Brian Bailey: Welcome to the Federal Reserve Bank of Atlanta's Perspectives on Real Estate podcast series. I'm Brian Bailey, senior financial policy analyst with the Federal Reserve Bank of Atlanta. Today, we're talking with Ann Hambly, CEO and president of 1st Service Solutions. Ann served as a panelist at a conference hosted by the Atlanta Fed on December 1 called Exploring Impediments to a Real Estate Recovery: A Policy Discussion. This podcast will highlight some of her remarks on the availability of credit as it relates to commercial real estate.
Ann, thank you for joining me today.
Ann Hambly: Thank you for the opportunity.
Bailey: First, why is the availability of credit so important for the commercial real estate market?
Hambly: Well, let me set the stage, actually first, and tell you that the primary problem, I think, with commercial real estate right now can be simply worded as "overleveraged." And so, regardless of the property type, or the location of the property, the ones that are in trouble today are the ones that were overleveraged in the last few years before our crash, or some people even call it "the storm." So, before the storm—and those were years of 2005, 2006, and 2007—and so, the vast majority of the defaults we have today are on loans where the debt was put in place in those years, 2005–2007, and there really was just too much debt put in place. There was a little bit of it that played into this was the fallacy that commercial real estate values could only go up, so people banked on that and put a lot of debt in place. Now, you add that to the fact there are $1.7 trillion of maturities that are going to happen in the next five years in commercial real estate, and what you've got is a recipe for a disaster, or a "perfect storm." So, it's going to take a massive amount of credit to solve the default problems and to allow there to be some available credit for the refinances that are going to have to take place at the maturity.
Bailey: What does the recent and long-term trend look like for the availability of credit?
Hambly: I think the trend, the recent trend, is going to be that underwriting is going to stay very, very conservative, which means that there will be very little capital available for quite a while. And I think that the trend will be a long, slow slope, but when it does start to recover, I think it's going to recover very quickly. I think, really, the overleverage in the marketplace that we see today is really a result of the weakening or loosening in the underwriting. And that didn't happen because people were sloppy or lazy, it happened because of heavy competition in the commercial real estate industry. There are probably three factors, I think, that were at play here:
So you put those three things together and you've got, I think, the recipe for the problem that we have today.
I don't know if you've seen that commercial that was out there in the market a few years ago, where a guy sits at a table in a boardroom and all these lenders come in and make a presentation to him about why they should go with him. Well, that was funny, but that was exactly what commercial real estate was really like in 2005, '06, and '07. A borrower could shop for his own credit and pretty much get anything he wanted.
So, I think the recovery, the trend is going to be long. It's going to be slow to start with, but at some point the competition is going to get heavy again and we're going to get back there. So, I think it's going to recover quickly once it starts.
Bailey: What potential policies or solutions could be implemented to overcome this issue?
Hambly: Boy, there're a few that are in process right now. Let me just add something here. I personally think that up to about 60 percent loan-to-value, if you consider today the value of a property, you can, as an owner, go out and get a loan. There's a lot of capital available up to about 60 percent of that value, so 60 percent loan-to-value. Now 60 percent to 75 percent, that little sliver, there is some available capital—not a lot, but some—and the over-75-percent is where there is a real void. So when we talk about availability of capital we really probably need to break it into some of those slices. I think the over-75-percent—in the olden days, that would have been the borrower's equity. In today's market, that is still debt. And so, I believe the private sector will really have to step up, and is doing that, and is trying to fill that void.
You know, one of the policies—everyone talks about the Dodd-Frank Act, and I think that policy will be a game changer. Of course, it requires—just a small piece of the equation here is that it requires the originators and underwriters to have some long-term "skin in the game," if you will. And I think it's going to require us in some ways to go back to basics. I think we've gotten a little too creative in our financing structures for our own good, and I think the answer here really is to, you know, really deleverage.
Now, I spend most of my time in the CMBS arena, and I think this is another thing that is very, very important to figure out a way to fix, and I don't know how, I don't know exactly the solution, but I know that it needs attention. There has to be someone or some agency or somebody watching out for these lenders, underwriters, and servicers. Banks are regulated, you know, banks have regulators and people looking out for them. Insurance companies do. Government-sponsored entities have oversight. But CMBS—I personally just believe that no one is watching. They're not accountable to anyone. And the special servicers, there is no one watching out for what they do. And there are three of them that have 75 percent of all this business. So, that's a little scary, and I think that needs some attention somewhere.
Bailey: From your perspective, are appraisal-related issues hampering the CMBS market or the commercial real estate lending space?
Hambly: Absolutely. It is probably one of the most complicated considerations in commercial real estate right now. And the problem is because appraisals are pretty much driven on comps and "like" sales and trades in the market, and there just hasn't been any. So, it's very—in fairness to appraisers, I don't know how they do their job. It's got to be very difficult to come up with a value of real estate. For the special servicers for CMBS (just to talk specifically about that segment for a minute), when they are tasked with working out a loan, a problem loan—which there are a lot of those right now—one of the first things they have to do is they have to determine the real value of the real estate because that is the only way they can feel comfortable in making a decision about what to do. "What is the value versus my loan?" And in a lot of cases right now, the value of the real estate is a lot less than the loan, so the outcome results in a big loss to a lot of people. So, there is a lot of time spent trying to understand the real value of real estate today, and I think it's done, we see it done by a combination of an appraisal, and an internal review of that appraisal, and in an individual company determination of value of real estate through other brokers in the industry or their own credit committee, etc. But, it is definitely a tough, tough thing to get your arms around today in the industry.
Bailey: Ann, thank you for joining us.
Hambly: My pleasure.
Bailey: This concludes our podcast with Ann Hambly, CEO and president of 1st Service Solutions. For more podcasts on this topic and others, visit the Atlanta Fed's website at www.frbatlanta.org. If you have any comments or questions, please e-mail firstname.lastname@example.org.
Thanks for listening.