Before the August credit crunch hit, legendary investor Sam Zell remarked of prevailing free and easy lending practices to the Associated Press: “The idea that this excess is some kind of a giant contagion that’s going to destroy the economy is preposterous.”
And yet, the extent to which subprime housing would affect the debt markets in 2007 was underestimated by many. Billions of dollars of toxic asset-backed securities still sat on balance sheets of lenders by the end of the year, some four months after the initial credit crunch.
Worse, there were few signs the backlog of un-syndicated debt would be clearing any time soon. Heads rolled at the highest levels of corporate America where exposure to US subprime was worst.
Charles (Chuck) Prince and Stan O’Neal, chairmen and chief executives of Citi bank and Merrill Lynch respectively, resigned in the wake of massive falls in third quarter profits. In Citi’s case, profits collapsed 57 percent thanks to a $5.9 billion write-down on holdings in structured credit vehicles.
The effect on large real estate deals was equally pronounced: they stopped happening. In the case of deals previously agreed, they caused the banks a real headache. In the case of The Blackstone Group’s $26 billion acquisition of Hilton Hotels Corporation, the debt was stubbornly sticking with lenders.
Goldman Sachs’ Whitehall funds had to restructure its $2.2 billion acquisition of Equity Inns. The plan was to acquire America’s third largest hotel company with $940 million of debt from the usual lenders, but instead the Wall Street firm reportedly turned to other sources for a near $1 billion loan. Walking away from the deal to buy Equity Inns would have come with an unpalatable break fee.
Europe did not escape the turmoil. Lehman Brothers re-priced its syndication of a €1.5 billion portfolio in August. Large deals such as London-listed Delek Global Real Estate’s €2 billion ($2.9 billion) acquisition of a package of properties owned by Switzerland’s Jelmoli Holding AG was scrapped after Jelmoli refused to entertain a downwardly revised price offer.
The mood on the subject was summed up by participants at the October property fest, Expo Real in Munich. Chris Jolly, managing director of corporate finance at Jones Lang LaSalle, said: “Banks, whoever they may be, are going to be lending less money at higher cost; the IRRs are going to come down. That has to lead to at least a reassessment by asset allocators. All that adds up to a hiatus until we get into the new year.”
Private equity real estate deal people are already feeling nostalgic for the free and easy debt days leading up to August 2007. It is unlikely that this vanished environment will be recreated any time soon.