Real Estate Inv. Trusts: REITs
The Looming Tsunami of CRE

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By LanRes
January 14, 2009

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

Steven L. Good, the entrepreneurial lawyer / real estate auctioneer par excellence, was a generous, hardworking businessman. He literally wrote the book on how to succeed in real estate auction sales - be ethical and professional, work hard, network, network, network, and give a lot of your time and effort back to the community at large. Whether that was the Chicago business community, the national real estate industry, or numerous charitable organizations, Steven Good was actively involved, serving on committees, and generously contributing to others. I also was always impressed by Steven Good's generosity to students, giving lectures at several universities and helping real estate education programs to flourish.

Hence, hearing news last week of his death, apparently a suicide, has been very troubling. Extremely sad and tragic, this sudden, unexpected passing is a tremendous loss for his family and for society in general, and terribly worrisome for anyone else concerned about the crashing global economy. What rash of problems beset Steven's mind so intensely, so painfully, for this disaster to occur?

As recently as mid-December, Good told that, "... we see a tsunami coming in the commercial markets that will dwarf in dollar terms the problems in the residential markets if something isn't done." Steven was gravely concerned about illiquidity in the CRE market, about how no one was able to obtain financing to complete any deals. I had noticed that some of his firm's high-profile auctions in 2008 were busts - buyers wouldn't bid high enough so that sellers could accept and repay their lenders. His sales activity undoubtedly had plummeted, just as it had for all CRE brokers and auctioneers in 2008.

Perhaps making matters worse, Steven Good had been expanding his Sheldon Good-related operations in recent years - more regional coverage in the U.S., expanding operations abroad, and raising a pool of capital that advanced money to sellers in anticipation of repayment after successful auctions. These were bold moves, very entrepreneurial, and very "Steven Good". He wanted to emulate the profitability and prestige of art auction houses such as Christie's and Sotheby's. Unfortunately, growth initiatives of this nature (as was the case for a number of leading REITs) wound up being vulnerable last year as the global financial crisis suddenly mushroomed up like an atomic bomb being exploded in the midst of the economy and the CRE market.

Steven's lifeless body was found early on Monday morning last week, in a wildlife preserve in Kane County near East Dundee, IL. I believe the COO of Sheldon Good (at least as of last fall) lives in West Dundee, so perhaps Steven had driven out there on Sunday hoping to discuss the global financial crisis, its harsh impacts on his business and investments, and if there was anything they could do. Whatever occurred that ill-fated weekend, Steven obviously wound up extremely depressed, more depressed than we would have ever suspected or could have imagined.

Beyond sorrow for Steven and deep sympathy for his survivors, what can we learn from his stern warning to us? How severe is this potential tsunami of CRE problems awaiting us this year if government and lenders don't do something big and soon? Steven Good probably saw financial troubles in the CRE market with a magnified lens, as his primary business - real estate transactions - was getting slammed to a crawl by the global financial crisis and his equity and debt investments were likely in peril. Moreover, from a social perspective, he was undoubtedly concerned about how others were being impacted by the global financial crisis, by the Madoff Scandal, by war in the Middle East, and so forth.

The looming tsunami of CRE problems that Good perceived is a very real risk to all, but will impact various properties, REITs & REOCs, lenders, and investors to widely different degrees. Well-leased office properties to healthy tenants at below market rents with no leases expiring during the next four or so years may ride out the tsunami in fairly good condition, with relatively low risk attracting low interest rates and low cap rates. In contrast, a lower quality, Class B shopping center may implode as retailers go belly up like lemmings and no investors or lenders want to touch the doomed property (unless ultra-conservatively underwritten and priced for 20%+ unleveraged IRRs). In between, of course, there are thousands of variations in terms of tenant mix, rent roll, deal structure, demand & supply trends, etc., so the specific impacts of this looming tsunami will range tremendously if/when it crashes upon us this year.

Current market pricing seems to reflect a weighted distribution of plausible scenarios, with some scenarios reflecting effective government help coming to the rescue by mid-year and some scenarios reflecting the tsunami crashing hard upon us. For most investors, this weighting is probably done in an informal, intuitive manner. We simply weigh our fears about missing out on a potential buying opportunity of unprecedented scale against fears that we could be hammered again by a CRE crash of unimaginable proportions. Tragically, Steven Good drowned in those downside fears, which were probably terribly real for him.