Tom Barrack, one of private equity real estate’s most senior executives, is concerned that social distancing and related shelter-in-place measures will lead to the collapse of the commercial mortgage market, which will in turn trigger a financial crisis.
In a blog post published on his personal Medium page, the boss of Los Angeles-based manager Colony Capital urged lenders to work with borrowers to avoid this worst-case scenario. Barrack said the current halt on commerce would lead to an economic fallout worse than the Great Depression of the 1930s.
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To mitigate the effects, he called for the roll-out of “a menu of comprehensive financial subsidies, regulatory reliefs, forbearances, liquidity support and monetary time outs for the monetary obligations” for those impacted by the shutdown.
Several of these suggestions are aimed squarely at the commercial mortgage industry. In his post, he advocated easing the loan qualifications for troubled debt restructuring measures and for regulators to peel back liquidity requirements so banks can tap into reserves. He also urged the Securities and Exchange Commission to temporarily curtail certain accounting standards.
The ongoing disruption, in his view, is likely to hamper the real estate whole loan origination and commercial mortgage-backed securities markets. If banks holding those loans impose margin calls on issuers or move to foreclose upon delinquent landlords, the ripple effects could be devastating, he cautioned.
“If these institutions are not permitted to maintain the flexibility and patience needed to undertake the loan restructuring efforts that will be critical to weathering the covid-19 crisis, loan repayment demands are likely to escalate on a systemic level, triggering a domino effect of borrower defaults that will swiftly and severely impact the broad range of stakeholders in the entire real estate market, including property and home owners, landlords, developers, hotel operators and their respective tenants and employees,” he wrote.
During the past two weeks, real estate lending has come to a halt, market sources have told PERE, as buyers reassess their strategies and capital sources and lenders adjust their underwritings.
Widespread delinquencies are expected to surface as soon as April, with many landlords being unable to service their debts due to their tenants failing to pay rent. One market source told PERE that even borrowers with cash reserves will elect not to pay debts, either because they know they would be forced to default in the near future or because they anticipate some sort of government intervention. “Nobody is paying their debt services and it just trickles down,” he said. “This is affecting everyone.”
Vik Uppal, chief executive of Terra Capital Partners, a New York-based lender, said his conversations with borrowers have been more constructive, with only some reporting tenants that would not be able to pay rent. Beyond the more drastically impacted property types, such as hotels and shopping centers, Uppal told PERE it is too soon to make broad assessments of the market: “It’s only been three or four weeks but the amount of distress the pandemic has caused around the world has made it feel much longer. For the most part, other than hospitality or retail, it’s too early to say what the effects are going to be. We should have a better understanding over the next four to six weeks.”
In his post, Barrack wrote about the dangers of banks imposing margin calls on mortgage REITs and debt funds that have financed mortgages through repurchase agreements. As collateral asset values fall, lenders can force their borrowers to make immediate equity payments to keep loan-to-value ratios in check. However, as Barrack argued, doing this at a time when liquidity is already limited will put undue strain on the system. He urged the SEC to put a hold on this and other mark-to-market requirements.
Barry Sternlicht, chairman of Starwood Capital, also called for a hold on mark-to-market in an interview with CNBC this week. “There are distressed marks everywhere, people are trying to scramble to come up with liquidity, and those are not real marks,” he said. “We saw this in ’07 and ’08. These are marks that are being forced by institutions that have to mark to market and have to call their loans or try to get cash from people who have cash to pay down the loans, so you have this cascading effect.”
The market is already seeing this scenario play out. AG Mortgage Investment Trust filed a lawsuit Wednesday seeking an injunction to stop the Royal Bank of Canada from auctioning off an $11 million CMBS portfolio. The New York-based mortgage REIT failed to meet a margin call this week, triggering the liquidation event.
David Stern, president of the New York-based real estate lending consultant Townhouse Partners, told PERE decisions about mark-to-market valuations and borrower delinquencies are on hold for lenders as they wait for the dust to settle. Many will wait to see the effects of the Coronavirus Aid, Relief and Economic Security Act making its way through Congress.
Another principal with a real estate debt firm, who asked for anonymity to discuss market activity, told PERE that banks and other lenders will also have to eventually weigh the danger of holding onto devalued assets against the reputational risk of moving against borrowers impacted by a market-wide dislocation outside their control.
“This is more akin to a wartime effort where everyone is expected to chip in and take equal parts pain,” he said.