By Steve Van
November 13, 2009
 

Extend and pretend will be bad in the end, and the end is 26 months from now. The Fed and most lenders are driving commercial real estate into a box canyon. You know the kind: three tall sides and no way out, used in the old West to drive game in and ... kill ... easily. And hotel loans are the lead cows. Sounds like the perfect scenario for our dear friends the vulture funds.

Our canyon has three sides:

• the massive maturity wall looming in 2012;
• the towering US$850-billion equity gap; and
• the race between London interbank –offered rates and revenue per available room—which RevPAR will lose.

The maturity wall is the worst—from now until 2012, there are US$170 billion in commercial mortgage-backed securities maturities alone in the U.S. Those maturities will hit at the same time hundreds of billions of corporate bond debt comes due. Hordes of real estate and corporate borrowers will be gathered around a limited watering hole of fresh capital, and there won't be enough to go around.

And the U.S. industry's extend-and-pretend philosophy is driving all the already weakened loans toward that end.
 
The equity gap is the shortfall between the US$2.8 trillion (you know, it's sort of fun to type $trillion) in commercial real-estate loans originated between ‘05 and ’08, which, if refinanced today, would be worth US$2.0 trillion. So US$850 billion will need to come from write-downs and equity. Hotel loans are about 10 percent of this US$280 billion with, say, an US$85-billion shortfall. Pundits estimate there is about US$12 billion fresh hotel equity raised to help with the butchering. So that leaves about US$73 billion in loan losses. For comparison, the TOTAL market value of all hotel real estate investment trusts and hotel public companies is US$33 billion. Did that sink in?  Yes, the loss is twice as much as the total value of all hotel REITS and public companies. This will stink.
 
The race between LIBOR and RevPAR will start to sink most floating loans as soon as the economy starts to recover. When each of the past recoveries has taken hold, LIBOR increased around 300-400 basis points in 12 months. So today's fairy land of 2 percent hotel loans (175 over LIBOR at 0.24 today) will evaporate, and payment rates will increase by 150 percent to 300 percent. Some of these loans won't even make it to the end of the canyon.
 
So what do we do? Collectively we as a nation could create another Resolution Trust Corporation. (And for those originators I have talked to who didn't know what the RTC was, please call me.) The likelihood of that happening in today's put-it-off-’til-the-next-election political environment is, shall we say, slim. Smart money will wait at the end of the canyon and have a historic feast of cheap hotel asset buys. Most of us will just keep our heads down and try to do the best we can as owners holding on to our hotels or as lenders working out loans. But all of us taxpayers as the lender of last resort will pick up the bill in the end. And a big bill it will be.