because your aversion to risk should be near an all time low. Does it really matter if you buy at 45% or 50% off the peak? So, keep saving and waiting and watch for the recovery to appear first in home inventory levels.

The time to move is when inventory gets below 8 months of supply. When this happens, we should be 12 to 18 months away from the rebound. In downtown Los Angeles, most of the backlog in the first wave of residential foreclosures has already been absorbed, much of it at incredible prices.

Unfortunately, with large pending bond sales like Corus bank, wave two has not yet hit. When / if it does, it will make the first wave look like a ripple.


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