The Strategy Of Defaulting By Big Developers

Like Homeowners walking away from mortgaged houses that plummeted in value, some of the largest commercial property owners are defaulting on debts and surrendering buildings worth less than their loans.

Why are some of the largest commercial-property owners defaulting on debts and surrendering buildings worth less than their loans ? Just like homeowners walking away from mortgaged houses that plummeted in value…companies such as Macerich, Vornado Realty Trust and Simon Property Group Inc, have recently stopped making mortgage payments to put pressure on lenders to restructure debts. In many cases they have walked away, sending keys to properties whose values had fallen far below the mortgage amounts, a process known as “jingle mail.” These companies have piles of cash to make the payments. They are simply opting to to default because they believe  it makes good business sense.

“We don’t do this lightly,” said Robert Taubman, chief executive of Taubman Centers Inc. The luxury-mall owner with upscale properties such as the Beverly Center in Los Angeles decided earlier this year to stop covering interest payments  on its $135 Million Mortgage on the Pier Shops at Caesars in Atlantic City, N.J.

Taubman, which estimates the mall is now worth only $52 Million, gave it back to its mortgage holder. “Where it’s fairly obvious that the gap is large, as it was with the Pier Shops, individual owners are making very tough decisions,” he said.

These pragmatic decisions by companies to walk away from Commercial Mortgages come as a debate rages in the residential-real estate world about “strategic defaults,” when homeowners stop making loan payments even though they can afford them. Instead, they they decide to default because the house is “underwater,” meaning its value has fallen to a level less than its debt. Banking-industry officials and others have argued that homeowners have a moral obligation to pay their debts even when it seems to make good business sense to default. Individuals who walk away from their homes also face blemishes to their credit ratings and, in some states, creditors can sue them for the losses they suffer.

But in the business world, there is less of a stigma even though lenders, including individual investors get stuck holding a depressed property in a down market. Indeed , Investors are rewarding public companies for ditching profit-draining investments. Deutsche Bank, which manages $56 Billion in real-estate investments, now favors companies that jettison cash draining properties with non recourse debt, loans that don’t allow banks to hold landlords personally responsible if they default. The theory is that those companies fare better by diverting money to shareholders more lucrative projects.

“To the extent that they give back assets or are able to rework the mortgage terms, it just accrues to the benefit of the real estate investment trust, says Jerry Ehlinger RREEF’s co-chief of real-estate securities.

Earlier this month, a group led by investment firms Colony Capital relinquished control of the $2Billion Xanadu Retail Development in New Jersey to a Bank Group, blaming  their creditors for balking at a restructuring. The Lender group said it is disappointed that despite its best efforts it couldn’t reach a deal.

More Landlords are expected to follow suit. Of the $14 trillion of commercial-real-estate debt coming due by the end of 2014, roughly 52% is attached to properties that are underwater, according to debt-analysis company Trep LLC. And as the economic recovery sputters, owners of struggling  properties are realizing a big property-value rebound isn’t imminent. Owners of commercial property have an easier time walking away than homeowners because commercial mortgages are typically non recourse. That means the biggest penalty of walking away is the forfeiture of assets and cash flow they may generate.

Whether landlords walk away from properties often depends on the lender. In recent years, most projects were financed by the use of commercial mortgage-backed securities, or CMBS, which are effectively bundles of mortgages sold as bonds to thousands of investors. Restructuring debt with scores of bondholders is more difficult than with Banks.

If borrowers do walk away from bond-finances properties, the real estate is often foreclosed and sold for less than the loan balance. Investors holding those loans take another hit paying fees to loan servicers that handle liquidations.

Also, public and private real-estate companies don’t often default on mortgages provided by Banks, because the same banks are likely to be providers of credit lines or other loans. Playing hardball with a bank on one loan could adversely affect the relationship and other loans.

In one recent CMBS default, Vornado, one of the country’s largest owners of offices and malls, stopped payments on an $18 Million Mortgage on the Cannery at Del Monte Square, a mixed -use development in San Francisco. Simon Property Group last year  also walked away from the struggling Palm Beach Mall in West Palm Beach, Florida, and Macerich in July forfeited Dallas’s Valley View Center mall, which was saddled with a $135 million mortgage.

Harris Trifon , Chief  of Research on Commercial -Real estate debt for Deutsche Bank, says walkaways won’t derail the return of CMBS-financed properties. ” But you have the potential  for more pain for a select group of investors,” he says.  (credit WSJ, k. hudson, ad pruitt, n. timiraos)