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What Happens Next to All This Bad Debt?

By Fred Cordova
Published: Wednesday, October 07, 2009, at 09:40AM
Aggregate Report: October 1 Fred Cordova []

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 recession may be technically over according to Bernanke and Obama, but if you listen to Buffet or any credible economist, this jobless economic “recovery” is likely to be slow and ugly.

We expect the government to allow unemployment to remain high to keep interest rates low so that banks can get healthy quickly by borrowing from the Fed at .25% and charging us 19%+ on our credit cards. Very soon, the OCC (Treasury guys) will start making the banks take the losses they need to take to clear the bad debts so that they can start lending again.

For real estate, this means that Multi-family is now entering the transaction / recapitalization phase, which will bring in new money at much lower prices, but it's still early and will continue for years. This will enable buyers to lower rents and condo prices. Retail and Hotels are getting slammed now. You can stay almost anywhere for $150 a night, including the Ritz. Industrial will soon to follow then office.

The Concerto bankruptcy filing and auction of $5 billion in loan assets by its lender, Corus Bank — which the Feds took over two weeks ago – is the latest close to home example of how banks will deal with nonperforming projects (debt) and how the Feds will deal with the zombie banks.

So what happens next in this ‘food chain” of bad debt? Here is what we are seeing based on meetings with owners, banks, and loan servicers:

  • The FDIC will close 200-300 banks next year and clear out non-performing assets by first trying to sell notes (debt), then the real estate.

  • The anticipated "tsunami" of foreclosures is probably an illusion as banks and debt servicers do not want to own property. If a loan is servicing the debt, they will modify it to keep it in place.

  • Banks will move very slowly as they try to shore up their balance sheets. Ignoring or forestalling the inevitable, often referred to as "kicking the can down the road" or “extend and pretend” buys them time, which helps them get healthy.

  • Pricing for properties is going to stabilize or rise (based on current bids of 50% to 60% off peak), not fall as aggressive seller financing drives value accretion by 10% to 20%. With interest rates where they are and pricing falling, there is no better time to buy a home or condo.

The equity market is already pricing stocks based on expected future performance. While the opportunity there may have already played out, with the markets up 50% in the last 6 months, there is a lot of money to be made in real estate from the recovery. So assess your situation, map out your journey and get going. It's not too late, but others have already started and are well on their way.


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