Wayne Falbey

The New Landscape in Lending 
By Wayne Falbey
Receiverships: The New Sheriff In Town
April 2011
Wikipedia, the online encyclopedia, currently defines receiverships as follows:
“In law, receivership is the situation in which an institution or enterprise is being held by a receiver, a person "placed in the custodial responsibility for the property of others, including tangible and intangible assets and rights. Various types of receiver appointments exist: A receiver appointed by a (government) regulator pursuant to a statute; A privately-appointed receiver; and a court-appointed receiver.”
Because of the recent financial meltdown, many loan portfolios, investment portfolios, and development entities and projects contain or are troubled assets. The classic method for dealing with these has been, and remains, the appointment of a receiver.
Formally speaking, the receiver’s principal duties include:
 Recover and take possession of the books
 Records and assets
 Complete a physical and accounting review of the assets
 Establish/adhere to a budget
 Stabilize the assets
 Establish the fair market value of the assets
 Preserve, conserve and protect assets
 Operate and maintain property
 Pay bills
 Avoid/settle liens and claims
 Complete the development process if so directed
 Otherwise control, oversee, supervise and direct all administrative, personnel, financial, accounting, contractual, legal, and other operational functions involving the assets
In simpler terms, the receiver’s duty is to mitigate as quickly and as completely as possible the lender’s, investor’s, or business owner’s (individuals and shareholders) financial bleeding.
This is a two-step process. First, the receiver must analyze the situation, mitigate costs and determine the intrinsic issues. The receiver also has to value the asset. Real estate valuations generally are thought to be the province of appraisers. But, at the risk of seeming a wag, didn’t the appraisal community contribute substantially to the over-valuing of real estate that led to the meltdown? Also, don’t appraisers generally use recent comparable sales as a method for determining a property’s value? If so, the danger is that recent sales in many cases have been of a distressed nature – short sales, foreclosures, bankruptcies, etc
The second step is to recommend the optimal course of
action designed to cut the bleeding and stop the burn. In a nutshell, the receiver is operating the business, which, for our purposes, is a real estate development company or project. So why is it that receivers so often are drawn from the disciplines of accounting or lending?
It is eminently more reasonable to engage as a receiver someone from the development community. Who knows more about the issues – large and small – involved in the day-to-day operation of a development project or company than an experienced developer? Who is better qualified to:
Determine actual value, restructure the operation for optimal cash flow, restructure capitalization, reposition the asset for added value, and dispose of the asset on optimal terms? I’m not suggesting it be the same developer who was involved in creating this troubled asset, although that does sometimes happen. No, I’m talking about the new sheriff in town; the experienced developer who has a track record of successful completion of projects stretching back over past recessionary cycles in the economy. These individuals exist and have experience in successfully cleaning up troubled projects for lenders, investors, and development entities, adding value and recouping capital.
DENSITY: The Elephant In The Middle Of The Room
January 2011

Other than a few metropolitan areas, such as Washington, D.C. or New York City, where unemployment doesn’t seem to be as big an issue as it is in the remainder of the county, there remains a huge housing inventory. With absorption (demand) running about one third of its norm, and the recovery limping slowly along, it will be awhile before that inventory is sufficiently reduced to justify significant new residential development.

When that time comes, however, where will new development and redevelopment occur? The pundits want us to believe that it will take place in the urban core, not in greenfields or suburban areas. Are they right, or is there something wrong with their logic? I believe it’s the latter. Let me explain my heretical view.

·         Major metropolitan areas have a distinct, 24/7 “downtown” or urban core. Most other cities and towns, including those with public transit systems, don’t have this type of 24/7 destination center with strong employment opportunities, shopping, and entertainment facilities.

·         Humans are not lab mice. We’re like the grains of sand on a beach; no two are exactly the same. You can’t generalize about the behavior of individuals.

o   Not all retiring Baby Boomers want to sell the house and cars, move to a high rise downtown, and resort to walking or riding a bike everywhere.

o   Not all members of Gen-Y, or Millennials, want to live, work, and play in the same place twenty-four hours a day. Once members of their generation begin having children, many of them will want to move to places where they will have some space around them and less 24/7 activities which aren’t necessarily positive for the wellbeing of the kids.

·         Much of the impetus for pushing everyone into residing in the urban core comes from misguided environmentalists who think getting people out of automobiles will save the planet, as well as urban planners who have been brainwashed by the current popular rhetoric.  It’s wishful thinking, and it’s very shortsighted.

·         It’s also very much about the benjamins. No, not that nice family down the street; the Founding Father whose face adorns the hundred-dollar bill. In other words, money. Compact urban development means putting more in less area. It means, in a phrase, greater density. We’re not talking about public housing. At the end of the day, the development has to prove profitable. The cost of land typically is higher in the urban core. Also, there are the costs of retrofitting frequently inadequate or outdated infrastructure, construction staging in an area that already is developed, and numerous other added expenses. Profitability in this type of milieu requires greater density; sometimes much greater density, and that often is very unpopular.

·         Even when public sector planners, appointed planning commission members, and elected officials understand the requirement for greater density, they are aware that the electorate often doesn’t get it. And the public sector necessarily is very sensitive and responsive to the wishes of the electorate regardless whether voters are well informed and can connect the dots between more efficient use of land leading to less issues relating to sprawl and the resulting need for higher density.

This argument for density applies equally to development in the exurbs, when that type of land development eventually returns. You can build smaller, more compact residences on a given parcel of land, but only if you can put more of those smaller residences on it than the larger ones contemplated in the original planning and zoning.

Suppose, for example, that you can build X units on a given parcel of property at a land cost of Y dollars for that property, and sell those finished larger units at a per unit market price that includes an acceptable risk-adjusted rate of return on total investment. Suppose, however, that for a variety of reasons, most of which relate to changes in the economic fiber of the country that alter expectations and perhaps the standard of living, market demand changes to smaller, less expensive residences. Now, in order to earn a return on investment, you must be able to build X+ units, assuming the price for the property remains Y dollars. Again, greater density is required in order for the numbers to work.

Otherwise, the residual land value per unit (the percentage of the total cost represented by the cost of the land) will be too high to produce an acceptable risk-adjusted rate of return on invested capital. The property won’t be sold and developed, which means that needed, affordable residential structures won’t be built. That, in turn causes demand to drive up the price of existing housing, which gives rise to other social, political, and economic issues. Bottom line: density can be a positive thing.

Getting that message across is a major challenge for those of us in the land use and development industry today.

September 2010

Lending (underwriting) standards will be very tough going forward. Interest rates may remain relatively low in the absence of inflationary threats. But, historically, rates of return are low only on investments perceived as safe, such as Treasuries. The first law of investing remains: The higher the perceived risk, the higher the expected rate of return. So, mortgage loans will have to be based on underwriting (risk assessment) standards that the ensure the safety of the capital loaned, meaning, in simplistic terms, a strict return to the “5 C’s” of lending:

¨ The character of the borrower(s) – do they meet their credit obligations?

¨ The capacity of the borrower(s) to service the debt;

¨ The collateral – is it likely to hold its value over time?

¨ The sufficiency of the capital – the portion of the purchase price contributed by the borrower(s);

¨ The credit history of the borrower(s) and/or the business entity – are they solid?

 The bottom line is that fewer individuals and businesses will qualify for residential and commercial loans. Hence, there will be fewer homes owned and fewer commercial deals. This will have a dampening effect on the level of activity in the real estate development industry. But this isn’t necessarily a negative. Given the size of the hangover from the latest industry feeding orgy, no rational person wants to go there again.

 As mentioned, this is not a negative statement regarding the future of real estate development. In fact, it is to the contrary.  True, more stringent loan underwriting standards certainly should shrink the percentage of candidates who can qualify for a loan, theoretically reducing demand for single-family residences.  This will be mitigated by at least two factors.

One is the expected increase in overall population numbers. Thus, the percentage of the population that can qualify for a home mortgage will decline, but the raw numbers will grow as the size of the population increases. So, demand for new housing will continue as the inventory of existing housing is drawn down over time.

Second, what about those who will no longer qualify for home ownership (financing) under stronger underwriting principles? Where will they live? To my knowledge, excluding moving back in with mom and dad, there are only two forms of tenure – ownership or renting. As a consequence of the decline in the percentage of the population who could qualify to purchase a single-family home, there should be a corresponding increase in demand for rental housing, much of which will be in multifamily product.

I’m not suggesting that those who can qualify should load up on single-family housing as rental properties. The economies of scale – mortgage payments, taxes, insurance, maintenance, management, etc. – make competing on price with multifamily projects difficult at best. And, in moving forward from the Great Recession, price will be paramount in decision-making. Value – what you get for that price, and location also will be critically important for competitive edge.

 At worst, this simply means a change in lifestyle for many people who aspire to own their own home, as that event will be pushed off into the future when they may be more able to qualify for the necessary financing.


  Another Challenge for Real Estate Development
July 2010
For tax purposes, the term “carried interest” refers to an interest a real estate developer, as a partner in a real estate development project, may have in that project’s outcome. For example, a developer, as a partner in a real estate partnership (as defined under the tax code), has an interest in that partnership based on services (in addition to any capital invested) provided in steering the project from start to finish.  

To realize that gain, the project has to be financially successful; the land has to be acquired, the improvements constructed and leased, and sale has to occur in a future year.

 Thus, the developer’s interest in the project is carried through to the termination of the venture, and then distributed to him or her. Currently, this interest is treated as long-term capital gain and taxed at the lower 15% rate. Under proposed changes, carried interest could be taxed as high as 39.6%.

This is troubling for at least two reasons:

1. The developer’s carried interest, payable as it is on the backend, often is the impetus for putting in the years of effort and assuming the high degree of risk involved in creating real estate projects. The effort and risk remain unchanged, but the compensation will be greatly reduced by the tax bite; perhaps fatally skewing the risk/reward formula. This results in less development activity, in turn leading to an imbalance in supply and demand and, ultimately, higher residential and commercial rents.

2. The disincentivizing effect of the higher tax bite on investors and developers also has a dampening effect on the pricing of investment real estate, which in turn adversely impacts the economy in which it is an important component.

There is no real upside to this tax increase, as it will result in less of the activity it’s aimed to tax and lowering of values.

 -Wayne Falbey, in addition to serving as president of the Falbey Institute for the Development of Real Estate, also is President of the Falbey Group, LLC, a real estate development and advisory firm.  He is a Real Estate Developer, Industry Advisor, Attorney, University Professor, Speaker and  Author.