The new 'Hope Note' new hope or new risk for commercial real estate?

• Author: Taylor, John
• Position: Money Talk

Hope has been the inspiration for many great things in history. Columbus discovered the Americas hoping to find a quicker and more direct route to the Far East. Now there is hope for the commercial real estate industry and its "Queen Isabella" the lending and mortgage industry. A new strategy is emerging called a "Hope Note." To understand what it is, you must first understand what led to its creation.

Sharks in the Water

For the past two years, many in the commercial real estate industry have waited for a market meltdown, when property owners would walk away and lenders would dump both good and bad properties at deep discounts. Hungry investors accumulated cash with hopes of scooping up commercial real estate at once-in-a-lifetime prices.

In certain areas of the country, this scenario has occurred, to some extent. Yet in many other markets, such as Utah, the volume of lender-owned or lender-forced sales of commercial real estate has been limited. The threat of a large number of "distressed assets hitting the market soon" slowed regular market transactions to a trickle because non-distressed owners chose not to put their properties up for sale at a time when buyers were acting like sharks in the water. The result? There have been very few commercial real estate transactions, either distressed or non-distressed, over the past two years. Based on Utah sales data, 2010 showed the lowest volume in both transaction and dollar volume since 2001.

The limited number of transactions made lenders very reluctant to approve new loans on commercial real estate. They were also less aggressive with borrowers that had reduced equity or difficulties. With fewer sales, lenders had no yardstick of comparison and became very unsure of the current market value of real estate. They were justified in being conservative when asked to underwrite new loans or to refinance maturing loans. This abundance of caution further slowed real estate activity, even though the economy appears to be rebounding of late.

Extend and Pretend

Most commercial real estate lenders have been hesitant to force foreclosure or to work through the lender-owned (REO) backlog with sales at current market values. Much of this reluctance can be attributed to the damage done to lenders' balance sheets after the financial market meltdown late in 2008. Lenders did not want to write down the balance of their non-performing real estate assets to current market values. If they had, many would have...