May 25, 2022

Archives for October 2009

Depression In Commercial Real Estate Results In Bargains For Some

Depression Pricing As Empty Hotels Slash Rates

The recent era of easy lending was not confined to residential real estate.  Commercial real estate lending is the next big worry for a banking industry already beset by an avalanche of non performing loans.  The banking industry has $1.8 trillion dollars of commercial real estate loans and many analysts believe that banks have reserved for only a small fraction of current and future losses.  Recent examples of losses on commercial hotel loans  in major travel destinations such as Hawaii and Las Vegas indicate the severity of the problem.

Hawaii Hotel Industry Downturn Worse Than Great Depression

Hawaii Hotels Face Fewer Visitors – For the hotel industry in the continental U.S., this downturn is the worst since the Great Depression. But the Hawaiian resort industry is taking a beating that’s even more severe.

Meanwhile, revenue per available room has fallen nearly 25% in the past two years and now averages $150.75.

Major renovations of existing hotels are common in Hawaii because construction of new resorts has been limited since the 1980s because of steep land prices and local governments’ opposition to expansion. “So the name of the game is to buy, renovate and reposition,” says Joseph Toy, president and CEO of the hotel-consulting company Hospitality Advisors, based in Honolulu. Many of the resorts that changed hands in recent years were built by Japanese owners in the 1980s.

But practitioners of that pricey repositioning strategy now find themselves in a bind due to the recession, the capital crisis and Hawaii’s tourism downturn. “The operating numbers have cratered, the underlying fundamentals aren’t very good, and you have a whole bunch of problem loans,” says David Carey, president and chief executive of Outrigger Enterprises Group, which owns 30 Hawaiian hotels, none in foreclosure.

Las Vegas Hotel Worth 41% Of Construction Cost – Cheaper to Tear Down Than Finish

Doubts Are Cast On Value of Las Vegas’s  Fontainebleau – LAS VEGAS—The Fontainebleau the luxury hotel and casino development at the northern end of the Las Vegas Strip, sits more than half-finished after falling into bankruptcy in June.

But as potential suitors consider rescuing the project, they are facing a grim reality: It may not be worth the money it would cost to complete it. More than $2 billion has already been poured into construction.

“It is going to take $1.2 billion to $2 billion to finish Fontainebleau, and it’s not worth that much,” Penn National Gaming Chief Operating Officer Tim Wilmott said. Penn is currently negotiating to take it over from the project’s creditors.

When the 4,000-room Fontainebleau project was first mapped out four years ago, gambling revenues were soaring and Las Vegas barely had enough hotel rooms to accommodate a flood of visitors.

Now, Las Vegas has a surfeit of luxury rooms. Occupancy rates in August fell to 83% from 94.9% two years earlier, and room rates have fallen sharply.

An outside analysis contracted by some of the Fontainebleau lenders last spring found that Fontainebleau would be worth $1.76 billion if it were completed in May 2010, according to a court filing, far less than its $3 billion total cost.

Depression Pricing For Hotels

Overwhelming supply and weak demand have resulted in hotels slashing room rates to keep the cash flow going.  In many cases, the cost of lodging at major hotels and resorts has dropped as much as 50% from two years ago and vacancy rates still remain high.  For newer resorts that were built during the boom years, the picture is even bleaker, resulting in bargain rates that were previously unimaginable.  On a recent trip to Mexico in September, I had the occasion to visit the newly completed and mostly vacant multi billion dollar resort, La Amada Hotel, Playa Mujeres, Cancun.  The La Amada website describes the property, which opened in May 2009,  as follows:

La Amada Hotel is a 5-star luxury hotel. Here you’ll have a comfortable home base of contemporary luxury. Stylish hotel architecture and decor, generous suites, spotless service, deluxe facilities, and of course, our secluded beachfront setting, all enable you to let your days here happen naturally. Situated just 25 minutes from Cancun International Airport, Playa Mujeres is the newest luxury resort destination in greater Cancun.

This 922-acre (373 hectare) luxury development includes a boutique hotel, upscale residences, a golf, yacht, and beach club, and Cancun’s first marina situated on tranquil Playa Mujeres in the Mexican Caribbean. Envisioned as an exquisitely and carefully developed sustainable community, La Amada is a destination where culture, ecology, history and art are integrated in a stimulating style.

La Amada, located in the Marina section of the Playa Mujeres “master planned’ community, is a 552-unit project of one, two and three bedroom residences, a 110-room five star boutique hotel, and a top of the line spa. In addition, the developers have created a “marina village” with 150,000 square feet of commercial space for restaurants, bars, cafes and shops, creating an ambiance akin to top European resorts such as Puerto Banus and St Tropez. No expense was spared on this spectacular creation; residences can even fly in and land on the properties private helicopter pad.

La Amada is a spectacular luxury resort hotel.  Equally spectacular are the discounts  – luxury suites are being offered at $280 per night, marked down from $700.  Apparently, even at these discounted prices, income stressed consumers are saying no.  During three visits to the property, I saw only one couple on an otherwise deserted beach.  Finished units remain empty with no guests to be seen.   The planned bars, cafes and shops have not opened.   Virtually all of the 176 slips in the Marina remain empty.  La Amada was built during an era of easy money when it was assumed that prosperity, based on eternal asset appreciation, would never end.  There is little doubt that the investors in La Amada have created a truly fabulous resort – far less certain is whether or not they will ever see a return on their investment.

La Amada sign points to empty hotel

La Amada sign points to empty hotel

Deserted La Amada beach

Deserted La Amada beach

Beachfront La Amada

Beachfront La Amada

Empty boat slips at marina

Empty boat slips at marina

La Amada - where are the guests?

La Amada - where are the guests?

Discount prices fail to lure guests

Discount prices fail to lure guests

The Correlation Between Incomes And Default Rates

The Marginalization Of Risk

The massive number of loan defaults that has put the entire banking industry on the brink on insolvency did not happen by accident.   Banks recklessly extended credit, even to low income borrowers who obviously had the least ability to service their debts.   What may have seemed like a virtuous circle of increased consumer consumption and  higher banking profits has turned into a debt disaster for both borrower and lender – consider the Democratization of Credit.

WSJ -The recession has forced a financial reckoning for Americans across the income spectrum. The pressure is especially acute for the low-income Americans who relied on borrowing for daily expenses or to gain the trappings of middle-class life. Shifting credit practices over several decades had enabled them to live beyond their means by borrowing nearly as readily as the more affluent.

But the financial crisis and recession have reversed what some economists dubbed the “democratization of credit,” forcing a tough adjustment on both low-income families and the businesses that serve them.

“We saw an extension of credit to a much deeper socioeconomic level, and they got access to the same credit instruments as middle-class and mainstream Americans,”…

The financial crisis has forced lenders to be especially cautious with the riskiest borrowers, a category that low-income families often fall into because their debt tends to be higher relative to income and assets.

Some are turning to wherever they can for credit. A publicly traded pawnshop chain, EZCorp., reported a 37% rise in revenue in the second quarter. “With credit limited and other options disappearing, there are people looking for somewhere they can get emergency cash,” said David Crume, president of the National Pawnbrokers Association.

Cash-strapped workers have long obtained advances through “payday loans,” available at storefront lenders for fees that equate to high annual interest rates. Even that move is not so easy now.

“More customers are walking in the door, but turndowns are up,” said Steven Schlein, a spokesman for the payday-loan industry’s trade group, the Community Financial Services Association of America.

The Journal article also includes a chart showing that the combined delinquency and default rate for lower income groups dramatically exceeds that of higher income groups.  Are lower income groups inherently a poorer credit risk or did lenders create the conditions for default by recklessly granting credit in excess of a borrower’s ability to repay?

The Journal article perhaps should have more appropriately been titled “the marginalization of risk”.   Banks failed miserably in executing their basic mission – lending prudently based on a borrower’s ability to service the debt.   Regulators failed miserably by allowing banks to make inherently unsound loans.  Did the bankers really believe the income numbers supplied by borrowers who “stated” their income?  What were the regulators thinking when they allowed banks to lend money without considering a borrower’s income, such as with “no doc” loans?

The long term adverse economic consequences of reckless lending are now obvious – the bigger tragedy is that it was allowed to happen in the first place.

Japan’ Solution To Debt Crisis – Expand Zombie Banking

Japan’s Zombie Banking Taken To New Levels Of Lunacy

Japan’s real estate and stock market bubbles burst in the early 1990’s.   Since then, twenty years of non stop Government stimulus programs have failed and left Japan with the highest debt to GDP ratio in the world and two decades of lost economic growth.   The costly attempt to have failed banks prop up failed companies has lead to a massive misallocation of capital and resulted in Zombie Firms and Zombie Banks.

Banks were not forced to recognize the condition of their balance sheets and were encouraged to continue lending to firms that were themselves unprofitable. Anil Kashyap labels these “zombie firms.”

Zombie banks continued to direct capital to zombie firms. This charade continued for more than a decade, with the result that the once-powerful Japanese economy was completely stagnant for that period. The government’s main response was to dramatically increase spending on infrastructure and frantically try to get Japanese households to save less and consume more. The resulting “lost decade” of economic growth cost Japan more than 20% of GDP.

Japan has now decided to exponentially expand policies that have not worked for two decades by forcing banks to agree to debt moratoriums.

Oct. 6 (Bloomberg) — Japanese banks’ bad loans won’t be driven higher by a proposed moratorium on debt payments by struggling small companies, said Financial Services Minister Shizuka Kamei.

Lenders won’t have to classify loans encompassed by the plan as non-performing, Kamei, 72, said in an interview yesterday at his office in Tokyo. That means they won’t be forced to boost provisions when borrowers postpone repayments of interest or principal, he said. At the same time, Kamei vowed to push banks to extend more credit to small businesses after bankruptcies hit a six-year high in Japan.

“We’re going to get financial institutions to provide these firms with more loans,” said Kamei. “Banks won’t have to treat debt on which they provide a moratorium as bad.”

Japan’s three largest banks, including Mitsubishi UFJ Financial Group Inc., posted combined losses of almost $14 billion last fiscal year as bad-debt charges surged.

“There is a potential for any proposal along the lines Kamei has made of debt moratoriums to backfire horribly,” said David Threadgold, a Tokyo-based analyst at Fox-Pitt Kelton. The plan could make banks more reluctant to lend to small firms, Threadgold said.

The moratorium, postponing repayment of principal and interest, will be extended to individuals as well as firms Kamei said. It will aim at giving relief to companies with about 100 million yen ($1.1 million) or less in capital.

“As long as I’m financial services minister, I’m not going to leave small companies in the lurch unable to get loans,” Kamei said. “If a bank takes that approach, I’ll hit them with a business improvement order.”

Japanese “salarymen” struggling to pay mortgages after bonus cuts may be eligible, he said. “We’re going to make it extremely easy for very small companies to get money,” Kamei said.

Let summarize the lunacy of this new plan: debtors pretend they will pay later; the banks pretend that the defaulted loans will be repaid; banks will be forced by the government to lend more money to debtors who cannot repay what they already owe and the banks will not have to set aside loan loss reserves on the defaulted debt.  Japan’s debt moratorium is a final desperate attempt to “save the system” by preventing deeply indebted, income poor borrowers from defaulting on debts that can no longer be serviced.  It will move private bad debt onto the already over leveraged public balance sheet and will encourage debt repudiation on a massive scale.

When Debt Becomes Inconvenient

Debt that cannot be repaid won’t be repaid and the consequences of default are in many cases relatively minor compared to the burden of continued payments.   Japan now joins the U.S. in actively encouraging the repudiation of debt as discussed in How The Government Encourages Ruthless Defaulters and Loan Mods – Just A Warm Up For The Real Thing – A Mortgage Holiday.

Ironically, the biggest impediment to future bank lending is the growing trend of debt repudiation directly sponsored and encouraged by a government concurrently seeking to encourage more lending.

Consumers having trouble paying their debts can now chose from a long list of government programs for debt forgiveness, loan modifications, rate reductions, 125% loan to value mortgages and more programs on the way.  Their is no  longer any shame or embarrassment associated with defaults and bankruptcy.  Defaulting on debt has become a rational choice for many with little repercussions.

If the long shot odds of economic recovery and job growth do not materialize,  expect to see defaults worldwide increase exponentially as even those who can pay will chose not to.  Zombie banking is alive and well.