Commercial real estate will never be the same again ...

David Goldsmith

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... as millions of employees worked remotely and companies realized it wasn’t that big a deal


David Goldsmith

All Powerful Moderator
Staff member

Thousands of CRE borrowers call on banks for debt relief
Almost 90 CMBS loans have been sent to special servicing, Fitch Ratings found

The number of commercial real estate borrowers who requested debt relief during the escalation of the coronavirus outbreak in the U.S. has lurched to 2,600, with borrowers against hotel and retail assets among the most asking for help, one ratings agency found.

The borrowers represent some $49.1 billion of mortgage loans, according to new findings from Fitch Ratings, which analyzed debt-relief inquiries logged by Wells Fargo, Midland Loan Services, Keybank National Association and Berkadia Commercial Mortgage for the two weeks ending March 29. Those firms represent the largest servicers of commercial mortgage-backed securities and Freddie Mac borrowers.

There is no precedent for the number of borrower requests for debt relief, given the national scope of Covid-19, said Adam Fox, senior director of structured finance at Fitch, in an email. Even when borrowers ask for assistance during natural disasters, for instance, the requests are limited in geographic regions and impact fewer property types.

By addressing relief requests as “non-transfer events,” potential fees to borrowers would be reduced, but more storied assets may need loan modifications beyond short-term forbearance, leading to formal transfers to special servicing, he added.

David Goldsmith

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March saw fewer CMBS delinquencies. That is likely to change: Fitch
The delinquency rate fell just 4 basis points in March from the month before

Commercial loans expected to suffer because of the pandemic (Credit: iStock)
The delinquency rate for U.S. commercial mortgage-backed securities fell in March — but that is likely to change, according to a new report.
Last month delinquencies dipped four basis points to 1.31 percent from the month before, largely because of new loan issuance and minimal new delinquencies, Fitch Ratings said Friday. So far for the year, delinquencies also are down overall.
But the ratings agency warned that the coronavirus pandemic likely will cause the delinquency rate for loans attached to commercial properties will rise, with hotel and retail properties hit hardest. (Fitch said its projection will be released next week.)
There are already signs that commercial borrowers may be facing trouble. Over 2,600 borrowers have asked the four largest servicers of CMBS and Freddie Mac deals for some form of debt relief, ranging from payment forbearance to default waivers, Fitch previously found. Borrowers against properties secured by hotels and retailers again were among those asking for the most assistance.

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Missed loan payments to approach Great Recession levels: Fitch
Hotel and retail sectors expected to have highest delinquency rates

Missed loan payments are expected to approach Great Recession levels in the third quarter of 2020, part of the continuing fallout from a U.S. economy that remains virtually frozen.

The hotel and retail sectors are expected to have the highest delinquency rates, according to projections by Fitch Ratings.

Before the coronavirus pandemic, the delinquency rate had been steadily falling, and stood at just 1.31 percent in March. Now it’s expected to reach as high as 8.75 percent by the end of September — approaching its peak of 9.01 percent recorded in July 2011.

Earlier in the month, Fitch found that 2,600 commercial real estate borrowers requested debt relief, with borrowers against hotel and retail assets among the most asking for help.

While defaults are expected to spike in the months to come, Fitch also projects a decline in new loans issued, fewer maturing loans and fewer resolutions by special servicers.

Hotel and retail delinquencies — hit particularly hard by the coronavirus as travelers and shoppers stay home — are expected to increase to 30 percent and 20 percent, respectively. Those numbers would greatly exceed previous highs of 21.3 percent and 7.7 percent. In March, 1.4 percent of hotel loan payments were delinquent and 3.5 percent for retail.

And as retail tenants fall behind on their rent payments, class B and C malls — and outlet malls whose owners have limited ability to access capital to inject additional equity — are expected to default. Those loans maturing this year are also at a higher risk of default because of scarce liquidity for this property in the current environment.
The lucky ones
But loans secured by top tier-regional malls with pricier square footage are expected to fare better, and properties lucky enough to have “essential” retail tenants that can remain open — like supermarkets, pharmacies and banks — will also be less affected.

The multifamily sector is also expected to take a hit, especially student housing, as schools stay closed. Multifamily properties with many tenants who are hourly wage or service employees who interact with the public are also expected to miss loan payments.
But in a panel discussion this week on the multifamily market, Lightstone’s David Lichtenstein told The Real Deal that of all the “the food groups,” multifamily is the best positioned to weather the storm. He noted that tenants are, for the most part, continuing to pay rent and banks are still working with owners. Lichtenstein added that could change if the crisis stretches beyond six to nine months.

delinquency projections don’t include loans in forbearance. Many borrowers are frantically seeking to make arrangements with their lenders, while multifamily borrowers with federally-backed mortgages can receive forbearance from Fannie Mae and Freddie Mac as part of the federal stimulus package.

At the beginning of April, a Fitch analysis found that 105 multifamily borrowers, representing $810.2 million in mortgage loans, had already put in such requests for assistance.

David Goldsmith

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“Be very careful what you ask for,” top broker warns borrowers seeking relief
Simon Ziff, Ira Zlotowitz and Dustin Stolly talk debt markets, special servicing in age of coronavirus

As thousands of commercial real estate borrowers look for help to make their monthly mortgage payments, they should do so cautiously.

“We’re advising our borrowers, be very careful what you ask for,” warned Ackman Ziff Real Estate Group president Simon Ziff. “Make sure you can back it up and have a need for it, or you may find yourself in special [servicing] faster than you want to be,”

Servicers, he added, are open to working with borrowers who have truly been hurt by the Covid-19 pandemic, but they’re “very defensive if it’s not a real situation,” Ziff said.

Ziff joined Eastern Union Funding president Irz Zlotowitz and Newmark Knight Frank’s Dustin Stolly Monday for the latest installment of “TRD Talks Live.” The panel discussed the commercial mortgage brokerage industry’s perspective on the global crisis, with The Real Deal’s Keith Larsen moderating.

Stolly said that borrowers with loans pooled into commercial mortgage-backed securities will have a more difficult time dealing with special servicers than those who can turn to balance sheet lenders like banks.

“The balance sheet lenders are a little bit ahead of CMBS special servicers, who move at a slower, more bureaucratic pace,” he said, adding those servicers have been hit with a “tidal wave of requests from borrowers.”

Zlotowitz said smaller community banks are being more flexible.

“For the most part they’re taking the approach, any level of help you need we’ll work with you, but the work is for 90 days and then you have to pay it back for the most part over those next 12 months,” he said.

Shopping centers and other retail properties, along with hotels and apartment rental buildings have been hard hit as the economy has ground to a halt and millions have lost their jobs.
While the industry watches anxiously to see how many tenants pay their April rent, the panelists said May collections will draw a more comprehensive picture of how landlords will be impacted.
“People did or they didn’t get their April payments, but I think they’re more worried about what happens in May,” Ziff explained. “A lot of the conversation is around what’s going to happen with those debt service payments.”

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Palisades Center’s $390M loan on verge of default
Special servicing for massive mall, which lost anchor tenant JCPenney in 2017

UPDATED, April 17, 5:09 p.m.: One of the nation’s largest malls has been swept into the tidal wave of CMBS loans that have gone into special servicing.

A $388.5 million loan on the 2.2 million-square-foot Palisades Center in West Nyack, N.Y., has been transferred to special servicing because of imminent monetary default, Trepp reported.

The debt was originated by JPMorgan Chase and Barclays in 2016 and was included in a single-asset CMBS transaction, with Wells Fargo as both master and special servicer.

Robert Congel’s Pyramid Companies developed the mall, which opened in 1998 about 30 miles north of Midtown Manhattan and is the 11th largest in the country.

The loan covers 1.8 million square feet of retail space at the property, and excludes space occupied by Macy’s and Lord & Taylor. The mall’s capital stack includes an additional $141.5 million in mezzanine debt, according to rating documents.

Pyramid did not respond to a request for comment. No servicer commentary was provided in connection with the transfer. A spokesperson for Wells Fargo said that the servicer is “working with various borrowers, including this one, that are seeking relief at this time.”

Fully leased in 2016, the property saw occupancy fall to 82 percent by 2019 with the departure of tenants including JCPenney, Lord & Taylor and Bed, Bath & Beyond. JCPenney’s exit in 2017 led Moody’s to downgrade some classes of the CMBS trust.

The mall is also home to the 21-screen AMC Palisades Theater, which has been idled by the coronavirus. AMC’s struggles have spurred speculation that it will soon declare bankruptcy — although its owner, China’s Dalian Wanda Group, has denied this.

Last May a judge ruled that Pyramid could not expand the mall without voter approval

David Goldsmith

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After Palisades Center, 4 more Pyramid Group malls head to special servicing
The Upstate NY properties include Destiny USA, which has 2 loans with outstanding balance of $430M

A quartet of Pyramid Group malls in Upstate New York have gone into special servicing after the firm requested debt service relief because of the coronavirus pandemic.

Destiny USA in Syracuse, Walden Galleria Mall in Cheektowaga, Crossgates Mall in Albany and Poughkeepsie Galleria are now all in special servicing, according to Kroll. The company’s Palisades Center mall in West Nyack went into special servicing earlier this month.

Destiny USA has a pair of mortgage loans on it with an outstanding balance of $430 million, and Walden Galleria has a single mortgage loan on it, according to Kroll.

No additional details were provided for Crossgates Mall and the Poughkeepsie Galleria, the credit rating agency said. Pre-coronavirus, the Poughkeepsie Galleria’s income had already fallen to just 88 percent of debt service.

A $388.5 million loan on the Palisades Center was transferred to special servicing because of an imminent default, according to Trepp. A source at JPMorgan said the property could go into foreclosure by mid-summer if Pyramid does not find a buyer, Several developers, investors and hedge funds have already expressed interest in buying the mall at a steep discount, according to the Rockland County Business Journal.

David Goldsmith

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Tom Barrack says RE industry verging on collapse over rent, mortgage waivers
Colony Capital CEO warned last month of impact pandemic could have on commercial mortgage market

The country’s real estate market is in chaos and on the verge of collapse.

That’s according to Colony Capital CEO Tom Barrack, who said the industry was in such dire straits because the government is letting renters and homeowners skip payments due to the coronavirus. He made his comments in an interview with Bloomberg Television Friday.

Lenders and landlords can normally use the court system to enforce rent and interest payments, but they do not have that option at the moment with millions out of work and much of the country still under lockdown. Some banks like JPMorgan, are pulling back from mortgage lending by tightening standards.

In late March, Barrack posted a white paper to Medium warning that the country’s commercial mortgage market was teetering on the edge because of the pandemic and subsequent economic shutdown. Some of his proposals, such as market liquidity from the Federal Reserve and new accounting rule delays were adopted, but others like a halt on margin calls by banks were not.

Colony’s real estate portfolio had a roughly $50 billion valuation at the end of 2019, and Barrack said the number of tenants who paid rent in April was “amazingly good,” with a drop of just 3 to 5 percent from normal levels; he expects fewer tenants will remain current for May.

He said that Colony has a good amount of liquidity and should survive the fallout from the pandemic.
“The people who’ll be crushed are the people who own the equity, the people who own bonds and debt, the pensioners,” he told Bloomberg. “At the end of the day, the government is going to have to step in and subsidize it all if people don’t go back to work.”

David Goldsmith

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Lawsuit against TPG trust could be an omen for CRE finance
Complaint filed by Somera Road alleges lender created a “financial house of cards”

A mortgage lender sponsored by investment giant TPG stopped funding a loan to a New York-based developer due to liquidity strains caused by the coronavirus pandemic, according to a new lawsuit that could be a sign of where commercial real estate finance is headed.
Somera Road, a New York-based developer, alleges TPG RE Finance failed to advance $4 million in funds on a $60.2 million loan to buy and redevelop a distressed office building in downtown Kansas City, Missouri, according to a lawsuit filed in U.S. District Court for the Southern District of New York. Somera Road is alleging breach of contract and claims that TPG RE Finance didn’t advance the money due to a liquidity shortfall.
TPG RE Finance, the complaint states, “created a financial house of cards through various financial leverage structures and a maze of offshore entities and special purposes vehicles designed solely to increase yield and in actuality have placed the lender in a completely foreseeable position of much more unnecessary risk.” In an interview with The Real Deal Wednesday, Somera Road founder Ian Ross said that “there is certainly concern that this capital squeeze issue could be systemic.”
A spokesperson for TPG RE Finance said Somera Road’s claims are without merit.
“The borrower’s budget is out of balance and the borrower has failed to satisfy its obligations to post equity to satisfy the deficiency,” the spokesperson said. “This is nothing more than a contractual issue that predates the current economic situation. The borrower’s attempts to call into question TPG Real Estate Finance’s financial position are not only irrelevant but misguided.”
The complaint could be a sign of things to come as more mortgage REITS are facing liquidity strains from lenders now seeking to pull their lines of credit. In late March, the Mortgage REIT AG Mortgage Investment Trust operated by New York investment firm Angelo, Gordon & Co., said it faced a high number of margin calls. And in March, TPG RE Finance delayed its first-quarter dividend payments in preparation for needing additional cash collateral, noting in a statement that there’s “no certainty” it can continue paying. Tom Barrack of Colony Capital has pleaded for a government bailout for commercial mortgage real estate investments trusts to help solve these liquidity issues.

“There has been a lot of evidence that many of these mortgage REITs are looking to be re-capitalized with rescue capital,” Ross said.
Somera Road landed the loan for City Center Square, an office property at 1100 Main Street, in January 2019. The loan was split into two parts, with $28.25 million to be used for the acquisition of the property and $31.95 million would be used to help execute its business plan.
The complaint alleges $28.34 million of the loan was securitized in a Collateralized Loan Obligation (“CLO”), which leveraged the asset at 85 percent. TPG RE Finance then retained $31.81 million portion of the loan on its balance sheet.

But Somera Road alleges TPG RE Finance failed to advance two of its loan disbursements in March and April, at the same time the lender began experiencing financial issues due to the fallout from the coronavirus pandemic.
As of March 17, TPG RE Finance had just $143.2 million in cash on hand and $600 million of unfunded commitments, which included a portion of the Somera Road loan, according to the complaint, which also notes that in March, the company stopped paying its dividend.

David Goldsmith

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Behind Brookfield’s critical Covid moment
Real estate giant’s high-stakes retail bets raise new questions at time of extreme uncertainty

Brookfield Asset Management is taking a bold step in the thick of the Covid-19 crisis.

The Canadian real estate giant is looking to invest $5 billion in retail companies hit hard by the pandemic, the Wall Street Journal reported on Wednesday. Brookfield is expected to focus on stores that had revenues of at least $250 million prior to March, and the company may look to raise additional capital to bolster the investments.

Thuy Nguyen, Moody’s lead analyst on Brookfield Property REIT, said the strategy is a smart move and shows the company still views retail as an important part of its overall strategy. “From our perspective, this is good for retailers with viable business models that will rebound but need liquidity to make it through this crisis,” she said.

But some say Brookfield’s previous bets on the struggling mall industry look all the more risky due to the highly unpredictable coronavirus.

Strict social distancing measures and stay-at-home orders have forced retail properties across the country to shutter, magnifying the many problems retail tenants and landlords were already facing. That trend could complicate Brookfield’s $14.8 billion acquisition of mall owner General Growth Properties, which turned heads when the deal closed in 2018 during a much healthier economy.

Now, as it gets ready to pour billions more into the beleaguered retail market, Brookfield may need to cook up a new long-term strategy to navigate a drastically different consumer market, observers told The Real Deal.

And several zeroed in on the company’s shopping malls as the most vulnerable part of its $500 billion-plus portfolio. Moody’s, for one, is weighing a downgrade of Brookfield’s retail REIT — largely due to hurdles the company faces with refinancing $1.7 billion in debt coming due this year.

Brookfield Property Partners, which will hold its quarterly earnings call on Friday, declined to comment for this story.

The company’s goal of reinventing at least 100 GGP malls across the country “was an ambitious plan to start with,” said Joseph French Jr., a commercial broker at Marcus & Millichap who specializes in shopping centers. “Out of all of retail, the malls are the product that is going to be the most damaged long term.”

But, to be sure, skepticism over Brookfield’s high-stakes mall bets in the face of Covid-19 doesn’t equate to concerns about the company as a whole. RXR Realty’s Scott Rechler predicted that Brookfield would be well positioned to take advantage of troubled assets once the dust settles given the diversified company’s track record with salvaging underwater companies and properties.

“They’ve done a good job, historically, pivoting. They have a strong balance sheet,” he said, noting that there is “distress in the system, and my guess is they’re well positioned to take advantage of it.”

On top of the $5 billion the company may reportedly invest in struggling retailers, Oaktree Capital Management — which Brookfield bought a majority stake in last year — is looking to raise $15 billion for a new distressed debt fund. And while Oaktree plans to spread its bets across multiple industries, the company is no stranger to opportunistic real estate plays.

But with a growing number of retailers — including several luxury brands — filing for Chapter 11, that remains to be seen.
In a March 20 letter to investors, Brookfield Property Partners CEO Brian Kingston maintained that the company was ready for a market downturn and a difficult year, especially for its mall properties.
“In the long run, the high-quality nature of our assets and the prime locations the centers enjoy give us an advantage and will allow us to recover,” Kingston wrote. “But this segment of our business will undoubtedly face a challenging year ahead.”

Global cushions
Brookfield’s business is split between real estate, infrastructure, energy and private equity. Epstein said the company’s other business lines — which extend across more than 30 countries — will also help it withstand the pandemic.
Brookfield’s largest retail assets
Ala Moana Center, Honolulu, Hawaii:2.65M SQ FT.
Oakbrook Center, Oak Brook, Illinois:2.19M SQ FT.
Baybrook Mall, Friendswood, Texas:1.89M SQ FT.
Fashion Show, Las Vegas, Nevada:1.87M SQ FT.
Stonebriar Center, Frisco, Texas:1.8M SQ FT.
Woodbridge Center, Wodbridge, New Jersey:1.65M SQ FT.
Natick Mall, Natick, Massachusetts:1.59M SQ FT.
Mall of Louisiana, Baton Rouge, Louisiana:1.57M SQ FT.
Park Meadows, Lone Tree, Colorado:1.57M SQ FT.
Perimeter Mall, Atlanta, Georgia:1.55M SQ FT.
Source: Brookfield Property Partners data as of Dec. 31, 2019
“A hydroelectric windmill is not going to suddenly lose all its revenue because property taxes are declining,” he noted. “We think that a lot of their investments have long-term stability.”

The income Brookfield receives from fees it charges to manage third party capital should help them get through the pandemic as well, Epstein added. The company also has about 58,000 apartments and 280 office properties in its portfolio, which analysts across the board expressed fewer concerns about.
Brookfield Property REIT also has a good amount of cash available, which several analysts cited as a good indicator of how prepared companies are to weather the pandemic. As of the end of 2019, the REIT had about $198 million in cash and cash equivalents on hand, and it had about $22 billion in total assets, according to filings with the U.S. Securities and Exchange Commission.

A recent research note on Brookfield Asset Management from RBC Capital Markets summarized the company as “insulated but not immune.”

The investment bank’s report, which expressed confidence in Brookfield’s long-term prospects, singled out mall and hotel properties as two assets that will almost certainly struggle until the pandemic ends.

Lessons learned

By and large, many public real estate firms have learned since 2008 that having access to cash is an important factor when it comes to surviving a crisis, said Nguyen.


David Goldsmith

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Tom Barrack’s Colony Capital defaults on $3.2B in loans
The financing is backed by hotels and health care properties

Tom Barrack’s prediction that the commercial mortgage market would collapse has now hit close to home.

The magnate’s Colony Capital has defaulted on $3.2 billion in loans backed by hotel and health care properties, according to a regulatory filing first reported by the Financial Times.

Before the coronavirus crisis sent the economy into a spiral, that portfolio of 157 hospitality and health care-related properties accounted for three quarters of Colony’s real estate balance sheet. However, the company did not specify how many properties were at risk because of the defaults.

Barrack, longtime pal of President Donald Trump, in March authored a white paper on Medium predicting that margin calls, foreclosures, evictions and bank failures stemming from the crisis could have an impact greater than that of the Great Depression on commercial real estate. He called for government support of the industry and a $500 billion tax-payer funded liquidity injection into the financial system.

In April, the CEO appeared on Bloomberg Television claiming that the real estate industry was in dire straits because the government was allowing homeowners and renters skip payments. At the time, Barrack said the number of tenants in Colony’s portfolio that paid rent was “amazingly good,” but predicted a falloff in May.

As for its recent defaults, Colony said that it could not guarantee its current talks with lenders would be successful. The investment firm has $1 billion of cash on hand and tapped into a $600 million credit facility. Colony’s chief financial officer, Mark Hedstrom, said the company expects to meet its obligations.

David Goldsmith

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TPG Real Estate Finance sells off $1B worth of CRE debt
Nonbank lender made the move to fight off margin calls from coronavirus-fueled cash crunch

Nonbank mortgage lender TPG Real Estate Finance Trust has sold off nearly $1 billion worth of commercial real estate debt to fight off margin calls, as it faces a coronavirus-fueled cash crisis.
TPG RE Finance made the disclosure at its first quarter earnings call Tuesday, saying liquidity constraints raise substantial doubt about its ability to continue “as a going concern.” The announcement also follows a lawsuit New York real estate developer Somera Road filed against the lender that alleges it is skipping out on loan payments due to liquidity issues.

In order to add cash to its balance sheet, TPG RE Finance said it had unload 49 separate commercial real estate debt securities investments, amounting to its entire portfolio. The company sold off these investments — with a $961 million face value — to meet a $722 million debt payment, according to its Q1 report.

Still, TPG RE Finance — which is sponsored by investment giant TPG — said it projects that the company “will not have sufficient liquidity to repay maturing debt balances of $432.2 million and meet its obligations as they become due to sustain operations through at least one year.” The company said it is in discussions with its lenders to gain extensions and expects “that such extensions are probable to occur.”

Additionally, the company extended for another year its repurchase agreement with Morgan Stanley, which is providing a commitment of $500 million. TPG RE Finance also announced the deferral of its dividend payments until July 14.

For the quarter, TPG RE Finance reported a net loss of $233.1 million compared to net income of $28.3 million in the first quarter of 2019. Most of the loss is attributable to an impairment charge of $167.3 million related to the sale of its debt securities. The company’s stock price fell 10 percent to $6.61 on the late-morning news.

During the conference call with analysts, TPG RE Finance executives projected that the impacts to certain sectors of real estate could be felt for some time.
“The economic strain experienced by tenants and landlords will not disappear,” said Greta Guggenheim, CEO of TPG RE Finance.

The company said a number of its loans are now reclassified to riskier categories. Among the hardest hit are hotels, which have been decimated during the pandemic. It moved nine hotel loans to Category 4 risk — Category 5 is the highest — due to “operating challenges in the lodging industry caused by the Covid-19 pandemic and the travel and social-distancing policies that ensued.”

Real estate investment trusts like TPG RE Finance, hedge funds and private equity firms that have issued billions in construction loans, mortgages and bonds backed by property debt are now facing a cash crunch. They borrow short-term debt from banks in the form of repurchase agreements, which they use to buy mortgages with relatively little cash and pool them into commercial mortgage-backed securities, which it sells to bond investors. But when the coronavirus hit, prices for CMBS loans fell. Mortgage REITs had to mark down the assets on their books and their repo lenders instituted margin calls that required the companies to add cash to their accounts in order to keep them in balance.

David Goldsmith

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Nothing like the financial crisis of 2008 you say?

Whistleblower: Wall Street Has Engaged in Widespread Manipulation of Mortgage Funds
Securities that contain loans for properties like hotels and office buildings have inflated profits, the whistleblower claims. As the pandemic hammers the economy, that could increase the chances of another mortgage collapse.

A whistleblower complaint accuses 14 major lenders, including Wells Fargo, one of the country’s biggest CMBS issuers, of widespread manipulation of mortgage funds.

Among the toxic contributors to the financial crisis of 2008, few caused as much havoc as mortgages with dodgy numbers and inflated values. Huge quantities of them were assembled into securities that crashed and burned, damaging homeowners and investors alike. Afterward, reforms were promised. Never again, regulators vowed, would real estate financiers be able to fudge numbers and threaten the entire economy.

Twelve years later, there’s evidence something similar is happening again.
Some of the world’s biggest banks — including Wells Fargo and Deutsche Bank — as well as other lenders have engaged in a systematic fraud that allowed them to award borrowers bigger loans than were supported by their true financials, according to a previously unreported whistleblower complaint submitted to the Securities and Exchange Commission last year.

Whereas the fraud during the last crisis was in residential mortgages, the complaint claims this time it’s happening in commercial properties like office buildings, apartment complexes and retail centers. The complaint focuses on the loans that are gathered into pools whose worth can exceed $1 billion and turned into bonds sold to investors, known as CMBS (for commercial mortgage-backed securities).

Lenders and securities issuers have regularly altered financial data for commercial properties “without justification,” the complaint asserts, in ways that make the properties appear more valuable, and borrowers more creditworthy, than they actually are. As a result, it alleges, borrowers have qualified for commercial loans they normally would not have, with the investors who bought securities birthed from those loans none the wiser.

ProPublica closely examined six loans that were part of CMBS in recent years to see if their data resembles the pattern described by the whistleblower. What we found matched the allegations: The historical profits reported for some buildings were listed as much as 30% higher than the profits previously reported for the same buildings and same years when the property was part of an earlier CMBS. As a rough analogy, imagine a homeowner having stated in a mortgage application that his 2017 income was $100,000 only to claim during a later refinancing that his 2017 income was $130,000 — without acknowledging or explaining the change.

It’s “highly questionable” to alter past profits with no apparent explanation, said John Coffee, a professor at Columbia Law School and an expert in securities regulation. “I don’t understand why you can do that.”

In theory, CMBS are supposed to undergo a rigorous multistage vetting process. A property owner seeking a loan on, say, an office building would have its finances scrutinized by a bank or other lender. After that loan is made, it would be subjected to another round of due diligence, this time by an investment bank that assembles 60 to 120 loans to form a CMBS. Somewhere along the line, according to John Flynn, a veteran of the CMBS industry who filed the whistleblower complaint, numbers are being adjusted — inevitably to make properties, and therefore the entire CMBS, look more financially robust.

The complaint suggests widespread efforts to make adjustments. Some expenses were erased from the ledger, for example, when a new loan was issued. Most changes were small; but a minor increase in profits can lead to approval for a significantly higher mortgage.

The result: Many properties may have borrowed more than they could afford to pay back — even before the pandemic rocked their businesses — making a CMBS crash both more likely and more damaging. “It’s a higher cliff from which they are falling,” Flynn said. “So the loss severity is going to be greater and the probability of default is going to be greater.”

With the economy being pounded and trillions of dollars already committed to bailouts, potential overvaluations in commercial real estate loom much larger than they would have even a few months ago. Data from early April showed a sharp spike in missed payments to bondholders for CMBS that hold loans from hotels and retail stores, according to Trepp, a data provider whose specialties include CMBS. The default rate is expected to climb as large swaths of the nation remain locked down.

After lobbying by commercial real estate organizations and advocacy by real estate investor and Trump ally Tom Barrack — who warned of a looming commercial mortgage crash — the Federal Reserve pledged in early April to prop up CMBS by loaning money to investors and letting them use their CMBS as collateral. The goal is to stabilize the market at a time when investors may be tempted to dump their securities, and also to support banks in issuing new bonds. (Barrack’s company, Colony Capital, has since defaulted on $3.2 billion in debt backed by hotel and health care properties, according to the Financial Times.)

The Fed didn’t specify how much it’s willing to spend to support the CMBS, and it is allowing only those with the highest credit ratings to be used as collateral. But if some ratings are based on misleading data, as the complaint alleges, taxpayers could be on the hook for a riskier-than-anticipated portfolio of loans.

The SEC, which has not taken public action on the whistleblower complaint, declined to comment.
Some lenders interviewed for this article maintain they’re permitted to alter properties’ historical profits under some circumstances. Others in the industry offered a different view.

Adam DeSanctis, a spokesperson for the Mortgage Bankers Association, which has helped set guidelines for financial reporting in CMBS, said he reached out to members of the group’s commercial real estate team and none had heard of a practice of inflating profits. “We aren’t aware of this occurring and really don’t have anything to add,” he said.

The notion that profit figures for some buildings are pumped up is surprising, said Kevin Riordan, a finance professor at Montclair State University. It raises questions about whether the proper disclosures are being made.

Investors don’t comb through financial statements, added Riordan, who used to manage the CMBS portfolio for retirement fund giant TIAA-CREF. Instead, he said, they rely on summaries from investment banks and the credit ratings agencies that analyze the securities. To make wise decisions, investors’ information “out of the gate has to be pretty close to being right,” he said. “Otherwise you’re dealing with garbage. Garbage in, garbage out.”

The whistleblower complaint has its origins in the kinds of obsessions that keep wonkish investors up at night. Flynn wondered what was going to happen when some of the most ill-conceived commercial loans — those made in the lax, freewheeling days before the financial crisis of 2008 — matured a decade later. He imagined an impending disaster of mass defaults. But as 2015, then 2017, passed, the defaults didn’t come. It didn’t make sense to him.

Flynn, 55, has deep experience in commercial real estate, banking and CMBS. After growing up on a dairy farm in Minnesota, the youngest of 14 children, and graduating from college — the first in his family to do so, he said — Flynn moved to Tokyo to work, first in real estate, then in finance. Jobs with banks and ratings agencies took him to Belgium, Chicago and Australia. These days, he advises owners whose loans are sold into CMBS and helps them resolve disputes and restructure or modify problem loans.

He began poring over the fine print in CMBS filings and noticed curious anomalies. For example, many properties changed their names, and even their addresses, from one CMBS to another. That made it harder to recognize a specific property and compare its financial details in two filings. As Flynn read more and more, he began to wonder whether the alterations were attempts to obscure discrepancies: These same properties were typically reporting higher net operating incomes in the new CMBS than they did for the same year in a previous CMBS.

Flynn ultimately collected and analyzed data for huge numbers of commercial mortgages. He began to see patterns and what he calls a massive problem: Flynn has amassed “materials identifying about $150 billion in inflated CMBS issued between 2013 and today,” according to the complaint.

The higher reported profits helped the properties qualify for loans they might not have otherwise obtained, he surmised. They also paved the way for bigger fees for banks. “Inflating historical cash flows creates a misperception of lower current and historical cash flow volatility, enables higher underwritten [net operating income/net cash flow], and higher collateral values,” the complaint states, “and thereby enables higher debt.”

Flynn eventually found a lawyer and, in February 2019, he filed the whistleblower complaint. The complaint accuses 14 major lenders — including three of the country’s biggest CMBS issuers, Deutsche Bank, Wells Fargo and Ladder Capital — and seven servicers of inflating historical cash flows, failing to report misrepresentations, changing names and addresses of properties and “deceptively and inaccurately” describing mortgage-loan representations. It doesn’t identify which companies allegedly manipulated each specific number. (Spokespeople for Deutsche Bank and Wells Fargo declined to comment on the record. The complaint does not mention Barrack or his company. )

The SEC has the power to fine companies and their executives if fraud is established. If the SEC recovers more than $1 million based on Flynn’s claim, he could be entitled to a portion of it.
When Flynn filed the complaint, the skies looked clear for the commercial mortgage market. Indeed, last year was a boom year for CMBS, with private lenders in the U.S. issuing roughly $96.7 billion in commercial mortgage-backed securities — a 27% increase over 2018, which made it the most successful year since the last financial crisis, according to Trepp. Overall, investors hold CMBS worth $592 billion.

Flynn’s assertions raise questions about the efficacy of post-crisis reforms that Congress and the SEC instituted that sought to place new restrictions on banks and other lenders, increase transparency and protect consumers and investors. The regulations that were retooled included the one that governs CMBS, known as Regulation AB. The goal was to make disclosures clearer and more complete for investors, so they would be less reliant on ratings agencies, which were widely criticized during the financial crisis for lax practices.

Still, the opinion of the credit-ratings agencies remains crucial today, a point reinforced by the Fed’s decision to hinge its bailout decisions on those ratings. That’s a problem, in the view of Neil Barofsky, who served as the U.S. Treasury’s inspector general for the Troubled Assets Relief Program from 2008 to 2011. “Practically nothing” was done to reform the ratings agencies, Barofsky said, which could lead to the sorts of problems that emerged in the bailout a decade ago. If things truly turn bad for the commercial real estate industry or if fraud is discovered, he added, the Fed could end up taking possession of properties that default.

CMBS can be something of a last resort for borrowers whose projects are unlikely to qualify for a loan with a desirable interest rate from a bank or other lender (because they are too big, too risky or some other reason), according to experts. Underwriting practices — the due diligence lenders do before extending a loan — for CMBS have gained a reputation for being less strict than for loans that banks keep on their balance sheets. Government watchdogs found serious deficiencies in the underwriting for securitized commercial mortgages during the financial crisis, just as they did in the subprime residential market.

The due diligence process broke down, Flynn maintains, in precisely the mortgages he was worried about: the 10-year loans obtained before the financial crisis. What Flynn discovered, he said, was that rather than lowering the values for properties that had taken on bigger loans than they could pay off, their owners instead obtained new loans. “Someone should have taken the losses,” he said. “Instead, they papered over it, inflated the cash flow and sold it on.”

For commercial borrowers, small bumps in a property’s profits can qualify the borrower for millions more in loans. Shaving expenses by about a third to boost profit, for instance, can sometimes allow a borrower to increase a loan’s size by a third as well — even if the expenses run only in the thousands, and the loan runs in the millions.

Some executives for lenders acknowledged to ProPublica that they made changes to borrowers’ past financials — scrubbing expenses from prior years they deemed irrelevant for the new loan — but maintained that it is appropriate to do so. Accounting firms review financial data before the loans are assembled into CMBS, they added.

The financial data that ProPublica examined — a sample of six loans among the thousands Flynn identified as having inflated net operating income — revealed potential weaknesses not readily apparent to the average investor. For those six loans, the profits for a given year were listed as 9% to 30% higher in new securities than in the old. After they were issued, half of those loans ended up on watch lists for problem debt, meaning the properties were considered at heightened risk for default.

In each of the six loans, the profit inflation seemed to be explained by decreases in the costs reported. Expenses reported for a particular year in one CMBS simply vanished in disclosures for the same year in a new CMBS.

Such a pattern appeared in a $36.7 million loan by Ladder Capital in 2015 to a team that purchased the Doubletree San Diego, a half-century-old hotel that struggled for years to bring in enough income to satisfy loan servicers, even under a previous, smaller loan.

The hotel’s new loan saddled it with far greater debt, increasing its main loan by 60% — even though the property had landed on a watchlist in 2010 because of declining revenue. Analysts at Moody’s pegged the hotel’s new loan as exceeding the value of the property by 40.5% (meaning a loan-to-value ratio of 140.5%).
Filings for the new loan claimed much higher profits than what the old loan had cited for the same years: The hotel’s net operating income for two years magically jumped from what had previously been reported: 21% and 16% larger for 2013 and 2014, respectively.

Such figures are supposed to be pulled from a property’s “most recent operating statement,” according to the regulation governing CMBS disclosures.
But, in response to questions from ProPublica, lender Ladder Capital said it altered the expense numbers it provided in the Doubletree’s historical financials. Ladder said it wiped lease payments —$700,608 and $592,823 in those two years — from the historical financials, because the new owner would not make lease payments in the future. (The previous owner had leased the building from an affiliated company.)

Ladder, a publicly traded commercial real estate investment trust that reports more than $6 billion in assets, said in a statement, “These differences are due to items that were considered by Ladder Capital during the due diligence process and reported appropriately in all relevant disclosures.”

Yet when ProPublica asked Ladder to share its disclosures about the changes, the firm pointed to a section of the pool’s prospectus that didn’t mention lease payments, or explain or acknowledge the change in income.

The Doubletree did not fare well under its new debt package. Revenues and occupancy declined after 2015 and by 2017, the hotel’s loan was back on the watch list. The hotel missed franchise fee payments. Ladder foreclosed in December 2019, after problems with an additional $5.8 million loan the lender had extended the property.

The Doubletree loan was not the only loan in its CMBS pool, issued by Deutsche Bank in 2015, with apparently inflated profits. Flynn said he was able to track down previous loan information for loans representing nearly 40% of the pool, and all had inflated income figures at some point in their historical financial data.
There was also a noticeable profit increase in two loans Ladder issued for a strip mall in suburban Pennsylvania. The mall’s past results improved when they appeared in a new CMBS. Its 2016 net operating income, previously listed as $1,101,207 in one CMBS, now appeared as $1,352,353 in another, data from Trepp shows — an increase of 23%. The prospectus for the latter does not explain or acknowledge the change in income. The mall owner received a $14 million loan.

Less than a year after it was placed into a CMBS, the loan ran into trouble. It landed on a watchlist after one of its major tenants, a department store, declared bankruptcy.

Ladder said it excluded $203,787 in expenses from the new loan because they stemmed from one-time costs for environmental remediation of pollution by a dry cleaner and a roof repair. Ladder did not explain why the previous lender did not exclude the expense also.

The pattern can be seen in loans made by other lenders, too. In a CMBS issued by Wells Fargo, a 1950s-era trailer park at the base of a steep bluff along the coast in Los Angeles reported sharply higher profits — for the same years — than it previously had.
The Pacific Palisades Bowl Park received a $12.9 million loan from the bank in 2016. The park reported expenses that were about a third lower in its new loan disclosures when compared with earlier ones. As a result, the $1.2 million in net operating income for 2014 rose 28% above what had been reported for the same year under the old loan. A similar jump occurred in 2013. (Edward Biggs, the owner of the park, said he gave Wells Fargo the park’s financials when refinancing its loan and wasn’t aware of discrepancies in what was reported to investors. “I don’t know anything about that,” he said.)

Flynn said he found that for the $575 million Wells Fargo CMBS that contained the Palisades debt, about half of the loan pool appeared to have reported inflated profits at some point, when comparing the same years in different securities.

Another of the loans ProPublica examined with apparently inflated profits was for a building in downtown Philadelphia. When the owner refinanced through Wells Fargo, the property’s 2015 profit appeared 23% higher than it had in reports under the old loan. Wells bundled the debt into a mortgage-backed security in 2016.

The building, One Penn Center, is a historic Art Deco office high-rise with ornate black marble and gold-plated fixtures, and a transit station underneath. One of the primary tenants, leasing 45,000 square feet for one of its regional headquarters, happens to be the SEC. The agency declined to comment.

David Goldsmith

All Powerful Moderator
Staff member

David Goldsmith

All Powerful Moderator
Staff member
More shady dealings in CMBS?

“Corporate shell game”: Special servicer says Hudson’s Bay undermined $850M loan
Retail operator’s move to go private improperly transferred company and assets to Bermuda-based entity, lawsuit charges

The special servicer for an $850 million CMBS deal has accused Hudson’s Bay Company of engaging in a “clandestine corporate shell game” as it took the department store operator private, a move that undermined the creditworthiness of the loan, which now faces default. And as with many other real estate-related court cases lately, Covid-19 is a focus.
The CMBS loan provided by JPMorgan Chase, Bank of America, and Column Financial is secured by 24 Lord & Taylor stores and 10 Saks Fifth Avenue stores across 15 states. As the parent company of both brands at the time, Hudson’s Bay was the tenant at all 34 stores and a partial landlord through a joint venture with mall operator Simon Property Group.

Hudson’s Bay was also the guarantor of rent payments at the stores. But over the past several months, the now-private company “engaged in deliberate and concealed corporate restructurings that stripped assets” from the original parent company and “transferred them to newly formed, foreign entities,” special servicer Situs claimed in its federal lawsuit against Hudson’s Bay. That alleged action violated “loan documents and related guarantees,” according to the complaint, filed Monday in New York on behalf of the CMBS trust.

The suit also accuses Hudson’s Bay of improperly using the coronavirus as an excuse for not addressing concerns about the asset transfer, which it called “an opportunity to try to smokescreen their numerous breaches of their obligations.” A number of real estate-related lawsuits have emerged in recent weeks that allege defendants improperly use Covid-19 as an excuse to break off signed deals or terminate leases. In late February, Hudson’s Bay shareholders approved the move to take the company private in what was seen months earlier as a $1.3 billion deal.

Hudson’s Bay said it rejects the lawsuit’s accusations. In a statement, a company spokesperson said the Simon Property joint venture was the loan borrower while Hudson’s Bay was “simply a guarantor of lease obligations” under the terms of the joint venture. “To suggest that HBC has violated any loan document provisions is categorically false,” the spokesperson added.

“Empty shell”
Situs claims to have only discovered the alleged scheme in April after Hudson’s Bay fell behind on rent payments. Following negotiations to address the shortfall, Situs says it was informed that a signature block on a document had to be changed because Hudson’s Bay Company, the entity that guaranteed rent payments, no longer existed.

In its place, the lawsuit says, was “an empty shell” called Hudson’s Bay Company ULC, all of whose assets and liabilities had been transferred to a Bermuda-based limited partnership whose general partner is controlled by Hudson’s Bay CEO Richard Baker, and whose limited partners include the Abu Dhabi Investment Council.

Situs says that these transfers were improper because loan documents required the CMBS trust to approve of — or at least be informed of — the transactions. Hudson’s Bay, for its part, says the restructuring was “driven entirely by tax considerations” and that the servicer’s concerns are “irrelevant distractions,” according to correspondence included in the lawsuit.

But Situs claims “defendants simply do not have the right to deliberately and secretly violate the contractual restrictions on such corporate maneuvers and then, when caught, declare it to be all fine.”
Situs did not respond to a request for comment.

The CMBS loan was transferred to special servicing on April 23, “due to the borrower’s failure to make the April debt service payment,” according to servicer commentary provided to Trepp.

The special servicer is now seeking a declaratory judgment to void the allegedly improper transfers, a temporary restraining order to prohibit Hudson’s Bay from engaging in additional restructurings and transfers, and an order expediting discovery for documentation of the transfers.

Situs pointed to reports that Lord & Taylor may liquidate its stores upon reopening following coronavirus-related shutdowns nationwide, and that Hudson’s Bay may attempt to acquire bankrupt rival Neiman Marcus.

Hudson’s Bay sold Lord & Taylor to clothing rental service Le Tote last August for $100 million, but remains the guarantor for rent payments at the Lord & Taylor properties in the loan portfolio.

David Goldsmith

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Staff member

Mall of America falls behind on $1.4B mortgage
Delinquency poses threat to mortgage-backed bonds

The country’s largest shopping mall has reportedly fallen behind on its $1.4 billion mortgage, posing a threat to the wider bond market.
The Mall of America in Minnesota, which features more than 500 stores across 2 million square feet, missed mortgage payments in both April and May, according to the Financial Times.
The mall has been shut since March because of the pandemic, and has reportedly notified its mortgage servicer, Wells Fargo, about hardship stemming from the closure.

Retailers across the country have been hit hard by the pandemic, which has led to mass store closures and layoffs. Earlier this month, Neiman Marcus, the anchor tenant at Related Companies’ luxury Hudson Yards mall, filed for bankruptcy. J. C. Penny, another major department store chain, filed for bankruptcy last week.

The pressure on retailers has implications for the commercial mortgage-backed securities market, which distributes loans through bonds.

The FT reports that upward of one in five loans bundled into commercial mortgage-backed securities are currently on “watch lists” that are recorded by mortgage-servicing companies.

Last month, Don Ghermezian of Triple Five Group — owner of Mall of America — said in an interview that “many malls will be headed into default” if they can’t secure federal assistance.

The mall is set to reopen in June.

David Goldsmith

All Powerful Moderator
Staff member

Commercial deal volume plummeted 71% in April
With $11B in trades, the month’s transaction volume was the lowest in a decade

The volume of commercial real estate deals fell to the lowest level in a decade, according to a new report.
Deal volume totaled $11 billion in April, a 71 percent year-over-year drop, according to commercial real estate data provider Real Capital Analytics. The number of deals, meanwhile, has fallen an average of 36 percent since January, but saw a drop of 61 percent between March and April.
Although some property types fared better than others, not one ended the month on a high note. Hotel sales descended to $5.1 billion, their lowest level since RCA started recording transactions. The office and industrial sectors performed the “best,” but each still notched a 60 percent drop in transactions.

Entity-level, or company sales, and portfolio trades saw deal volume contract by 80 percent year over year. The report notes that the freeze on mergers and acquisitions will continue until the market stabilizes — or until more distressed opportunities appear.

David Goldsmith

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How this deal actually gets done could be a bellwether for most of the upcoming mall restructuring.

Competing bids for Starwood’s suffering retail
Washington Prime Group, Mission Peak Capital and Pacific Retail have made proposals

Starwood Capital’s seven-property regional mall portfolio, already beset by high vacancy rates and in deep trouble with Israeli investors, has hit a new low as the coronavirus has sunk rent collection to around 20 percent.
Now, with bondholders poised to accelerate payments and a senior lender threatening to foreclose, six competing proposals to restructure the assets have emerged, according to documents recently filed on the Tel Aviv Stock Exchange.
The first batch, submitted May 17, came from Global Fund Investments, Namdar Realty Group and Kohan Retail Investment Group. Starwood presented its own proposal a week later jointly with Mission Peak Capital, followed by Washington Prime Group and a joint venture of Pacific Retail Capital and Golden East Investors.

Starwood has seen its Israeli bonds downgraded three consecutive months, to C-, a rating low enough that bondholders can demand immediate repayment. Meanwhile, the firm has also defaulted on a $549 million CMBS loan that covers five of the properties, according to disclosures.
The bonds, which traded around a dismal 30 cents on the dollar for most of 2019, have fallen to around 15 cents during the coronavirus pandemic.
Washington’s letter of intent outlines a plan to buy a 75 percent ownership interest in the properties, with Starwood retaining the rest. Washington would assume management of the properties, including leasing, and would provide Starwood with $45 million.

Mission’s letter expresses support for a plan Starwood outlined in a May 24 term sheet, which would involve Mission injecting $5 million of new capital into Starwood to support its retail assets and start a restructuring agreement with its senior lenders.

Under this agreement, Mission would receive 30 percent of profits moving forward, and Starwood, which would stay on as the property manager, would be released from all liability and garner 20 percent of profits. The company’s bondholders would get the remaining half of profits along with $19 million in the trustee account.

Mission first approached Starwood Retail Partners in mid-May to discuss restructuring the company. Its letter lists the reasons it prefers Starwood’s plan: It offers the most cash to the company’s bondholders; it would allow the companies to act quickly on troubled properties; and firms making competing bids “suffer from a lack of credibility” and are more interested in paying themselves through fees instead of helping bondholders.
“The properties are in a dire financial situation where rent collections hover around 20% due to Covid-19 related closures,” its letter states. It adds that changing the property manager “would signal a sinking ship to tenants and embolden attempts to seek rent reductions and holidays,” and make foreclosures at the retail properties more likely.

Pacific Retail and Golden East Investors would distribute 65 percent of Starwood’s unrestricted cash balance for its bondholders and use the rest to support the company’s ongoing operations. Its proposal would entitle it to multiple management fees.

The letter says Pacific Retail has “unparalleled knowledge” of the seven mall properties it aims to manage, as it had run them before Westfield sold them to Starwood in 2013 for $1.6 billion. Contrary to Mission’s letter, it claims that special servicers do not see Starwood as the ideal manager for its mall properties and that Starwood has a “lack of conviction in its ability to create value from the properties.”

Starwood and Washington declined to comment. Representatives for Mission, Pacific Retail, Golden East Investors and Kohan did not respond to requests for comment. Global and Namdar could not immediately be reached.

In a recent interview with The Real Deal, Starwood Capital Group CEO Barry Sternlicht said the pandemic was “a dagger to the chest” for the retail industry but that the firm’s retail outfits were “not really significant investments.”

David Goldsmith

All Powerful Moderator
Staff member
This was a major merger of mall operators announced back in February.

Simon is buying Taubman Centers
Taubman Centers’ entire board of directors is up for election this
Simon Property Group, the country’s largest mall owner, is buying Taubman Centers, the smaller rival that it’s had its eye on for nearly two decades.
The two companies announced Monday they had reached an agreement for Simon to buy an 80 percent stake in Taubman at $52.50 per share. That’s a 51 percent premium over Taubman’s closing price on Feb. 7.

The Taubman family will retain 20 percent ownership.
The deal puts an end to one of the longest-running will-they, won’t-they stories in REIT mergers and acquisitions.
Taubman Centers, the $2 billion mall company that’s been tightly held by the Taubman family since 1950, successfully fended off a hostile takeover bid by Simon and Westfield in 2003.
But this time around, the Taubmans appeared to be in a weaker position.
That’s because CEO Bobby Taubman, whose father founded the Bloomfield Hills, Michigan-based mall operator, has recently bowed to investor pressure and ceded his family’s tight grip on the real estate investment trust’s board of directors.
All nine members of the board will be up for election at the same time this year. That meant David Simon and his $45 billion mall giant could have run a slate of directors who would vote in favor of a tie-up.
“This is the first year Taubman seemingly does not control its own destiny in terms of an M&A transaction,” Green Street Advisors analyst Vince Tabone wrote in a note last week after Bloomberg reported that Simon and Taubman engaged in merger talks beginning late last year. “A new board could decide to make a change in leadership and if Taubman were to lose control of its family business, a sale of the company would seem inevitable.”
A spokesperson for Taubman declined to comment and a representative for Simon did not immediately respond to a request for comment.
Observers have long noted that the two companies would make a good fit with one another. Simon is the largest mall operator in the country with a portfolio of 233 malls, outlets and other properties in North America, Europe and Asia. Green Street values the assets at about $100 billion.
Taubman is a much smaller company with interests in just 24 properties, valued by the advisory firm at about $11 billion. But it’s widely viewed by observers to be the highest-quality mall operator in the country with the best anchor tenants and mix of stores.
Long after the 2003 takeover bid, the M&A drum continued to beat.
Most notably, activist investor Jonathan Litt took a position in Taubman in 2016 and started pushing for changes to the company’s corporate governance. The Taubman family owns roughly 2.9 percent of the company’s common stock. But through ownership of preferred shares under the REIT’s dual-class share structure, the Taubmans control about 30 percent of the voting rights.
That means a hostile bidder would need to convince six of the board’s nine members to vote in favor of a sale.
Another advantage the family held was the board’s staggered structure, meaning all nine directors normally stood for election at different times instead of at the annual meeting. Litt unsuccessfully pushed to unseat Bobby Taubman from the company’s board. But he did prevail in compelling the REIT to hold de-staggered elections.
In an open letter to investor’s last year, the activist investor hinted at the possibility of waging a contentious proxy contest this year.
“All directors and specifically, Bobby Taubman, can be held accountable by shareholders for the company’s atrocious absolute and relative performance for the first time since 2017 at the annual 2020 meeting,” he wrote.
Indeed, while Green Street’s Tabone noted that news of the talks didn’t necessarily describe them as hostile, he wrote, “they probably aren’t overly friendly conversations either.”

Simon Property Group And Taubman: Divorcing Before The Honeymoon
Jun. 10, 2020 3:12 PMSimon Property Group, Inc. (SPG)
  • It seems long ago, but in early February, Taubman Centers was trading below $30. Taubman, one of the better mall REITs, traded in the $60s as recently as 2018.
  • Around Feb. 10, Taubman's stock approximately doubled to $52 on news Simon Property Group made an offer to buy the firm.
  • Simon was trading around $150 after the news was digested but fell to $42.24 as the coronavirus forced the shutdown of malls around the country.
  • What we initially described as an "expensive" valuation for Taubman has become Rolls Royce type opulence. We discuss the costs and where each are likely to end up when the smoke clears.
The Many Roads Leading Here
"They say, timing is everything. But then they say, there is never a perfect time for anything." Anthony Liccione
Simon Property Group
(SPG) CEO, David Simon, would likely agree. Within days of the proposed $3.6 billion "mega merger" between Simon and Taubman Centers Inc. (TCO), two of the premier mall owners in the U.S., the coronavirus began sweeping through Italy and generating global headlines. Italy initiated what's likely the harshest nationwide lockdown of any Western government in the post World War II era shortly thereafter.
Within three weeks of Italy's lockdown, federal officials in the U.S. had initiated controversial travel bans and recommended similar measures. In total, 32 of 50 U.S. states had significant restrictions on citizens' ability to congregate and open businesses by March 31.
With mall owners' facilities effectively shuttered two weeks into March, coupled with widespread financial vulnerability in the apparel and movie sector, retail real estate's struggles accelerated. Those dependent on large gatherings of people were the hardest hit: Malls, movie theaters, and theme parks.

Source: Yahoo Finance
Simon and Taubman are shown alongside The Macerich Company (MAC) on a one-year stock chart. Simon was holding up considerably better than its two peers thanks to its much larger ($34.1 billion in total assets) and stronger (S&P Credit Rating of "A," tied for best in the REIT sector) balance sheet. Taubman's spike in mid-February looked disproportionate, even for a buyout, before its peers Simon and Macerich declined by 50% and 70%, respectively, as government shutdowns and concerns surrounding the coronavirus reverberated throughout financial markets.
Foreshadowing Of Today's "Surprise" Announcement
Despite a general consensus (which is often wrong) that the deal would close regardless of market conditions, the market began discounting the probability as demonstrated by Taubman's stock falling well below the $52.50 agreement price.
Every day that the industry's outlook darkened and the peer groups' stock prices declined, the probability of Simon terminating the Taubman deal rose.
For those who invested the time to listen in on the Q1 conference call or read the transcript as we did, management commented on the subject twice. The first was in the customary fashion:
Let me turn to the Taubman transaction. As you know, we announced a transaction with Taubman on Feb. 10, 2020, and we will not make any comments or provide any updates on this call about the status of the Taubman transaction.

That "we will not make any comments or prove any updates on this call" didn't exactly turn out to be the case.
After analyst Christy McElroy inquired about the desire to issue more long-term debt and any changes to that plan related to the Taubman purchase, David Simon, CEO, answered:
“OK. So, I have nothing to say on the further on Taubman. We’ll let you know when we have information to provide. So, there’s not much more I can say on that front.”
Another analyst asked a question involving Taubman later in the Q&A.
“Derek Johnston
OK. Understood, and thank you. So, a lot of investors are going to bring negative assumptions and speculation from your lack of commentary on the Taubman merger. So, without talking about Taubman at all, what would you say to those investors here and now directly?
David E. Simon
I said what I have to say, Derek.”
We were not the only market participants who noticed David's tone. Within the constraints of the legal system, Simon told us as much as they could regarding their stance on the deal and it wasn't optimistic. Simon had the option of providing positive commentary on the deal but chose not to. Like most areas of life, what people choose not to do can be as telling as what they decide to do.
Key Aspects Of The Contract and Simon's Claims
To start, the merger agreement for Simon to purchase 80% of Taubman has been appropriately described as "iron clad" by many research institutions. The following assessment of the agreement's legal terms is strictly our opinion and should not be used to make a decision to buy or sell any security. We obtained a scanned copy of the complaint filed by Simon.

Source: State of Michigan
The contract has a "material adverse effects" clause, and to the average reasonable person, the pandemic and its externalities certainly seem to fit that description. We disagree. Pandemics are specifically excluded. Simon must convince a court that Taubman was disproportionately impacted by the coronavirus and its implications. Taubman closed its malls exactly one day after Simon and has already began opening stores in Asia where the coronavirus appears to have run its course. Taubman also reduced costs significantly. Per the formal complaint it filed, Simon argues they are justified as Taubman's properties are:
“...uniquely vulnerable to the post COVID-19 retail environment for a multitude of reasons, including because they are primarily indoor properties that many consumers will avoid, are heavily dependent on a tourism industry that has been decimated, serve wealthy consumers who are now more likely to shop online and feature high-end upscale stores that are suffering heavily from the economic effects of the pandemic.”

Simon continues by claiming Taubman's properties are more susceptible to the current crisis than its peers.
“The vast majority of Taubman’s properties are indoor malls in densely populated areas. Indoor malls account for more than 80% of Taubman’s properties and more than of its net operating income. Taubman’s competitors, in contrast, have far more open-air malls, outlet centers, strip malls and outdoor “lifestyle centers” or “power centers” featuring large retailers such as Home Depot and Target. As many financial analysts have observed, and as the superior performance of outdoor shopping centers during the pandemic already clearly demonstrates, the indoor malls that Taubman owns and operates are the last types of retail real estate properties that most consumers will want to visit on a long-term basis after COVID-19.”
We went through Simon's claims line by line totaling nearly 40 pages. Simon's argument is that the merger should be terminated under the material adverse effect, or "MAE" clause. Our non-legal and non-binding opinion is it is possible but unlikely that a court will consider the long list of complaints to reach the MAE standard.
An important caveat is that Simon has much deeper pockets than Taubman and has no problem spending a hundred million in legal expenses to either terminate the deal or renegotiate the purchase price lower. As demonstrated, Taubman's stock is likely to fall another 50% from today's 30%-40% drop if they are priced on a standalone basis. TCO's management has a strong incentive to make some deal go through, even at a lower valuation.
Another clause often included in these types of deals is "force majeure" language where one or both parties can terminate the proposed deal because of unforeseeable events. That was not included in Simon's proposed purchase of Taubman, and if it had, Simon would potentially have an easy out.
Now that we have a baseline understanding of the deal, we can accurately predict what Simon said in the press release prior to reading it.
Simon's grounds to exit the agreement are two-fold.
  • The coronavirus and associated government shutdowns had a "uniquely material and disproportionate effect on Taubman" compared to its peers.
  • Taubman breached its obligations by failing to properly mitigate the impact of these related variables compared to industry peers.
Simon claims its target didn't reduce costs and capex sufficiently compared to the rest of the industry. Predictably, at least for those with a fundamental understanding of the agreement, Simon did not justify terminating the deal based on the coronavirus itself, but rather Taubman's response to it.

In terms of where the deal goes form here, a person "familiar with the matter" told MSN there are no discussions about renegotiating the transaction at a lower valuation. That is not mentioned in any of Simon's public statements but we don't put too much emphasis on this.
Simon has been trying to buy Taubman for nearly 20 years and there's no reason it wouldn't consider the assets attractive at a favorable valuation. It's possible Simon wants to pay less, swap cash payments for SPG stock, or some combination.
Article VIII, Section 8 of the original agreement outlines the provisions and effects of terminating the deal. Specific penalties are associated with exiting agreement during the go-shop period, but that 45-day period is long gone.
Impact To Simon and Taubman's Stock Prices
Taubman currently trades ~$35 per share compared to its pre- and post-deal price in the high $20s and low $50s, respectively. The corresponding market capitalization ranges from approximately $2.25 billion to $3.6 billion. These are important to keep in mind given Simon's current market cap is ~$26.5 billion was above $50 billion earlier in 2020.
Taubman was never more than a strategic "bolt-on" to Simon's 10x larger retail real estate empire. In our assessment, a major, if not primary, benefit was that Simon would end up owning the top dozen or so malls in the U.S. thanks to several trophy assets within Taubman's portfolio.
We can ascertain where Taubman is most likely to trade if the deal fully collapses via several methods. A direct comparison based on changes in stock prices can be performed with Taubman falling at the midpoint between Simon, the highest quality and most fortified player, and Macerich, a higher levered peer that still has considerable quality assets alongside a segment of lower performing properties.

This corresponds with a -46.2% decline from Taubman's 1/30/2020's stock price or $12.94 per share.
Another strategy is applying cash flow multiples. This works similarly to our previous example as TCO has historically traded with valuations approximately in the middle of SPG's and MAC's.
Simon's trades at a 10.1x forward multiple compared to Taubman and Macerich's 14.9x and 4.6x respectively. Applying Simon's multiple brings Taubman's stock price down to $30.8 per share. The historically more accurate midpoint multiple of 7.4x or a stock price of $22.57. In case it's not obvious, the specific multiples used and cash flow projections are immaterial to this analysis: It's all on a relative basis and the assumptions behind the calculations are identical.

This exercise suggests TCO stock is likely worth $12.94 to $22.57 per share if the deal collapses assuming no penalty or benefit to Taubman. Concerning legal payments, and to make the math easy, each $100 million in cash paid from Simon to Taubman corresponds to a 3.6% increase in TCO's market capitalization. If Simon is forced to pay Taubman $1 billion, TCO should move 35%-40% higher, all other things equal (note: REITs are valued on their balance sheet and future cash flow, a single cash payment received today will not increase future cash flows unless they are invested in cash flowing assets).
The situation is more complex for Simon although less significant. The maximum risk to Simon is the combination of significant legal expenses and compensation to Taubman for terminating the deal outside of the terms of the agreement. The ~50% premium to Taubman's pre-agreement price corresponds to approximately $1.35 billion.
That's the potential benefit Simon essentially offered Taubman shareholders.
On top of this, Simon is likely to absorb $10-$25 million in legal expenses. This is lower than many other firms as Simon's large legal team already is battling tenants and insurance companies on a regular basis. We'll round up to $1.5 billion to be conservative but that still represents less than 6% of its current market capitalization and less than 2% when the stock was at 52-week highs.
Taubman's current share price is betting on a significant monetary recovery or renegotiated deal with Simon around $40 per share. There's 50%-plus downside risk if one of those two does not occur. For those reasons, and despite a great appreciation for Taubman's assets and management team, we do not consider TCO attractive above $25 per share.
Simon continues to provide among the best risk-adjusted return opportunities in the REIT space despite doubling from recent lows. A weak and prolonged economic recovery still results in a fair value 50% higher than today's levels. Economic activity and normalization in line with expectations puts a minimum value for SPG at nearly 100% higher. For context, the corresponding $150 share price is still 10% below 52-week highs and 25% below two-year highs.