Clarity On Recent Events Sought by CRE

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WASHINGTON, DC-Another day, another government action to stave off an economic catastrophe. The commercial real estate industry, perhaps shell shocked at the rapidity of events over the last few weeks, is pondering what Friday’s $700 billion rescue plan will mean for the business, both now and in the far term.

Indeed, the ramifications are already becoming clear with Goldman Sachs and Morgan Stanley’s conclusion, apparently reached this weekend, that there is no future in investment banking anymore. With the Federal Reserve Bank’s approval of their bid to become bank holding companies, Wall Street as it is currently structured at least, is no more.

What it will look like in the future is anyone’s guess at the moment–hardly a comfort to developers and CRE borrowers that still need the Street’s liquidity to continue to survive, if not thrive. One unforeseen consequence of investment banks shifting to depository models is that deposits could begin to color approval–or not–of applications for loans, Laurie Grasso, a Herrick, Feinstein transactional real estate partner who specializes in finance and development, tells GlobeSt.com. “The banks depend on deposits as a revenue-stream and as stability for funding–viewing them as an essential part of their business–while developers aren’t focused on deposits and want simply to borrow and develop.”

Developers want to keep things relatively simple on the banking side and consolidate their deposits and tenants’ security deposits with one or two ‘relationship’ commercial banks, she explains. “So a developer may look to borrow from a variety of banks for a variety of development projects, but they don’t want to split their deposits among all those banks because it’s inefficient. I have seen banks turn away commercial borrowers for failing or refusing to deposit funds with them, and I could envision an increase in that scenario.”

On a more macro-level, Grasso observes that the world of commercial banking is highly regulated, and the former investment banks that were lending in their own unregulated universe will now find the new regulations cumbersome and difficult to navigate. In the end, she speculates, they will conclude that such regulations will significantly lower their profits. “Among the issues they’ll be looking at are fair-value accounting standards and the issue of posting large reserves for bad loans.”

Inherent in this changeover is a yin and yang of constraint due to regulation and strength based on deposits as a stable source of capital, Scott Singer, executive vice president of Singer & Bassuk Organization, tells GlobeSt.com. “Which direction the pendulum swings remains to be seen and understood. Will the entrepreneurial spirit of the investment banks find a way to continue to thrive? Or will it be quashed by more stringent regulation?”

Because we don’t know, each company’s appetite for commercial real estate finance is an unanswered question, he continues. “The influx of deposits would be a positive force for stabilizing the situation at any financial institution. Combining the tremendous amount of brain-power at those institutions with the financial core of a depository institution will hopefully create a platform that is advantageous for the real estate market.”

Underlying these hopeful prognostications is the question of whether Lehman Bros., Bear Sterns, Fannie Mae, Freddie Mac, AIG, Merrill Lynch and now Morgan Stanly and Goldman Sachs represent the worst the market will deliver. There is no guarantee of that, Lawrence Selevan, principal with the New York City-based merchant investment bank firm Chesterfield Faring, tells GlobeSt.com.

“No one is talking about the huge amount of derivatives that are out there. The reason is that no one knows what the actual losses might be, so it is impossible to estimate what the final bill could wind up being.”

Barring the worst-case scenario–say, some tens or even hundreds of trillion of dollars worth of derivatives that are hiding more bad loans–Selevan believes that that current tract on which the government is heading will ultimately usher in a more liquid environment for developers. “A lot of steps have to be taken besides what was announced on Friday, of course. For securitization to begin again there needs to be some kind of clearinghouse mechanism which provides transparency to the participants.” The current methodology of relying on rating agencies, obviously, did not work, he dryly observes.

About the only certainty is that Wall Street’s ongoing implosion is going to impact occupancy rates and building valuations in financial center cities, starting with, of course, New York City.

The federal bail out does not preclude an exodus by these firms, Yevgeniy Gutsalo, principal with Corporate Suites Business Centers, tells GlobeSt.com. It is still expected that these and other financial firms will vacate millions of sf of office space in Manhattan.”

The good news, he continues, is that the demand for sub-leases and smaller spaces will remain stable as companies downsize, or are forced to move as larger spaces are vacated. “Many companies now on the market are also looking for shorter commitment, and more services included in the lease such as pre-built offices and more months free.However, there will be a great decision lag as businesses stay put, meaning the demand may remain stable but actual lease signing may not reflect it.”