Many in the commercial real estate investment community have waited patiently for an avalanche of highly discounted commercial property to flood the market. To date their patience has been mostly in vain and we suspect that they ultimately will be disappointed as we go through this market cycle.

Much of the current distressed assets are either construction and land loans or performing assets that were purchased at the height of the market with aggressive, high leverage interest only debt. These properties tend to be undercapitalized and need new equity contributions, a reworking of the debt, or both.

Many lenders prefer to sell off their problematic debt before it reaches foreclosure. This simplifies the process of clearing their books and provides an opportunity for distressed property investors who are willing and able to deal with the legal challenges, time and expense of the foreclosure process.

Another factor that has reduced the number of REO properties is due to a change in regulatory policy. This regulatory changes encourage banks to "extend and pretend" troubled loans. If these lenders had been forced to foreclose or sell the debt at a deep discount many would have had to close their doors putting further stress on the economy and taxpayers.

The impact of the "extend and pretend" policy can be seen when compared to past downturns. In the 1990s regulators took the approach of closing weak lenders then "foreclosing and disposing" of commercial properties on a massive scale through the Resolution Trust Corporation (RTC) to recoup government rescue dollars. The net result of this activity was to eventually deleverage an over leveraged market, a significant reduction in the number of lenders and a few investors making fortunes. This was all accomplished at a high social and economic cost with the tax payer paying the bill.

Today's regulatory policies that allow "extend and pretend" loan modifications are avoiding closure of many local and regional lenders overburdened with problematic commercial real estate loans. Lenders are working with borrowers providing that the borrower is not considered the problem and they can service their debt even if their loans are for more than the current value of their property.

Currently 15-16% of overall commercial sales are considered distressed with less than 3% being REO properties. In the category of distressed properties delinquency rates are as fallows:

We do expect to see an uptick in foreclosures for properties bought in 2005-2007 with unrealistic projections and high loan-debt loads. This will happen for marginal borrowers who do not have the staying power or a cooperative lender willing to wait for the economy to recover and for rents to rebound. The big question is how much if any of these foreclosed properties will actually hit the market. Lenders can keep them on their books until the market turns, or they could be securitized through some future government program.

At the present time many lenders are not motivated to sell the properties that they have foreclosed on at the discount prices investors are demanding. TARP and other government money is helping lenders build back their capital requirements without having to sell off assets.

Properties purchased between 2005 and 2007 tend to be undercapitalized and need new equity contributions, a reworking of the debt, or both. They are also frequently confronted with the uncomfortable reality of actual rents and occupancy that are significantly less then the rosy projections used to obtain the loans in the first place.

Borrowers and lenders of construction and land loans are reluctant to put in additional capital to finish their projects as long as demand for the finish product remains low. For REO investors looking for the steepest discounts these types of properties often offer the best opportunity.

The pipeline for Troubled Commercial Mortgages is as follows:

	Number of Properties	Dollars
Troubled properties	6,425	$139,500.6 mm
Restructured/Modified	725	17,109.4
Lender Owned (REO)	1,411	21,992.1

Troubled properties are those that are in process of being foreclosed on, in bankruptcy or are undergoing workouts.

Restructured/Modified properties where workout strategies including loan extensions for less than two years have been implemented.

Lender Owned (REO) properties are those that have been taken through foreclosure.

Current lender recovery rates are as follows:

Recovery Rates:

The lowest lender recovery rates are in Michigan, Florida and Arizona where the economic downturn has hit hardest.

Insurance companies have the highest recovery rates, at 79%, with securitized loans (CMBS) being the lowest at 62%. Smaller regional and local banks have slightly better recovery rates than their large national and international counterparts.

Even when well capitalized banks foreclose on a commercial property many elect to keep performing assets on their books to be sold at a later date. The net results of these policies are relatively few REO sales. For quality, highly desirable, performing properties that are foreclosed on and sold by lenders frequently receive multiple offers.

The possible chance of an RTC 2, where the government steps in and forces massive cleansing of over leveraged properties as seen in the 1990s is unlikely for both economic and political reasons. There is currently a proposal being considered by the FDIC to securitize these troubled assets. Such an approach would help deleverage the market, and in the long term assist the government in recovering dollars spent. We don not expect the massive forced sales and dumping of commercial real estate that was witnessed in the 1990s because of the cost to taxpayers and the economic, moral, and political hazards that such policies entail.

Currently commercial property and debt are available in limited amounts from sales by the FDIC, CMBS special servicers, institutions that have bought bulk portfolios from the FDIC and lenders who do not have the financial strength to wait out the market.

Our Distressed Property/Debt Program provides access to both commercial, multi family properties and debt as it becomes available. Please contact us for further details.