Why Trump Can Get a Break and You Can't
Just like homeowners, owners of commercial real estate like office and apartment buildings have been walking away from their mortgages. Dow Jones reveals the latest bombshell: Vornado Realty Trust, one of the biggest real estate investment trusts in the nation, has announced it's planning to stop making payments on two loans worth $235 million. And as you've probably also heard, such "strategic defaults" are understood to be a fair part of the commercial real estate business – when you've got a bad hand, you fold.
But what you probably don't know is that commercial real estate owners who are too deep in debt have options to avoid foreclosure that homeowners don't, thanks to federal banking regulations introduced late last year. As a result, relatively few commercial real estate developers have had to resort to walking away from their mortgages. Note how the Dow Jones piece is supposed to be about the walkaway trend, but then immediately quotes commercial real estate investment advisor Rob Little saying: "Frankly, I am surprised that we have not seen a lot more" strategic defaults. After all, countless offices, hotels, rental buildings and shopping malls have income far smaller than their debts.
Well, no one should be surprised -- least of all federal banking regulators. Late last year, the FDIC and Treasury handed a lifeline to commercial real estate owners and investors and the lenders who finance them. Borrowers whose income from their real estate fell short of their debt payments are now allowed to downsize their debts to the size of their actual income, assuming the lender is willing to agree to it, and extend the duration of the loan. Like a cancer, the lender cuts out the "bad" part of the debt to avoid the worst-case-scenario of foreclosure, and takes a writeoff on its ledger. Lenders have reportedly flocked to the opportunity, understanding that they'd be much better off taking a haircut than getting wiped out and stuck with a white elephant shopping mall or hotel. At the end of this month, the FDIC will come out with 1st Quarter 2010 stats on lender "charge-offs," and we'll get some sense of how big a hit lenders have been willing to take to keep their loans performing.
Now, banking regulators really didn't have a choice but to take this drastic action. Commercial mortgages generally run for terms of just a few years, and when the terms expire the borrowers must refinance. But if a property is worth less than the mortgage on it, a refinance is only possible with a big infusion of new cash. Even in cases where a property is not underwater, commercial credit has all but dried up, so refinancing is not readily available. Last year, Deutsche Bank commercial credit analyst Richard Parkus calculated $2 trillion in commercial debt was set to expire by 2012, almost all of it underwater and therefore likely ineligible for refinance. For lenders, and the FDIC that insures their deposits, that would have been an apocalypse.
But think about the unjust double standard that has resulted. Commercial real estate investors, who entered the game for the money, are now able to get mortgage principal reductions in the tens of millions of dollars because lenders have a clear way to take the writedowns, with the endorsement of federal regulators. Meanwhile, consumers and their advocates have been pleading to no avail with government banking regulators and Congress to encourage reductions of mortgage principal owed by borrowers. Indeed, loan modifications that include principal reductions are much less likely to go into foreclosure than those that simply reduce interest rates.
But the Obama administration has backed off pressing for principal reductions for homeowners. (Remember the proposal that bankruptcy courts could force "cramdowns"?) Because most home mortgages last for 30 years, not five or so, there's no looming calamity so huge that it could collapse the banking system, so regulators aren't forced to take action. Au contraire, if homeowners were offered principal writedowns, they'd probably take them in droves, pulling down all their neighbors' home prices and leading to huge losses for lenders and investors.
So if you're wondering why you can't get a principal reduction, when real estate moguls can: it's for the national good. But there are ways to offer some homeowners principal reductions without bringing the whole house of cards crashing down.