‘Extend and pretend’ will be bad in the end
‘Extend and pretend’ will be bad in the end
13 NOVEMBER 2009 8:43 AM

The Fed and most lenders are driving commercial real estate into a box canyon. You know the kind: three tall sides and no way out, used in the old West to drive game in and ... kill ... easily.

Extend and pretend will be bad in the end, and the end is 26 months from now. The Fed and most lenders are driving commercial real estate into a box canyon. You know the kind: three tall sides and no way out, used in the old West to drive game in and ... kill ... easily. And hotel loans are the lead cows. Sounds like the perfect scenario for our dear friends the vulture funds.

Our canyon has three sides:

  • the massive maturity wall looming in 2012;
  • the towering US$850-billion equity gap; and
  • the race between London interbank –offered rates and revenue per available room—which RevPAR will lose.

The maturity wall is the worst—from now until 2012, there are US$170 billion in commercial mortgage-backed securities maturities alone in the U.S. Those maturities will hit at the same time hundreds of billions of corporate bond debt comes due. Hordes of real estate and corporate borrowers will be gathered around a limited watering hole of fresh capital, and there won't be enough to go around.

Steve Van

And the U.S. industry's extend-and-pretend philosophy is driving all the already weakened loans toward that end.
The equity gap is the shortfall between the US$2.8 trillion (you know, it's sort of fun to type $trillion) in commercial real-estate loans originated between ‘05 and ’08, which, if refinanced today, would be worth US$2.0 trillion. So US$850 billion will need to come from write-downs and equity. Hotel loans are about 10 percent of this US$280 billion with, say, an US$85-billion shortfall. Pundits estimate there is about US$12 billion fresh hotel equity raised to help with the butchering. So that leaves about US$73 billion in loan losses. For comparison, the TOTAL market value of all hotel real estate investment trusts and hotel public companies is US$33 billion. Did that sink in?  Yes, the loss is twice as much as the total value of all hotel REITS and public companies. This will stink.
The race between LIBOR and RevPAR will start to sink most floating loans as soon as the economy starts to recover. When each of the past recoveries has taken hold, LIBOR increased around 300-400 basis points in 12 months. So today's fairy land of 2 percent hotel loans (175 over LIBOR at 0.24 today) will evaporate, and payment rates will increase by 150 percent to 300 percent. Some of these loans won't even make it to the end of the canyon.
So what do we do? Collectively we as a nation could create another Resolution Trust Corporation. (And for those originators I have talked to who didn't know what the RTC was, please call me.) The likelihood of that happening in today's put-it-off-’til-the-next-election political environment is, shall we say, slim. Smart money will wait at the end of the canyon and have a historic feast of cheap hotel asset buys. Most of us will just keep our heads down and try to do the best we can as owners holding on to our hotels or as lenders working out loans. But all of us taxpayers as the lender of last resort will pick up the bill in the end. And a big bill it will be.
Read more from Steve Van at

Steve Van is president and CEO of Prism Hotels & Resorts. Founded in 1983, Prism works for special servicers, lenders and owners to rapidly reposition and turn around under-performing hotels.

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No Comments

  • Neither a borrower nor a lender be November 13, 2009 4:09 AM

    Or right on the money

  • rhcaldwell November 13, 2009 4:22 AM

    Right on. There's denial all around in the lender community. No upside in RevPAR until 2012 (maybe), rising interest rates, falling cap. rates... The sad part is that lenders' collateral value will be impaired even further, and recoveries far less in the end, than if they acknowledged reality today and acted now. I say, hoard cash, and standby for some incredible deals!

  • CountingSheep November 13, 2009 6:00 AM

    Ah, so that is why so many companies are pre-paying their 2012 maturities now.

  • CountingSheep November 13, 2009 6:35 AM

    Avalon Bay even paid a whopping premium to retire their debt early. Have these prepayments been factored into the doomsday scenario? With essentially no new construction, companies paying off debt, one would think there may be capital available. But I guess with the government borrowing so much, I guess not.

    Here is what AVB just did in October:

    ALEXANDRIA, Va. (AP) Real estate investment trust AvalonBay Communities Inc. on Wednesday said it accepted $300 million of outstanding notes for payment in a tender offer that expired at midnight Monday.

    The company will record a charge of approximately $24.7 million in the fourth quarter to reflect the tender premium paid in excess of the par value of the notes.

    The notes accepted included $46 million in 7.5 percent notes due Dec. 5, 2010; $150 million in 6.65 percent notes due Sept. 15, 2011; $55.6 million in 5.5 percent notes due Jan. 15, 2012 and $48.4 million in 6.125 percent notes due Nov. 1, 2012.

  • Little Guy did the right thing November 13, 2009 6:50 AM

    I hear what your saying, but the reasons there is resistence to an industry-wide reset is because the middle-size player with a non-monetary default situation and a personal guaranty would be wiped out by no doing of his own. Where's the justice in that?

  • pc November 13, 2009 6:52 AM

    Funny that a "new" RTC is the solution from Mr. Van, who admittedly built his company on RTC. LIBOR is a concern,extending is a necessity for paying customers since there's little refinance money available, and the maturity numbers are WAY overstated as it relates to hotels. With $40 billion of "vulture" money on the sidelines (not $12 billion), the "good" assets will be swept up fast and the marginal ones will fall to the funds with the higher return requirements.

    Finally, remember that, other than REITs, most all of the hotel franchise public companies are not holders of hotel real estate. Can't wait for another cycle to make its regular run. Same stuff, different time...

  • Anonymous June 14, 2011 5:01 PM

    "Extend and pretend" is a phrase I never liked. Its callous as it assumes that the owner under the gun deserves to fail or to be cut. In many cases if not most the crisis was not of his making. The extensions made a lot of sense to debt and equity paritcipants as values have recovered, not fully but recovery even partial, does benefit the lender. If the property does fail the owner will likely have zilch but he will have had the extra opportunity to survive. As for the taxpayers they would have been more exposed if loans were not extended. Without doubt all property values would have been severely impacted. Frankly my business does better if lenders do take back these properties earlier but I do prefer to see some fairness.

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