October 2012 – The Pathfinder Report

The Pathfinder Report
October 2012
In This Issue
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Charting the Course: Bernanke Made
Us Do It
Selected Pathfinder Closed Transactions
Finding Your Path: Unlocking the
Mysteries of CMBS
Guest Feature: The Magic of
Google Earth
Guest Feature: Why Institutional
Investors are Getting the Residential
Rental Investment Market Wrong
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Zeitgeist: News Highlights
Trailblazing: Tuscan Townhomes
Notables and Quotables
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WE’RE GROWING (NOW IN LARGER QUARTERS)!
Our new address:
4380 La Jolla Village Drive, Suite 250
San Diego, CA 92122
CHARTING THE COURSE
Bernanke Made Us Do It.
By Mitch Siegler, Senior Managing Director
We’re in escrow to buy a house. Don’t know if we’ll close on the deal
but the fact that we’re even considering purchasing a single-family home
(to live in) is a huge about-face.
You see, we sold our home in 2006, convinced that the pressure that had
built up in the residential real estate market in the first half of the decade
was leading to a bubble. And we wanted to be on the sidelines when it burst, which it did in
most markets the following year (Florida, Las Vegas, Phoenix and other mega-bubble
markets peaked in 2006).
We’ve been renting ever since. It’s been a good move, since the market hasn’t moved up
much during the past six years (to say the least). And, until very recently, it’s been cheaper to
rent than to own a house in San Diego at our price point.
The Fed has succeeded in changing investor psychology on risk
But, all that’s changed now. And there’s one guy to thank for the turnaround. Federal Reserve
Chairman and Currency Doctor Extraordinaire Ben Bernanke and his merry band of Fed
governors have changed Americans’ psychology about investing and risk. In 2008, when
Lehman Brothers failed and early 2009, when the equity markets were in a free-fall, nobody
wanted to take risk and gazillions flooded into “risk-free” assets, notably U.S. Treasury
securities. Today, with yields on treasuries virtually non-existent, the worm has turned and
those gazillions are returning to riskier assets – like stocks, high-yield bonds and – gasp –
residential real estate!
The Fed Chairman has been clear about this: he wants to improve consumer sentiment, create
wealth through housing and the stock market and generally use the consumer to prime the
economic pump. The flip side is he’s creating huge debt on the Fed’s balance sheet but we’ll
create inflation now and worry about controlling it down the road.
The big upshot of the Fed’s quantitative easing (read “money-printing”) programs – QE, QE2
and QE3 – is that Ben & Co. have pumped so much cashola into the economy that they’ve
succeeded in driving mortgage rates down to über-low levels. Today, 30-year fixed-rate
mortgages can be had for around 3.125%. If that’s too pricey for you, nab a 15-year, fixedrate mortgage for around 2.5%.
Mortgage rates have never been this low
In 1983, when we bought our first home, 30-year rates were around 13.5%. Rates hit doubledigit levels in October 1979 and trended into the teens in the early 1980s. They peaked at
18.5% in October 1981 before declining over the next few years. So, in the context of 18.5%
rates a couple of years earlier, 13.5% rates seemed like a veritable bargain basement rate for a
first-time homebuyer.
Mortgage rates didn’t return to single digits (and remain at that level) until December 1990,
when they hit 9.67%. By the late ‘90s, rates were in the 6s and 7s. When mortgage rates fell
into the 5s in 2003, people were refinancing like there was no tomorrow. Rates remained in
the 6s and 7s during the housing boom years and didn’t fall below 5.0% until March 2009 –
when the stock market hit its low of the Great Recession (and a 12-year low – 6,547 on the
DJIA and 676 on the S&P 500).
It took 20 months (until November 2011) for
rates to fall below 4.0% and another ten
months for them to hit 3.5%. Today, with the
Fed’s Red Bull® economic program –
Helicopter Ben and pals buying $40 billion
per month of mortgages for the foreseeable
future – we’re all enjoying the incredible
caffeine and sugar buzz but not really
thinking about the hangover when the
chemicals wear off.
We read, with interest, in late September, Goldman Sachs’ forecast that QE3 purchases will
exceed $2 trillion and the Federal Funds rate won’t be raised until 2016. In that context,
mortgages in the 3% range seem like a pretty sure thing as far as the eye can see.
While we’re not in the habit of blaming others for our actions, we’ll say it again: Bernanke
made us do it. Because unless something major changes on the mortgage interest tax
deduction or we’ve misread the tea leaves and mortgage rates skyrocket soon – causing
housing prices to swoon – it seems that the pendulum has shifted on housing and the “owners
become renters” phenomenon we’ve observed from 2009-2011 has reached its climax and
may now begin to reverse.
Sure, millions of Americans face foreclosure and tens of millions more have damaged credit,
have lost their down payment in the housing decline or are among those for whom home
ownership has lost its allure. But, we’re ringing the bell, repeating our January 2012 call that
the housing market had bottomed. And we’re advising our loyal readers who may be moving
off the housing sidelines to lock-in fixed rate debt – lest your rate run away from you when
(not if) inflation rears its ugly head in the nottoo-distant future.
We’ll say it once again for the hearingimpaired – don’t expect a big uptick in housing
prices anytime soon. And home prices could
still fall in those markets with extreme supply,
a large overhang of pending foreclosures or
shadow inventory and a lack of jobs or
employment drivers. But the bottom is in. And
we have Chairman Bernanke to thank for it.
Mitch Siegler is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding
Pathfinder in 2006, Mitch founded and served as CEO of several companies and was a partner with a
boutique investment banking and venture capital firm. He can be reached at
msiegler@pathfinderfunds.com.
FINDING YOUR PATH
Unlocking the Mysteries of CMBS
By Lorne Polger, Senior Managing Director
We’ve been at the distressed real estate business for over six years now.
Seems like just yesterday that we were building databases of lenders
with the greatest exposure to condominium loans.
Through the cycle, we’ve prided ourselves on being a little smarter than
the next guy, trying to stay on top of industry trends and regulatory
changes. The one thing that has always perplexed us, however, is the process of dealing
with distressed Collateralized Mortgage-Backed Securities (“CMBS”). Sure, we’ve all
heard about the gazillions of CMBS loans currently in default, and the huge numbers of
maturing loans coming due in the next few years, but the whole default scenario has been
pretty much a mystery. You talk to seven different people, you get seven different answers.
You talk to one person, you get three different answers. You try to talk to someone with
authority to make a decision….well, that’s a different topic.
Fortunately, we have recently been enlightened on this subject. I attended a double secret
conference this summer with virtually every CMBS special servicer in the U.S. (I was able
to sneak in, posing in my khakis and blue blazer as a special assets guy from U.S. National
Megabank of Sheboygan, Wisconsin). What a gold mine! I can’t believe my fortune in
finally, after six long years, finally unlocking the mysteries of CMBS. Now, this is a very
special column in that Pathfinder won’t be charging you for this incredibly valuable
information that will help you achieve wisdom, enlightenment, health, prosperity and
eternal happiness. But, before you read further, you have to promise that it’s our little
secret. Just between us. So without further ado, I present the mysteries of CMBS,
unlocked, from A to almost Z:
Appraisal Reduction: This is what happens when the
appraiser hired by the Special Servicer values your
property 25% below current market prices, requiring you to
reduce the staff in your office so that you can come up with
enough money to keep your loan in balance. See “Credit
Enhancement,” below.
A-Piece Bond-holder: The guy who gets all the money.
B-Piece Bond-holder: The guy who gets a tax write-off.
Balloon Risk: When your loan is coming due in the next year and the only thing that might
help you is prayer and divine intervention.
Cash Flow Note: When you sign a note modification and the servicer keeps all of your
cash. Forever.
Consultant: The former bank loan officer who is trying to save his own home from
foreclosure by pretending to understand how to fix your CMBS loan.
Controlling Party: Your spouse. Oh, sorry, wrong audience.
CMBS 2.0: A joke. Like, “Heh, did you hear Jay Leno’s monologue on The Tonight Show
yesterday? When he talked about guys on Wall Street making loans again?”
Credit Enhancement: When the special servicer tells you to unconditionally give them
your last $2,000,000 of available liquid assets in exchange for a 6-month extension (read
“life support”) on your underwater loan.
Dark Space: The part of the office building that you couldn’t lease to a group of teenage
video game programmers for free, even if you provided them with daily doses of Red Bull®
and Taco Bell®.
ERISA: Something so complicated that even after you pay tax lawyers $850 per hour to
explain it to you, it still doesn’t make any sense.
GPM or Graduated Payment Mortgage: A type of CMBS
loan where the increase in the interest rate is directly
proportional to the shrinking size of your balance sheet.
Haircut: When the Special Servicer agrees to take a $100,000
discount on the loan in exchange for your $2,000,000 cash
payment to them. See “Credit Enhancement,” above.
Impound Account: When you pay the Special Servicer all of your available remaining
cash flow, just in case something bad might happen sometime during the next seven years.
Loan Sale Advisor: The guy who tells you absolutely nothing about the CMBS loan
you’re trying to buy in the auction. That guy.
Mark-to-Market: The Federal
Fantasyland at Disneyland.
Government’s
version
of
Master Servicing Fee: A fee for telling borrowers they need to
speak with someone else.
Non Consolidation Opinion: A completely useless document that costs you $25,000 in
legal fees just because lender lawyers need a fifth set of belt and suspenders in case the first
four sets somehow fail.
Non-Performing Loan: When you unknowingly violate Section VIII, Subparagraph 6,
Romanette (vii) of the Loan Agreement by neglecting to inform the master servicer within
56 hours of switching insurance carriers.
Over-collateralization: When your property is worth so much more than the loan that the
lenders don’t watch you anymore. It has never happened, so don’t worry about it.
Priority of Distributions: The language in the Pooling and Servicing Agreement which
reads like a California style divorce for the “A” Piece: “What’s mine is mine and what’s his
is mine.” See “B Piece” above.
Qualified Institutional Buyer (QIB): The 11 hedge funds in Greenwich, Connecticut that
are the only ones able to buy pools of CMBS product.
Rating Agency: The gang that couldn’t shoot straight. See
“CMBS 2.0,” above.
Right to Cure: The theoretical right provided to both
borrowers and Middle East peace negotiators. Neither
happens, but it’s a nice gesture, right?
Special Servicer: The guy you hated in high school.
Special Servicing: Hell. Purgatory. The lost luggage department of the real estate world.
Stress Test: What you take at your cardiologist’s office after spending six weeks trying to
get a loan modification done.
Trending Toward Default: When you have absolutely no chance of rescuing this dog of a
property.
Up-Front Due Diligence: The $80,000 in third party reports that the CMBS originators
made you get that are now sitting in the basement of an office building in Dallas that no one
can seem to find.
Voluntary Prepayment:
Maintenance,” below.
What you do if you have money to burn.
See “Yield
Waterfall: What it feels like you’ve stood under for three hours after attempting to
negotiate a loan modification with your special servicer.
Workout Fee: The large fee that the special servicer gets for simply agreeing to the plan
that you authored, implemented and sweated over.
Yield Maintenance: A calculation performed in conjunction with an early loan payoff that
goes something like this: (Remaining principal balance/remaining months in loan term) x
(the GDP of California + the National Debt).
Feeling like the rules are made up as you go along? Me, too. Having attended dozens of
conferences and hundreds of meetings with bankers, special assets executives and special
servicers, I feel like I know less about the CMBS black box today than when I began. But
don’t worry about it, I’m sure you can find a consultant to help out.
Lorne Polger is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding
Pathfinder in 2006, Lorne was a partner with a leading San Diego law firm, where he headed the
Real Estate, Land Use and Environmental Law group. He can be reached at
lpolger@pathfinderfunds.com.
GUEST FEATURE
The Magic of Google Earth
By: Matt Quinn, Director
About 18 months ago, I received an email containing a broker’s listing
package with instructions to “Google Earth it and tell me what you find.”
I looked at the property from the street-view perspective – an empty
police car was parked in front of the complex and three teenagers
lingered next to a graffiti-covered wall. At the time of the last
presidential election, it would have taken several days to complete a preliminary assessment
of the deal. Now, we could reach the same conclusion in 30 seconds. (This property was
clearly a pass.)
Google Earth has changed the game for property investors working outside of their local
market. You can now immediately evaluate the building, cross-streets and sketchiness-level
of the surrounding neighborhood. You can see the
billboard behind the building and assess the makes,
models and conditions of the cars in the parking lot.
You can look at a marketing package for a new
townhome development and chuckle about how the
vacant land adjacent to the property has been cropped
out. In the case of one particularly high-profile
Google Earth street-view of a home in Detroit, you
can see the occupant standing on the porch pointing a
shotgun at you. Google Earth provides an uncensored
perspective by providing a stripped-down and
unstaged view of a property. With over a billion downloads to date, the program has quietly
become one of the most powerful research tools available in today’s marketplace.
Keyhole, Inc. – a Silicon Valley based software developer with financial backers that
include the CIA – created the initial version of the program, under the moniker
“Earthviewer 3-D”, in 2001. In its simplest form, Google Earth is a globe residing inside
your computer. This program uses a combination of satellite and ground level photos to
allow its user to zoom-in and view three-dimensional photos of a specific location from
bird’s eye and street-level views. The bird’s
eye photos come from a consortium of
international satellites and the street-level
photos are created by a network of roaming
Google cars, equipped with periscope
cameras constantly snapping photos. Google
Earth allows the user to view a freeze-frame
of a specific location and fly around the area
as if in a flying saucer.
It has been
particularly valuable to those in the real estate
industry by enabling the new generation of
investors to immediately evaluate properties
without paying a dime.
Tony O’Neill, Pathfinder’s director of acquisitions, explains how Google Earth changed the
way he analyzes new deals. “It’s literally the first thing I pull up when I get a package or
phone call about a deal. It allows me to walk a neighborhood from my desk.” Allowing the
user to virtually “walk” the area surrounding the subject property is perhaps Google Earth’s
most powerful research tool. “I can identify nearby businesses, services, community features
and see neighborhood attractions and deficits. It’s also incredibly helpful for comparing
subject properties to comps, again being able to see them from a proximity and street-view
standpoint,” Tony adds.
Beyond just exploring the neighborhood, the
program allows an investor to size-up their
competition in the surrounding marketplace.
When researching a potential retail
investment, the user can view the area from a
bird’s eye perspective to see what other
businesses already exist. Almost all large
companies are “pinned” on Google Earth,
meaning you can see the names and locations
of the business when looking at a satellite
image of a particular area. Tony adds, “If I’m
researching a big-box retail project with
significant vacancy, I can search the
surrounding area to see what competition exists and what consumer needs may be
unsatisfied. For example, if there isn’t a drug store within five miles of the site I know there
may be an opportunity to potentially fill the spot with a Walgreens or a RiteAid.” The
program can also be used to assess the potential environmental pitfalls of a new investment.
If there is a dry cleaner or gas station within 100ʹ of a potential acquisition you know your
lender is going to require environmental testing. If the dry cleaner is ten feet away, you
know that redevelopment could be difficult.
It’s not just commercial investors who are using
Google Earth to research new investments; retail
buyers are also using the program to quickly
assess the neighborhood of their next singlefamily home or vacation property. The images
produced by Google Earth will often allow a
prospective buyer to see a property in a not-soappealing light. While the MLS listing or broker
flyer will show the home at its very best (i.e. it’s
always sunny, the lawns are perfectly manicured,
and in an amazing neighborhood), the Google
Earth bird’s eye view will show the junk-filled
backyard of the hoarder next door. In the case of
homes or condominiums in urban areas it will
often show who hangs out in front of your
building. In a Google Earth image of an apartment in Brooklyn, New York, the street-level
view showed four wanted gang members congregating on the corner. The image was later
used as evidence to bust their heroin ring. These stories are not anecdotal – if you do a
quick Google Earth search of any seemingly underpriced MLS listing, you will find that the
property is inevitably located on a major street, in a seedy part of town or next to a
dilapidated structure.
Real estate brokers, both commercial and retail, can no longer rely on using the marketing
package to get the buyer in the door and then using their salesmanship to close the deal.
Today’s buyer can visit the property from his computer and then decide whether it is worth
his time and money to actually visit the property. Brokers beware: although you may have
painted over the graffiti, you can’t hide your property from Google Earth.
Matt Quinn is Director of Pathfinder Partners, LLC. He is actively involved with the firm’s
asset management and plays a key role in overseeing the management of a number of
portfolio investments. He can be reached at mquinn@pathfinderfunds.com.
GUEST FEATURE
Why Institutional Investors are Getting the Residential
Rental Investment Wrong
By: James Paine, Partner, Realty West Advisors, LLC
[Editor’s Note: Pathfinder has been acquiring single-family
homes for rental for the past few years. Recently, the supply of
such homes has become increasingly scarce yet several large
investment groups – among them Goldman Sachs, Morgan
Stanley and Colony Capital – have raised billions of fresh capital to exploit the
opportunity. We’ve scratched our heads wondering where they’re going to find the
buying opportunities if we – and other groups we know who have been at it for a while –
are finding it challenging to do so. We’re indebted to James Paine of West Real Estate
Advisors for this great perspective.]
Over the last few months, the press has
started picking up on an emerging asset
class that pensions, endowments, private
equity funds and family offices have been
diving into. The residential single-family
buy, hold, and rent strategy. Pension funds
love this investment because it offers strong
cash-flow to help meet their current
obligations. Private equity funds like it
because it’s easy to sell to their clients.
Currently, they are looking at turning this
investment into a REIT structure (so they can charge more fees), and the new managers
and operators involved in residential real estate are newer to the game and are easier to
bully on fees. Endowments and family offices see a lower risk, easy to understand
investment in an undervalued segment of the market.
Here’s what the investment looks like in a nutshell: A capital provider commits funds to
a local or regional operator, typically $5 to $10 million as a first draw on a larger
commitment of $25 to $50 million. The operator is given certain investment criteria, with
the most important being net cash-flow yield. When operators first started out, the goal
was to buy properties producing 8%-9% unlevered yields. Now, most of the larger
operators are down to 6% yields. While a 6% yield isn’t terrible, they are primarily
banking on the housing market correction and anticipated appreciation of 20%-30% over
the next five years, resulting in low double-digit returns. Sprinkle in a little debt at an
attractive rate and you’re in the mid-high teens on a hard, uncorrelated investment.
It’s rather vanilla (traders stopped reading this article after skimming the title) and
investors will probably make close to those returns on a project basis. So what’s my beef
with how these institutional investors are going about making this investment? In the
words of a famous comedian, “how much time ya got, buddy?” However, for today, I
will focus on the #1 mistake they are making – focusing only on cash-flow.
Currently, there is a huge disparity between prices paid for traditional real estate versus
prices paid for distressed real estate. Investors should really look at cash-flow on the
same level as built-in equity. If you run a very simple model over a five-year timeframe
on an investment purchased at a retail price (which is what a lot of operators are paying)
and an investment purchased at a 25% discount to market (what operators should be
paying), this is what you’ll see:
Retail Buy at Trustee Sale
(How it's done now)
Retail Value
$100,000
$100,000
0%
25%
100,000
75,000
Discount
Purchase Price
(i)
Yield
5 Years of Rent
Wholesale Buy
(How it should be done)
9%
(ii)
6%
45,000
22,500
0
25,000
45,000
47,500
9%
12.6%
Appreciation of 20% over 5 years
20,000
20,000
Profit From Rent
45,000
22,500
0
25,000
20,000
20,000
$65,000
$67,500
Total Int. Rate of Return
13%
18%
Total Project 5 Year Return
65%
90%
Resale Profit
Total Deal Profit
Int. Rate of Return Before Appreciation
Now add Appreciation
Discount Profit
Appreciation Profit
Total Profit
i) We are giving them a generous yield for this example.
ii) You do have to give up some yield to get the discount on retail so we will say it's a 3% decrease.
This model is just an example. Every operator and fund will tell you they are getting a
discount. The truth is that they probably are getting some kind of a discount but are
passing on opportunities with far greater discounts that would be available if they placed
more emphasis on those particular deals. Furthermore, the greater discounts can be
achieved without losing 3% of your net yield. I believe that over a five-year timeframe,
investors are losing 20% or more in return by focusing
on high cash-flow only, rather than high cash-flow with
discounts.
Overall, I think buying single-family homes for rental in
good markets is a “can’t miss” investment. However, as
with any investment, there is going to be a herd of
people doing it one way and making average returns and
just a few looking at it a different way and making great
returns.
James Paine is a partner at West Realty Advisors, LLC, a company focused on
residential housing investment. He has been focused on investing in and operating
lower-middle market real estate since 2005. James can be reached at
james@westrealtyadvisors.com.
ZEITGEIST - SIGN OF THE TIMES
A compendium of notable news articles relating to the economy, commercial lending
and real estate which we’ve edited and commented upon.
Households continue to de-lever
Four research economists from the Federal Reserve Bank of New York have reviewed the
recently issued second quarter, 2012 Quarterly Report on Household Debt and Credit.
They report that there’s a continuation of the trend by households to reduce their debt,
following a long period of substantial increases. Over-leveraged consumer households’
deleveraging is a natural part of the recovery process.
Housing: A bright spot
Much recent sunny economic news relates to the housing
sector. Within the past couple of weeks, we’ve learned
that September home-builder sentiment rose to its highest
level since June 2006. August housing starts climbed
2.3% while construction of single-family houses climbed
5.5%, the fastest pace since August 2010. The housing
industry continues to be driven by pent-up demand,
super-low interest rates and attractively priced homes.
Overlaid on the stronger demand is reduced supply – the perfect storm to move a market
higher. Inventories of pre-existing (not new) homes are at eight-year lows. New-home
inventories are lower than they’ve been in a half a century. In many markets, there are
25% to 33% fewer homes for sale than this time last year.
[Editor’s Note: The housing market remains far from normal. Hitting a bottom isn’t the
same as a full-blown recovery – which still looks to be a ways off. The huge supply
overhang of existing homes (including those in the foreclosure/pre-foreclosure pipeline) is
sure to keep pressure on prices for some time.]
And home-builder stocks are benefiting
Trulia, the online real estate listing company, launched its initial public offering in late
September and saw shares surge 35% the first day. Homebuilder Lennar Corp.’s stock is
hovering around $35/share, nearly 200% above its 52-week low. Ditto KB Home, at about
$14.50/share, up from around $5.00 within the past year.
Arizona housing market on fire
As the “Zonies” return from southern California to their homes in Phoenix, there are new
signs that the Arizona economy continues to improve.
A report by the Arizona legislature’s budget staff shows sales taxes paid to the state in July
were 4.9% greater than in the same period in 2011. Furthermore, the report by the Arizona
Joint Legislative Budget Committee shows a 6.8% year-over-year increase in retail sales.
That’s a big change from the 2.5% decrease between June 2011 and June 2012.
Also, the price of the average
Arizona home rose more than
anywhere else in the country in the
past 12 months. New data released
in late August by the Federal
Housing Finance Agency show a
year-over-year increase in sales
prices of 12.9% versus just 3.0% for
the nation as a whole. On top of that,
prices in the last quarter are up an
additional 6%.
More on the Phoenix Housing Market – You Heard it Here First
We attended a real estate conference in late August in Phoenix. (The 112° temperatures
weren’t the main draw – we were there for the real estate intel.) A few tidbits:

Phoenix monthly sales per new home subdivision were running at a pace of
1.5/month in 2011 and 2.0/month in February 2012. Today, they’re a sizzling 4.05.0/month!

Homebuilder Lennar has been restricting sales at just 2-3 homes per month for its
Phoenix communities to conserve its limited lot supply.

Traffic at new home communities is also up – from 9 units per week in late 2010,
10-11 in 2011 and is now running 15-16/week.

Phoenix foreclosures were 56,000 in 2009, 55,000 in 2010 and 50,000 in 2011.
They’re projected to fall to about 29,000 in 2012.

Builders are substantially raising prices in even the hardest hit areas. Prices at new
home Phoenix-area communities are up more than 10% in just the past two months
(up 11% in Gilbert and 10% in beautiful, south Buckeye).

Excluding sold homes that are pending, there is just a 1.6 month supply of homes
in the Phoenix Multiple Listing Service. In many subdivisions, there are literally no
homes for sale.

There were 1,200 active new home subdivisions in 2008. Today, there are just 450
with two-thirds of these expected to be completely sold out within 12 months.

In January, 2011, 69% of homes sold were foreclosures/short sales. In July, 2012,
the level had fallen to 45%. The decline in distressed homes has a dramatic impact
on pricing – median sold home price was $95,000 in the fourth quarter of 2011 and
$154,000 in the third quarter of 2012.
TRAILBLAZING: TUSCAN TOWNHOMES, RIVERSIDE, CA
Navigating a complicated loan assumption on a new, luxury townhome community
Initially, the proposed deal structure for the acquisition of Tuscan Townhomes – a fullyoccupied, luxury multi-family community located in one of California’s fastest growing
metropolitan areas – appeared straightforward and appealing. The existing loan was low
interest, high loan-to-value, non-recourse and assumable. Due to the time of obtaining
financing after closing, this type of structure is attractive to private equity groups like
Pathfinder. Additionally, the property was appealing because of (i) the stabilizing
Riverside housing market, (ii) the acquisition price, below replacement cost, (iii) potential
upside down the road from a possible sale of townhomes and (iv) strong local rental
demand. Because the seller was highly motivated and the lender was a sophisticated
government-sponsored entity, we assumed the acquisition process would go smoothly.
We were so wrong.
The problems began when the loan was collateralized and sold. As a CMBS
(collateralized mortgage-backed security) instrument, the loan now had two servicers.
The first was an international bank who handled the day-to-day operations of the loan and
the second, a “special” servicer, put in place to protect the interests of the bond holder.
We started the assumption process by working with the first servicer and submitting an
absurdly complicated loan package. After several weeks and input from every member of
our team, we completed the package and sent it off to the servicer. Since we had satisfied
all the requirements and this isn’t our first rodeo when it comes to getting loans, we
assumed approval was imminent and we would be receiving word well within our 60-day
loan contingency period.
Nearly 60 days later, we received an email that we had been rejected. Apparently, the
second servicer was much more stringent in their lending guidelines and they didn’t feel
Pathfinder was strong enough to assume the loan (this seemed counterintuitive
considering our track record and the non-recourse nature of the loan). Upon reflection,
the denial made complete sense. The second servicer was put in place after the original
lender’s approval of the first borrower; by approving another borrower they would be
making themselves liable in the event of a default. The second servicer’s compromise
was that they would approve the assumption if we held liquid assets equal to three times
the loan amount throughout the life of the loan.
That made zero sense so we went back to the original lender to plead our case. To
complicate things further, the original lender decided to hire a consultant to help things
proceed smoothly. The consultant was able to renegotiate with the special servicer
(alcohol may have been involved) and got the deal approved under reasonable terms.
After several months, headaches and lawyers, Pathfinder was able to close the deal. Now,
we’re hard at work managing the property.
NOTABLES AND QUOTABLES: ON “POLITICS AND ELECTIONS”
"The best argument against democracy is a five-minute conversation with the average voter."
-
Winston Churchill
"Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and
applying the wrong remedies."
-
Groucho Marx
"One of the penalties for refusing to participate in politics is that you end up being governed
by your inferiors."
-
Plato
“Observe, my son, with what little wisdom the world is governed.”
-
Baron Gabriel Gustaffson von Oxenstierna, 17th century Swedish statesman
"Politics is supposed to be the second-oldest profession. I have come to realize that it bears a
very close resemblance to the first."
-
Ronald Reagan
"That government is best which governs the least, because its people discipline themselves."
-
Thomas Jefferson
"In a time of universal deceit – telling the truth is a revolutionary act."
-
George Orwell
“A politician thinks of the next election. A statesman, of the next generation.”
-
James Freeman Clarke, 19th century American clergyman
Important Disclosures
Copyright 2012, Pathfinder Partners, LLC ("Pathfinder"). All rights reserved. This report is prepared
for the use of Pathfinder's clients and business partners and subscribers to this report and may not be
redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without our
written consent.
Materials prepared by Pathfinder research personnel are based on public information. The
information herein was obtained from various sources. Pathfinder does not guarantee the accuracy of
the information.
All opinions, projections and estimates constitute the judgment of the authors as of the date of the
report and are subject to change without notice.
Nothing in this report or its contents constitutes investment advice. Neither Pathfinder nor any of its
directors, officers, employees or consultants accepts any liability whatsoever for any direct, indirect
or consequential damages or losses arising from any use of this report or its contents.
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