Real Estate Firms Face Looming Shakeout

Though it came as no surprise to investors, the collapse of General Growth Properties, the nation’s second-largest mall owner, has stirred new fears about a coming debacle in commercial real estate. The company, which owns 200 shopping centers encompassing 200 million square feet and 24,000 tenants, filed for bankruptcy protection last week.


With the credit markets virtually shut down, General Growth said it was unable to refinance the $3.3 billion in debt that had already matured or would be due this year. These included loans totaling $900 million on two malls in Las Vegas—Fashion Show and the Shoppes at the Palazzo—that were due to be repaid in November. An additional $6.4 billion in debt matures next year.

The global credit crisis, weakening retail demand and rising unemployment have taken a toll on commercial property around the world. At least $153 billion worth of property is already in distress, according to Real Capital Analytics, a New York research company. Of this, $87.1 billion represents defaulted mortgages, while the rest is outstanding debt from about 40 commercial-property and investment companies that have failed, most of them outside the United States.

In Japan, Australia and Spain, more companies than properties have faltered, said Robert M. White Jr., the president of Real Capital. “Here in the U.S., the majority of the issues are more at the property level than the company level right now,” he said.

General Growth has a good reputation as an operator of shopping malls, but it has been widely criticized for relying heavily on short-term mortgage debt, a practice that most public real estate companies frown on. Analysts said General Growth’s failure does not mean that other large real estate investment trusts, or REITs, are likely to follow it into bankruptcy court.

On the contrary, the REIT industry is trying to reinvigorate itself. In recent months, 10 of the strongest REITs have issued $4.7 billion in equity, giving them capital for near-term debt maturities, said Keven S. Lindemann, the director of real estate for SNL Financial, a research company in Charlottesville, Va.

These companies include the Simon Property Group , the nation’s largest mall owner; Kimco Realty , an operator of strip malls; and AMB Property and ProLogis , which specialize in distribution centers. On Tuesday, Vornado Realty Trust , which owns office buildings and shopping centers, joined the list.

Other REITs are expected to follow suit, said Barry Vinocur, the editor of the trade publisher REIT Zone Publications. The infusion of new capital “removes the risk and the uncertainty,” Mr. Vinocur said, “and at some point in time, there are going to be opportunities, and these companies will be better positioned to take advantage of them.”

Mike Kirby, a principal at Green Street Advisors, a research company in Newport Beach, Calif., said he expected as many as 20 of the weaker REITs to “either vanish, get acquired or become inactive.”

Like General Growth, many highly leveraged private companies are finding it difficult, if not impossible, to refinance mortgages that were issued to them as real estate values were soaring. In the United States, about $537 billion in mortgages will mature before the end of next year, said Sam Chandan, the president of Real Estate Economics, a New York company that monitors the real estate debt markets.

“There is growing evidence that even good-quality borrowers do not have access to refinancing,” Mr. Chandan said.

In recent years, General Growth financed much of its rapid expansion with bonds made up of pooled commercial mortgages, which are then sliced into various categories of risk. Delinquencies of so-called commercial mortgage-backed securities represent only 1.4 percent of all outstanding loans, but they are increasing at an alarming rate. In February, the delinquent unpaid balance for these loans amounted to $11.99 billion, up from $3.48 billion in February 2008, according to Realpoint, a credit ratings agency in Horsham, Pa.

Two-thirds of the delinquency, in dollar volume, comes from loans issued in 2005 to 2007, a period when competition among lenders led to overly optimistic projections about rent growth. Delinquencies are expected to rise as borrowers exhaust reserve funds they established to cover their debt service while they waited for rents to go up.

General Growth’s problems have highlighted the difficulties for borrowers in modifying loans that have been securitized. In a filing with the bankruptcy court, Adam S. Metz, the chief executive of General Growth since John Bucksbaum, a member of the company’s founding family, stepped down in October, said the company faced “steep logistical challenges” in trying to negotiate extensions.

—This story was originally published on April 21 in the New York Times.

Pre-Bubble Values

Restrictions stemming from tax considerations make it extremely difficult to change the terms of a securitized loan, said Thomas A. Humphreys, a partner in New York at the law firm Morrison & Foerster.

Another obstacle for borrowers is that investors in commercial mortgage-backed securities have divergent interests, depending on their level of risk. Investors with the highest-grade bonds may want to cash out through a sale of the mortgaged property, while investors in junk bonds who face an immediate loss may want to hold a property in case values rise. Mr. Kirby said property values had declined as much as 40 percent.

The securitization system “didn’t contemplate that there would be such a rapid change in valuation, and that this would happen during a time when there wouldn’t be a functioning financial market,” said D. Michael Van Konynenburg, the president of Eastdil Secured, a national brokerage firm, and the head of its loan sale team.

With so few properties changing hands, values are hard to determine. One benchmark is the recent sale, reportedly for $355 million, of the office portion of the 40-story Bertelsmann Building at 1540 Broadway, between 45th and 46th Streets in midtown Manhattan, which had commanded $525 million when it was sold to Equity Office Properties in 2006.

The next year, the developer Harry Macklowe bought the property as part of a portfolio that he acquired for $7 billion. Last year, Mr. Macklowe surrendered the portfolio to his lender after he was unable to make his debt payments.

In another transaction that received widespread attention, the 60-story John Hancock Tower in Boston was auctioned off this month in a foreclosure sale for $660.6 million, half of what the previous owner paid for it in 2006.

The decline may seem steep, but Mr. Kirby said values are reverting to where they were before the commercial real estate bubble began in mid-decade.

Mr. Kirby said he could not say how much the value of shopping malls has slipped because there have been no sizable transactions in more than a year. General Growth has said that even as its problems worsened, its malls were more than 90 percent occupied, and its $2.59 billion net operating income last year was an increase of 4.5 percent over 2007. The company has said it plans to keep its portfolio intact during the bankruptcy proceeding.

But Jim Sullivan, an analyst at Green Street Advisors, said occupancy and rents were going to suffer, even in the strongest malls.

“This retail downturn is different from the ones we’ve seen in the past,” he said. “Even the successful retailers are suffering sales erosion. It impedes their ability to pay higher rent, and it makes them cautious about opening new stores and new concepts.”

—This story was originally published on April 21 in the New York Times.