Russ Keaton

Bluestone & Hockley Real Estate Service

Over the past several months in my role as Sr. Asset Manager for Bluestone & Hockley, I have been contacting financial institutions in the Portland metro area regarding their current Special Credits/Assets and commercial real estate owned portfolio status.  The feedback has been interesting with the consensus being that all is under control and that, in the foreseeable future, there is little anticipation of any increase in commercial REO properties.  As such, Oregon and Washington commercial loans are not experiencing the same levels of foreclosure activity,  as many other states are or that recently incurred by residential mortgages.

As a Special Credits veteran of the S&L crisis, from 1983 to 1993, my initial objective was to negotiate workouts for loans originated when interest rates were in the mid to upper teens.  The market was coming off of a prime interest rate of over 20%.  As such, my first series of modifications were for the purpose of resetting interest rates, into an 11.25% to 11.75% range, for grateful borrowers quite willing to pay fees of several thousand dollars.  One borrower gladly paid $3,000 each for two six-month extensions of his 18% loan.  It was a win/win for both parties.  Performing loans were kept on the books, the borrower had more cash to cover debt service and additional time to secure new financing and the banks avoided foreclosure while taking in some fee income.

Current market factors and workout solutions

Today, local banks are similarly focused on restructuring their current nonperforming assets while positioning themselves to handle the soon to be maturing commercial loans through workouts, modifications and extensions.  Most realize that the tight credit market will likely preclude the availability of funds for payoffs of commercial loans scheduled to mature in the next few years.  The bulk of these loans were made when interest rates were at or below 30 year lows.  Many of these loans were made from 2005 -2007 when property values were at or near their peak and underwriting criteria less restrictive.

Current economic conditions dictate a much different approach for troubled debt resolutions than that experienced during the late 80’s and early 90’s.  Aside from the afore-mentioned interest rate climate and availability of funds issues, there are several major factors for the loan analyst to consider.  First, as noted above, the maturing loans were made at some historically low interest rates.  Most lenders are “praying” that the Fed will hold rates steady for a while as a precautionary effort to avoid any negative impact on the nation’s economic recovery.  Second, steady or declining rents, increased vacancy rates and lower NOI could result in debt service coverage ratios below 1.0x.  Finally, calculating current collateral values may result with figures that are much lower than those used at origination and, in some cases, below existing debt.

Likely factors in the analysis equation:

When analyzing the numbers for a recommended workout, the chart shows the likely factors that will be involved in  formulating a solution.  There are a number of scenarios that can come into play for the analyst.  Concerns are already being expressed with regards to rent rates, vacancies and debt service coverage figures.  Commercial real estate is currently appraising at lower values across the country.  Today’s interest rates remain low so there is only one direction possible if they don’t hold at current levels.  Finally, the real deal breaker could be the necessity of requiring a substantial cash infusion from the borrower in order to make a workout transaction feasible.

Lenders are already tightening their underwriting criteria and requiring lower LTV levels.  Borrowers seeking to refinance debt will likely find it difficult without the required “down-payment”.   Asking for or requiring a fee to restructure the debt becomes much less important than bringing the LTV and/or debt service ratio to levels that conform with prudent underwriting practices in order to attain a market rate with appropriate loan terms and amortization schedule.  A full evaluation of the borrower’s or a guarantor’s current financial obligations and the collateral asset(s) must be performed to determine repayment capacity for the restructured debt.

Lender’s Priorities

Lenders are focused on working their own portfolios in an effort to “pre-empt” foreclosures and identify any possible nonperforming loans.  This is one of the factors contributing to the difficulties investors are experiencing when trying to secure new financing.  In the present environment, any new debt has to be “golden”.  We do not expect to see many foreclosures on borrowers that can not pay-off at maturity where there is a reasonable prospect for stabilization through modifications or extensions.  As such, the prospect for an increase in commercial REO properties in the near future is being projected by the banks as minimal.

Many interpret the Policy Statement on Prudent Commercial Real Estate Loan Workouts dated October 30, 2009 from the financial regulators (FRB, FDIC, OTS, etc.) as giving the banks more latitude for classifying commercial loans.  Scenarios cited in the letter  allow for higher LTV levels as along as debt service coverage and a financial analysis reflects a borrower’s ability to perform under the terms of the workout agreement.  The classification criteria described may appear less restrictive, however, in the opinion of this writer, the actual numbers may provide for more significant challenges.

Foreclosures in Oregon and Washington have yet to hit market en masse and, until then, we are not likely to see the deeply discounted offerings.  The need to deeply discount too many loans and, thus, being “forced” to start booking heavy loss reserves may change the banks’ current market stance.  There are a lot of special  credits/assets managers who believe or have a “gut feeling” that the market will reach a point where the quality of maturing loans will start to diminish.  If and when we reach that point, the REO properties hitting market would be those that couldn’t be saved through workouts.

Conclusion

There are at least two possible scenarios that can play out as part of the current economic crisis.

• Significant interest rates increases coupled with the maturity of some of the more “unfavorable” loans made at the peak of market pricing that can cause an increase in commercial loan foreclosures.
• Or, the banks continue restructuring loans to work their way through this current situation and, if successful, expect commercial REO to remains at a trickle.

To sum it all up, banks are looking to create a bridge between their current, mostly performing, commercial loan portfolios and a future that indicates a real potential for disaster, a “Bridge over Troubled Waters”, so to speak.  No one is forecasting a robust REO market in Oregon and Washington for the near future.  To paraphrase one manager, “we have it all under control today but that can change overnight.”

 Postscript for our investors that are reading this article:

 Regardless of which outcome occurs, the savvy investor will look to add quality assets to their portfolio whenever possible.  One can almost never pick the bottom of the market so making sound investments today should still look like a good deal a few years in the future.  Our recommendation is to look for quality assets that meet your long-term objectives, underwrite conservatively and begin enjoying the returns today rather than trying to time the absolute market bottom.

Russell F. Keaton is Sr. Asset Manager for Bluestone & Hockley Real Estate Services.  Russ earned a Bachelor of Science degree from Portland State University.  He began his mortgage career as a Customer Service Coordinator with Securities-Intermountain “Simco” here in Portland.  He subsequently worked as an Income Property Administrator for Lincoln Savings & Loan and as AVP and Manager of the Special Credits department for Willamette Savings & Loan.

Russ moved to Phoenix, AZ where he worked under a 3 year contract as an Asset Manager assisting in the liquidation of $1.2 billion of seized commercial real estate loan assets for the Resolution Trust Corporation and then for 7 years as Vice President and Manager of the Servicing, Secondary Marketing, Underwriting and Quality Control departments for Fairmount Mortgage.

REO SALES

February 2010 – Gross REO Sales were $1,955,000. Properties were located in Beaverton, McMinnville, Portland, Salem, and Hillsboro areas.

This issue of the Barry Apartment Report is based on five recent forecast type speeches given by Mark D. Barry, MAI, Apartment Appraisal Specialist, with research and professional contribution from Phillip E. Barry, Apartment Real Estate Broker.

Lease

Brian Gettlieb has leased a 3,829 square foot industrial space at 2211 SE Ochoco St. in Portland, OR from OMPA, Inc. John Brandhorst of Bluestone & Hockley Real Estate Services represented the landlord.

REO SALES

January 2010 – Gross REO Sales were $509,000. Properties were located in Sheridan, Portland, Warrenton, and Junction City areas.

Cliff Hockley

Bluestone & Hockley Real Estate Services

Real estate investing needs a long term vision.   As individual investors we save money, purchase real estate and try to increase our portfolio over time, hoping that by the time we retire, if not before, the cash flow from the investments might pay for college for our children and then pay for a comfortable retirement.

Curveballs

Around 40 we decide it is time for us to improve our money management strategies so that we have money available for our retirement. Typically this happens because we can see our parents aging. We choose good investments, great locations, super cash flow, we refinance and use the equity generated to buy other investments.  Our plans look good until……

Multiple marriages/partners

Maybe we have been married two or three times, but what about the adult children that came with your new spouse? What if your spouse passes away and the step children want their inheritance now?  The investment income you may have been counting on, or the house you thought you would live in for the rest of your years, may be in jeopardy.

Health

You were in good health but all of a sudden cancer caught up with you and you need to be in a rehabilitation facility. It was a good thing you purchased long term care insurance, but the drugs are affecting your memory; you are having a hard time making decisions.  

Investment partners

You invested with a partner for many years, but his wife is ill and he needs to liquidate to have enough money to take care of her.  Maybe our partner has four children and wants his assets to be passed to them.  How do these partnerships continue…or end, do we have an exit strategy that will work favorably for all of the partners?

Children

• We realize that our children are not as driven as we are. We have taken such good care of them, they don’t value money.  Sure, they received an education and are smart, , but they have no understanding for financial statements and  think real estate is too much trouble to deal with;  
• Or maybe we have a child that is handicapped. We need to make sure a trust is in place to take care of that child;
•  Or we started having children late in life and they are too young  to make financial decisions;
• Maybe we do not trust our children;  they think they are wise investors and money managers, or are greedy and want you  to turn all of your assets over to them before you pass;
• Or worse,  our children have gotten married we do not trust the in law to take care of us or our investments;

We have to figure out a system to help the next generation make the right decisions.  How are our children going to interact with one another or with a new spouse’s children? How can we avoid a conflict that may result in the sell off or destruction of our investments?

Involve your family early

If you have children get your kids on board now!  If you are married involve your spouse. Get them involved and educate them in your business..your real estate business, so they are prepared.   Have them help you collect rents, paint apartments, repair toilets and pull weeds.    If your children are not interested maybe, look around the family. Perhaps your son is the spend thrift but his wife is cautious with money.   Or you may have a grandchild that shares your thoughts on investing?

Communicate your wishes to your spouse and children.  Explain your goals.  Few parents really tell the story of how they got what they have and the hard work that it took.

Planning

Clearly you need to plan ahead.  You should have a Will.  It is good practices to update that Will every five years. If you have assets that are under $1,000,000, federal and state estate taxes will be minimal.  In Oregon the federal and state inheritance taxes are not aligned.  In other words Federal estate taxes don’t kick in for 2010 until we hit $3,500,000 per person (or a combined $7,000,000 estate).  But Oregon estate taxes kick in at over $1,000,000.   Estate taxes can eat up a lot of cash and may force beneficiaries to liquidate real estate in order to pay the taxes.

If we want our hard work and investments to be passed on to the next generation and our estate is worth more than $1,000,000 (cash, stocks, real estate etc) we need to hire an estate attorney to help we plan.  Have your real estate attorney refer you to at least three people.  If you do not have an attorney, search the internet or contact the Oregon State Bar, Estate Section for a referral.   Interview prospective attorneys; ask tough questions so that you can identify a person we can trust.  Remember this person will most likely be responsible for settling your estate once you pass.   They may suggest purchasing insurance to pay for long term care and estate taxes.  They may suggest you place your assets into trusts, or they may even suggest generation skipping trusts.

Pre-Nuptial Agreements

If you have significant real estate assets before you get married you might want to consider entering into a marriage with a pre-nuptial agreement to insure not only your retirement income but your children’s inheritance is protected.

 Philanthropy

If you have no children or other family members, you can always give money to a foundation.  They typically liquidate the real estate assets and then invest the money from the proceeds to create a fund that is invested.  The investment returns are then used as your donations to philanthropies that you specified in your will/trust.  (Examples of such foundations include the Oregon Community Foundation, and the Oregon Jewish Community Foundation, Portland Women’s Foundation and the Rotary foundation.)

On the other hand you might also leave your assets to a college, university, or not for profit organization such as a hospital, or Oregon Humane Society for example.  Your attorney and CPA can give you some ideas on how a charitable remainder trust can be used to donate your real estate investments without generating capital gains taxes while you are alive.

Summary

You have worked hard to build an estate. To keep it intact you must take the time to hire the right people to advise you and help with tax planning both while you are alive.  You can leave your mark on future generations, either by leaving the assets to your family or to philanthropic causes.

 On the other hand you could just sell the assets while you are alive, pay taxes and go to Las Vegas and have a great time gambling it away.  In any case it is up to you to decide.

This is merely an outline of some key issues.  Please consult an estate attorney or CPA to get information on the most current laws.

Sale

Jenner Lesser-Arnell has purchased a duplex at 2260 SE 44th in Portland, OR from David and Fiorella Featherston. Charles Barker of Bluestone & Hockley Real Estate Services represented the seller.

Lease

US Bank National Association has leased a 7,322 square foot office space at 12203 NE Glisan in Portland, OR from Menlo Park Associates, LLC. Tom Sjostrom of Bluestone & Hockley Real Estate Services represented the landlord.

In a somewhat surprising announcement, FHA has announced that it is waiving the property flipping rule for one year starting February 1, 2010, with regard to subsequent sales by purchasers.  Here is the link to the waiver:  http://www.hud.gov/offices/hsg/sfh/waivpropflip2010.pdf

In the waiver, FHA said it was taking this action to address the foreclosure crisis.

The waiver is limited to sales meeting the following conditions:

• All transactions must arms-length; no identity of interest between buyer, seller or third parties
  • Ways to ensure no unacceptable arrangements include:
    • Seller holds title
    • LLCs, corporations or trusts that are serving as sellers must meet applicable State and Federal law
    • No pattern of previous flipping activity exists on property (as evidenced by multiple title transfers w/i 12 month)
    • Property marketed openly and fairly (Any sales contracts w/ “assignment of contract of sale”) may be a red flag
• Sales w/ 20% increase over seller’s acquisition cost will only be permitted if the lender:
  • Provides supporting documentation and/or second appraisal which substantiates increase in value (I.e. renovation or rehabilitation)
  • Orders a property inspection and provides it to the purchaser. (Borrower may be charged for inspection.)
    • Waiver provides what the inspection must review and other requirements
• Waiver is limited to forward mortgages

Lease

Loudenback has leased a 800 square foot office space at 10818 NE Coxley Drive Ste. N in Vancouver, WA from The Cheng Family Trust. Laura Pallin of Bluestone & Hockley Real Estate Services represented both parties.