WSJ recourse loans

Wall Street Journal

After a decade of easy lending, the dreaded personal guarantee is making a comeback in the real-estate industry, bringing back the kind of tough terms that borrowers hoped not to see again.

As loans for commercial projects have become difficult to come by in this credit crunch, borrowers are being forced to consider loans that would give the lenders "recourse" to the borrowers' personal fortunes -- terms that led many a developer, including Donald Trump and William Zeckendorf Jr., to near ruin in the real-estate crash of the early '90s. More recently, New York developer Harry Macklowe found himself in a bind after he signed a personal guarantee on a $1.2 billion loan.
[illustration]
Rob Shepperson

Despite Mr. Macklowe's experience, these recourse loans -- once a staple of commercial lending -- had largely fallen by the wayside during the past decade as banks found ways to minimize their risk.

Now, with the securities market for commercial loans still anemic, recourse loans are popping up again -- and striking fear in the hearts of developers.

Dale Anne Reiss, global director of real estate for Ernst & Young, recalls the efforts involved in restructuring recourse loans, with some people losing numerous properties including their own homes: "Some of the workouts were extremely painful," she said. "You were tearing apart people's lives."

Yet commercial investors who can't wait out the credit crisis may have little choice but take a deep breath and sign a recourse loan. "Oftentimes, it's either sign personally or you don't get the loan," said Donald Isken, a real-estate attorney at Morris, Nichols, Arsht & Tunnell LLP. "The tide has changed."

Take, for example, Judah Hertz, chief executive of Hertz Investment Group in Santa Monica, Calif. About 3½ years ago, Mr. Hertz took out a $50 million mortgage from LaSalle Bank to buy an office building in New Orleans. That loan required no personal guarantee. As the loan is due next month, he is left with little choice but to accept a new $50 million loan from Wells Fargo that requires him to personally guarantee 25% of that amount.

"If you're going to banks today, they all require recourse," said Mr. Hertz, while adding that he isn't worried about his ability to pay off the loan.

During the recent sales frenzy for commercial properties, nonrecourse loans were the norm. Typically, this meant that the developers put up as collateral only the buildings they were purchasing. If they couldn't pay off the loans, they simply handed the building's keys to the lender and walked away. The borrowers' other holdings -- including personal assets such as homes and boats -- remained intact. The investment banks that originated many of these loans felt comfortable with the arrangement because they typically packaged those loans into commercial-mortgage-backed securities, or CMBS, and sold them as bonds, reducing their own risk if the borrowers couldn't pay.
[Harry Macklowe]

Now, with a 90% drop in CMBS sales, banks have all but stopped originating loans aimed at the bond markets. Instead, they are returning to the traditional model of holding on to -- as opposed to selling -- the loans. "We're not closing loans for securitization. We're closing loans for balance sheet," said Brett Smith, managing director in Wachovia Corp.'s real-estate group. And with the return of balance-sheeting lending comes the return of recourse loans.

Even for banks, recourse lending can cause headaches. Borrowers are more likely to fight the banks if they face losing much of their net worth over one bad gamble. Plus, the banks make less money; the interest rates they can charge on recourse loans are about 1% lower than on nonrecourse loans.

Banks that have already suffered losses related to residential mortgages are increasingly viewing recourse loans as a necessary layer of protection. When prices were rising, the bank could take control of a building and sell it to pay off the loan. Now, with falling valuations, the building could be worth less than the debt on it. In that scenario, banks want a way to make up the difference.

Investors who buy debt welcome the return of discipline that recourse loans represent. "With more discipline, you're going to develop and derive a better product," said Jack Foster, managing director for Franklin Templeton Real Estate Advisors.

Borrowing recourse debt is one of the few options available to Dallas developer John Sughrue, who is leading a group that is trying for financing to build a $180 million condominium project in the city's thriving new arts district. He and his partners can contribute about $40 million in equity and get an additional $100 million in conventional financing. "We're missing about $40 million," he said.

One possibility would be to take out a "mezzanine" loan, which fills the gap between the equity and the first mortgage, but the rates would be so high that it would make it unfeasible given the amount of risk involved. The other major option would be to guarantee the additional $40 million. Mr. Sughrue said he won't personally sign for the loan and is still pondering his options.

With such onerous terms, some developers may opt not to do deals at all. "It is definitely slowing down the pace of real-estate transactions," said Douglas Buck, a partner with Foley & Lardner who recently represented several developers who decided to put off doing deals because of their reluctance to sign a personal guarantee.

Mr. Macklowe's travails in buying $7 billion of Manhattan property in February 2007 provide a reminder of the high stakes. Even though Mr. Macklowe didn't have to tap into his personal fortune to pay off a loan from the private-equity firm that helped finance the transaction, Fortress Investment Group, the knowledge that $1 billion of his fortune was at stake likely made him work hard to pay off the creditor, industry observers said. He ended up selling five of his Manhattan properties including his trophy General Motors building at 767 Fifth Ave.

Many borrowers may have no choice but to swallow the tightened lending terms. According to a March study by the Mortgage Bankers Association, $16 billion in loans that were packaged into CMBS -- which are nonrecourse -- are expected to come due this year, followed by about $19 billion next year.

Jerry Wolkoff, a developer in Long Island, N.Y., is among those who will do anything to avoid recourse. Mr. Wolkoff is planning to build a $1 billion mixed-used property in Suffolk County. He said he plans to put down equity that represents as much as 40% of the value of the project, in hopes of qualifying for a nonrecourse loan.

--Peter Grant and Jennifer S. Forsyth contributed to the article.

Write to Lingling Wei at lingling.wei@dowjones.com

CA buyers decend

Mercury News

GREGG WINCHESTER and his wife, Cynthia, made an offer on the 2,430-square-foot, four-bedroom, three-bath house the same day they saw it.

"We felt now was the time to purchase something for our family now that prices had come down," he said. The couple bought the bank-owned house for $355,000.

Sales rose in most of East Contra Costa County in April, but Brentwood sales, rising to 107 purchases, ensured some of the highest sales in the Bay Area, DataQuick Information Systems reported.

Sales also rose significantly in Antioch, Daly City, Fairfield and most of San Joaquin County — all areas famous for foreclosures.

"Does it signal an absolute bottom?" asked DataQuick analyst Andrew LePage. "That's still unclear."

Last January, Antioch had 25.6 months and Brentwood had 22 months of inventory, or the amount of time it would take for all homes to sell if no new homes came on the market. In May, those numbers changed.

"Now we're looking at 4.9 months in Brentwood and 11 months in Antioch," said Bryce Ellsworth, a broker with Windermere Ellsworth & Associates in Brentwood. "Prices have come down. ."‚."‚. People have held back in buying and suddenly homes are flying off the market," he said.

"Flying" may be too a strong word, economists said.

"I think the movement begins where the prices have gotten low because there are a whole bunch
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of foreclosures. It's now become affordable," said Stephen Levy, director of the Palo Alto-based Center for the Continuing Study of the California Economy.

According to the National Association of Home Builders/Wells Fargo Housing Opportunity Index, price drops have changed affordability in the Bay Area — for the better.

In the East Bay, 32.4 percent of residents could buy a home in the first part of 2008 as opposed to only 17.4 percent in late 2007. In San Joaquin County, it went from 16.9 percent of people to 35.5 percent, while those on the Peninsula who could afford a home rose from 7.9 percent to 12.7 percent. Solano County's affordability rose from 20.4 percent to 35.1 percent.

First American CoreLogic reported prices in California declined 18 percent, with six markets, including Stockton, Merced and Modesto, experiencing price declines around 50 percent. The number of homeowners delinquent on payments rose from 1.5 percent in the first few months of 2007 to 4.8 percent during 2008. This "indicates that foreclosures and REOs will continue to rise for some time," the Core Mortgage Risk Monitor said.

Sean O'Toole, founder and chief executive officer of ForeclosureRadar in Discovery Bay, said that 22,324 homes reverted back to the bank in California in April. Of that, 954 were in Contra Costa County.

O'Toole, who also invests in real estate, said that the return on investment for buying distressed properties and renting them out is coming close to creating a positive cash flow. "We still have some people who are speculating that this is the bottom and they'll be rich in two years, but those are the same folks who got into trouble the last time."

Perhaps it's the price drops that are tempting more buyers. Homes that previously were selling for $800,000 can now be bought around $400,000, and although inflated prices were arguably due to a housing bubble, many are still attracted to what they view as a bargain.

Ellsworth said that homes that are priced well, especially foreclosures, receive multiple offers. And the majority buying are investors looking for positive cash flow, including himself. "Properties are being sold significantly below values. I think I'll take my chances," he said.

Mark Fleming, chief economist for First American CoreLogic, said that because of the tightening of the credit market in 2007, the number of loans with adjustable rates will peak and reset in 2008. He expects, as a result, that the numbers of foreclosures will begin to recede by next year.

"The ARM reset issue is coming to closure," he said. "But there's no guarantee prices won't continue to go down or whether it will rise, stay flat or reach back up to the prior peaks."

Fleming said that results can differ from recession to recession and he doesn't have a crystal ball. "It took the housing recession of the early 1990s until the late 1990s before it had recovered to pre-recession price levels," he said. "And if you look at 1910 or 1912, it wouldn't have been until the 1940s before it returned to price parity."

The Winchesters, who bought their Oakley home in 1997, wanted to move up to a home near the Highway 4 Bypass. He and his wife have decided to keep the Oakley house and rent it out to teachers at the private school where he works.

Although Winchester, 47, had to deal with some cracks in the pool and being overrun with mosquito larvae, he feels the Brentwood house was a good buy and paid 20 percent down.

"It was a great blessing," he said. Their home is scheduled to close June 20.

Barbara E. Hernandez covers real estate. Reach her at 925-952-5063 or bhernandez@bayareanewsgroup.com. Read her real estate blog, Property Lines, at www.ibabuzz.com/propertylines.
# FORECLOSED HOME SALES* Contra Costa County: 44.7 percent
# San Joaquin County: 70.2 percent
# San Mateo: 13.2 percent
# Solano County: 54.2 percent
*Percentage of homes that sold that were in foreclosure during the past 12 months
Source: DataQuick Information Systems

CA 200k

Mercury News

Renters Julie Herning and her husband, Oliver, have been trying to buy a home near San Jose's Japantown since February. With a slow housing market, and with enough money for a healthy down payment, they figured they finally had a shot at owning a piece of property.

What they didn't expect was the competition — so fierce that they've been outbid on four houses priced at around $500,000.

"It's kind of crazy," said Julie Herning. "One person I called said I would have been the 13th offer on the property."

Bidding wars have remained common in high-priced places where stellar school districts are the big draw. But in an area such as Santa Clara County — with more than 900 houses for sale for $450,000 or less — many home buyers assumed that the market was soft, and are shocked to find themselves outbid on foreclosed, bank-owned properties in this price range.

"The REO market is cooking-hot right now," said Jason Chan Lee of Intero Real Estate, who has numerous clients trying to buy REOs — real estate owned by banks and other financial institutions that have foreclosed on the properties.

Banks eager to unload their REO inventory — which forms a large chunk of the cheapest houses for sale in the county — have been lowering listing prices. It's become common to find bank-owned homes in South San Jose priced at roughly $400,000 that last sold in 2005 or 2006 for $600,000 or
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more, for example.

Lower prices have helped spur buyers' interest in bank-owned homes, especially because "regular" sellers generally have not brought their asking prices down to meet the banks' prices. Also, trying to buy homes in "short sales," another option for entry-level buyers, has proved frustrating, time-consuming and often fruitless for many buyers.

A short sale occurs when a mortgage lender gives approval to homeowners to sell for less than they owe on their mortgage in an attempt to avoid foreclosure. The trouble is, lenders often take months to OK the transactions, the foreclosure happens after all, and the property becomes an REO.

With more demand for REOs, multiple offers abound, a phenomenon that has stunned some buyers, said Lee.

"It's a secret nobody knows," he said. "You have to write a full-price offer. If you want it, everybody wants it."

Easy? Nah

The competitive landscape has discouraged the Hernings, who thought they'd have an easy time buying because "all you hear about is 'Oh, the market is terrible,'" Herning said.

"We had no idea we'd still be sitting here going, 'What's going on? Are we going to find a house?'"

As with "regular" listings, it's the bank-owned homes in the best condition that are most likely to attract a flood of offers. A bank-owned three-bedroom home for sale in South San Jose, for example, has new kitchen cabinets, a stainless steel dishwasher and pristine Pergo floors, with views of downtown San Jose. Listed at $429,500, it got five offers after only two days on the market, said listing agent Peter Carey of Realty World.

But not all REOs are as inviting. A few blocks away at a three-bedroom bank-owned house listed for $389,900, dirty water is stagnating in the backyard pool, unfinished construction remains in the family room, and a bedroom has been painted haphazardly in a deep-red color.

One San Jose resident, a mobile-home owner who has been looking for a house since February with a budget of up to $550,000, bid unsuccessfully on several short sales and half a dozen REOs before getting a bank-owned house for $540,000 that was listed at $529,900. The buyer, who did not want to be identified, said he's investing despite fears that valley home values may continue to fall.

"I have a feeling it's still risky to buy a house at this moment, but I want my kids to go to a good school, so I'll take a chance," he said. "I might stay there for 10 years. I look for the long-term, not the short-term."

Who's buying?

Some agents who specialize in REOs said about half the buyers now scouring the market for deals on bank-owned properties are people who want to live in the homes, while the other half are seeking investment property to rent out. But even at today's REO prices, some investors are waiting to buy because they can't get enough monthly rental income to cover their mortgage and expenses.

True, said Peter Carey, but the ones buying now are "gambling on better times" in the future, he said, hoping to buy property in the $400,000s that will eventually gain value.

It's not clear that the recent flurry of competition for REOs will last long.

Sen Dharmadas made an offer a few weeks ago on a bank-owned home in Los Gatos — a rare find compared with the number of bank-owned properties available in nearby communities. He offered the full list price of $775,000, and his was the lowest in a field of about five offers, he said. He raised his bid by $12,000, but the bank chose another, higher offer.

"Because of that we almost lost hope," said Dharmadas, a software engineer. "Getting an REO is very difficult."
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