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Antidotes for ailing real estate.

Informed opinion seems to be saying that the recession is over and the recovery has begun. Most of the recent economic data is confirming these opinions. The economy grew at an annual rate of 1.4 percent in the second quarter and new-home sales surged 7.9 percent in June. Layoffs have ceased and hiring has restarted. New public works have been announced as well as a surplus in the city's budget. Activity has increased on Wall Street for six consecutive quarters. Banks and securities firms are making money again by the bucketful, to judge by the half-year earnings they just have reported. Thrifts -- including those that the government is bailing out -- are in the black again, insurers are being upgraded by rating agencies and stock market analysts alike.

What is true for the overall economic appearance does not seem to realize in the real estate industry. It appears that the law of supply and demand does not apply anymore for an industry that -- only some years ago -- was responsible for an artificially fueled but continuing acceleration which helped to drive the economy with high employment and a generally healthy business climate. Although there is currently a tremendous supply of real estate assets for sale and an increasing amount of equity funds available, few transactions are recorded. With desire for transactions apparent on both sides, the current real estate market is rather disappointing to buyers and sellers and sometimes even lenders alike. Why is that so?

In the 1980's prices rose to unsustainable levels, propelled by the belief that real estate was one area where the laws of gravity did not apply. The decision to sell was easy since appreciation, inflation and the overflow of debt created market prices that exceeded original funding. The motivation to sell was strong because of the anticipated profits and the easy-to-realize liquidity of the asset.

The motivating force for sales today is primarily defensive. In today's market, when a real estate asset is to be sold, it suggests that the owner is desperate for cash. Balance sheet damage control, recovery of lost mortgage capital, covering (avoiding) personal guarantees or appeasing regulators are the names of one and the same game.

Also the buyer's concerns have changed since the days of access to easy-debt and 100 percent -and more-financing have been reversed. As the word 'appreciation' has become an exotic definition of what used to be circumscribed by 'residual value', and with debt unavailable, buyers have adopted a more conservative basis of valuation. Capitalization rates on existing cash-flow (or Net Operating Income) is the buyer's slogan for today's market, resulting in values far below the seller's essentials.

The shifts in seller motivation and buyer valuation methods are prevalent in today's environment and responsible for a real estate market that does not seem to clear.

Leaving aside the fact of a missing national real estate policy and the lack of fiscal incentives to encourage transactions in the actual environment, there are ways to structure transactions that benefit over-leveraged owners and lenders. Mega Invest International has been successfully involved in a number of these situations.

In cases where investors are under pressure from their lenders and market values are below the sellers obligations, our firm offers proven alternatives to impending foreclosures and bankruptcies. Mega Invest International intercedes to transactions, enabling both sides to "take a breather" and "reevaluate the situation" given the pending realities. This break in time by itself has enabled numerous resolutions to occur without protracted litigations and lengthy bankruptcies. Upon intervention, the following steps are taken:

1. Development of a systematic and regulatory acceptable "transaction book", detailing the essential economic and financial aspects of the property, the borrowing entities and the guarantors, if any.

We all know that the critical element to any successful transactions is a meeting of the minds. We have all heard stories of deals which seemed to be closing, yet at the last minute died. The reason most often stated is that the two sides never really understood the other one's position prior to that moment. In today's regulated and micro-managed real estate environment, both sides need to understand and see in writing what "has happened", what "is happening" and what "is expected to happen" before any transaction can be considered prepared for presentation to decision-making third parties and committees. This overview and direction of the project/entity is known as "Strategic Path Program", a logical, sequential and interrelated look at the past, present and expected future. This Strategic Path Program most of the time is prepared by our in-house team. On specific occasions when there is extreme work involved with large portfolios/entities, we work together with specialty firms such as Rye, New York-based Real Estate Evaluation Services, Inc.

2. After getting intimate with the essential economical and financial aspects of the property/portfolio via the Strategic Path Program, a primary plan is structured to introduce equity to deleverage the existent position. This corresponds in general with a conversion of at least part of the mature debt to equity-sometimes even combined with the commitment of additional funds-therethrough superseding the original borrower on the note.

3. A strong operating team is put together encompassing a representative of the owner/mortgagee, accountants, legal counsel, construction and architectural, and real estate marketing experts with solid local market knowledge and experience.

With respect to these circumstances a discussion with the lender pertaining to an extension of the loan and some flexibility in the interest rate will lead to the bank's inclination for restructuring.

4. Once this stage is achieved, and upon the approval of the Strategic Path Program, close monitoring and accountability is of paramount importance.

The objective of these negotiations is to supply the lender with cash today while establishing a workable loan structure with a conservative Loan to Value ratio, an adequate Debt Service Coverage and a Term that allows the project to survive and to generate enough income to compensate the outstanding mortgage balance.

The result is a |triple-win':

1. The lender avoids the costly foreclosure-resale process

2. The existing borrower, whose equity is already lost or reduced to some nominal value, receives a subordinated equity interest including participation in future increases and avoids the undesirable consequences of the foreclosure process

3. The buyer is capable to repay the entire principal and interest from the original loan and is able to consummate a transaction that meets its investment criteria

Today's corrective economy has resulted in a market full of workouts, foreclosures and REO divisions devastating institutions, investors and capital markets. In this environment where real estate is predominantly sold by institutions and the government, and inasmuch as sales prices are continuously dictated by balance sheet concerns and government regulators, the clearing of REO properties will require sellers to seriously begin to consider the highest obtainable offer, since it will be a long time before buyer valuation methods become less conservative.

However, in cases of over-leveraged properties, where lender pressure is the main issue and market values are below the seller's obligations, the end of the economical malaise resides in an acceptable approach for all parties via the |Strategic Path Program' resulting in a |triple win' eliminating otherwise frustrated buyers, sellers and lenders alike.

Wilhelm A. Rosenberg, President & CEO Mega Invest International, P.A.
COPYRIGHT 1992 Hagedorn Publication
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Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Rosenberg, Wilhelm A.
Publication:Real Estate Weekly
Date:Sep 30, 1992
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