Interesting Times

Distress Reliever

by Dana Rubinstein | 3:58 PM December 9, 2008

This article was published in the December 15, 2008, edition of The New York Observer.

Location: Why don’t you explain, in really simple language, what a distressed asset is? Aim low.

Mr. Levy: There are two basic types of distress. One [comes from a weakness in fundamentals], which is a weakness in the rent roll, weakness in the underlying credit of your tenants, decreasing [net operating income], increasing expenses. Basically, the value of the asset goes down because the value of your income stream goes down. … Category number two is an asset that might have fairly good fundamentals but because of capital markets constraints might be going through distress, because [its owners] can’t refinance their debt. … [Right now] the problem is almost entirely related to the second category of distress, which is capital markets. There’s just very little debt and equity capital out there to refinance these assets.

Everyone and their mother seems to have formed some sort of distressed-asset group. Where are all of these assets coming from?

The way it’s going down is very straightforward. The first level of distress was residential, single-family houses. And then as that problem became worse, it affected the capital markets and then started getting into the commercial asset classes. The first commercial asset class to get hit was land and development deals. As the capital market conditions continued to weaken, you started to see some distress in some of the core asset types. We haven’t seen a lot of it yet, but some of the core asset types that are beginning to show more weakness than others would include retail, hotels and flex industrial. And then if you take a look at certain markets outside of Manhattan, there are obviously pockets of weakness in some of the places like Las Vegas, Orange Country, Calif., Miami—places that had a significant bubble, particularly on the residential side.

So who are you working for besides the F.D.I.C. thus far?

We’re trying to focus in the beginning on just financial institutions; so, banks, insurance companies, [savings and loans] and special servicers. … We have an assignment out in California for IndyMac, which is one of the larger banks that, unfortunately, failed. … But in addition to that, our most active group this year in finance is our loan sales group.

So do you have any thoughts on how this is different from the Resolution Trust Corporation days of the late 1980s and early 1990s?

Do you want me to keep it simple?

None of this is particularly simple.

Everything is different. But I can say that from going into this recession, real estate fundamentals from a supply-demand standpoint are far stronger today than they were then—particularly in places like Manhattan, where you did not see a tremendous amount of overbuilding.

Of commercial real estate?

Of commercial real estate. Now, I think the situation may be different in residential. And that’s certainly the leading edge, and it’s all related. At the end of the day, the same person that was buying [residential mortgage-backed] securities was the same person who was buying [commercial mortgage-backed] securities. They got burned on one, and now they feel they got burned on both. Historically, I think it’s fair to say that a lot of people thought that residential and commercial real estate were not linked. Ultimately, this time, that was proven incorrect.

Simply because the same people who were buying the RMBS were buying CMBS?

That’s probably the biggest reason. I mean, what you’re dealing with here is a complete collapse of the CMBS industry.

So it’s not that the fundamentals underlying the CMBS market weren’t strong. It’s that there’s absolutely no demand anymore for CMBS?

Correct. And the investors won’t buy. Now, I will note it’s fair to say the CMBS underwriting got far more aggressive in the last two years, 2006, 2007, than they were prior to that. So there was certainly some weakness from the fundamentals standpoint in the underwriting of those loans. But, at the same time, the fundamentals of real estate until even today, are relatively strong, but certainly getting weaker in some of the obvious points, particularly retail and hotels.

Were you surprised by the enormity of this crisis?

I think everybody was. There’s obviously a lot of ways to characterize how things got so bad so fast. But I think the common knowledge, which I think is correct, is pre-Lehman and post-Lehman. When Lehman went down, that was the straw, the very large straw, that broke the camel’s back.

Even if they had saved Lehman, the underlying flaws in the system were still there.

Without a doubt. Underwriting of loans got to be too aggressive, from a loan-to-value standpoint, too aggressive in terms of interest rates. But at the end of the day, it was still being done with very strong real estate fundamentals.

So let’s talk about Manhattan commercial real estate. What do you think is going to replace …

… CMBS debt that’s no longer here?

Well, that’s a good question that I wasn’t going to ask.

Sorry. That’s like a politician in an interview [who is asked], ‘So Scott, how’s the weather today?’ ‘Well, let me tell you about my health care policy.’

What do you think will replace CMBS debt?

In the early ’90s, nobody thought that anything would come in to replace the broken [savings and loans]. And CMBS came in to replace that. Here today, people are like, ‘What’s going to replace CMBS?’ Something will replace it. … Number one, the banks are going to take more risk onto their balance sheets with respect to a piece of the security. Number two, private-equity firms, at least short-term, are going to step in to do it. Number three, insurance companies are going to get healthier again and they’ll be able to get back to historical lending standards. The issue is going to be the volume of the capital.

What I was going to ask is what sort of tenants will occupy the space once belonging to the financial services industry and the hedge funds?

New York’s economy has gotten far more skewed toward the financial services industry the past 25 or 30 years than obviously ever before. Will a new industry come in to take its place? It’s very hard to say. But I would suspect that given the infrastructure, the human capital of the New York City market, I’m very confident that some of the traditional industries will ultimately fill that void.

Is it safe to say we’re just at the preliminary stages of all of this unwinding?

Yes, and what’s interesting about it is, I’ve been … meeting with a lot of investors. … I’ve handed a lot of these investors a white sheet of paper and said, ‘O.K., you’ve got capital. Please write for me on this white sheet of paper what you will buy.’ … When it comes right down to it, very few of them can fill out that piece of paper, notwithstanding how much cash they have, because there is a tremendous amount of uncertainty out there.

So, when are we going to see this deluge of hard distressed assets, distressed skyscrapers and the like, coming to the market?

My answer is, hopefully never. But if the fundamentals continue to weaken, if the capital market conditions continue to stay frozen, it may not be for another six to nine months, maybe longer. Because the same thing that got us into this problem, or one of the things that got us into this problem, was overaggressive lending. It’s also the same thing that’s protecting us from falling faster, because overaggressive lending means that they lent at higher loan-to-values than you are going to get today and at lower rates. And a lot of this paper doesn’t come due till 2015 or 2016, so a lot of the problem may be deferred six or seven years out.

By which point the economy presumably will have recovered?

Presumably.