After Lehman, Banks Jettison Commercial-Property Debt

The bankruptcy of Lehman Brothers Holdings Inc. is adding pressure on banks and other financial institutions to sell off their holdings of commercial real-estate debt, as they try to stay out ahead of the Wall Street firm's expected liquidation of its $30 billion portfolio. The likely rush to sell is driving down the already battered market, forcing financial firms to take additional losses on the estimated $150 billion worth of commercial real-estate debt on their books as the once relatively resilient pocket of the property sector now comes under heavy fire. "As a result of Lehman's bankruptcy, other financial institutions will feel more pressure to sell assets at deeper discounts sought by investors," said Spencer Garfield, a managing director of Hudson Realty Capital, a New York-based real-estate fund manager. Goldman Sachs Group Inc. on Tuesday said it had reduced its portfolio of commercial mortgages and securities by about $2 billion to $14.7 billion as of the end of its third quarter, which ended Aug. 29, taking a $325 million loss. "It sure doesn't feel like the real-estate markets are improving anytime soon, and we will reduce that class going forward even if we think they are good assets," said Goldman Sachs Chief Financial Officer David Viniar. "Those assets are marked where they can be sold." Lehman's collapse was the most dramatic sign so far that the financial crisis sparked by residential real estate is spilling over into office buildings, strip malls, hotels and other commercial real estate. The firm was one of the most aggressive lenders on Wall Street, making whole loans, bridge loans and packaging debt into commercial mortgage-backed securities, or CMBS. About $4.3 billion of Lehman's $30 billion portfolio consists of securities. The prospect of that getting liquidated sparked the latest selloff in the CMBS market, as evidenced by widening spreads between the benchmark U.S. Treasury notes and the CMBX, a credit-market index that tracks the value of the bonds. Apartment-building investors also are likely to feel significant pressure to sell as Lehman unloads its debt and equity pieces of the $22 billion purchase of Archstone, the large multifamily company with buildings concentrated in Washington, D.C., California and New York City. For months, Archstone had tried to sell assets to reduce debt, but met mixed success. It resisted for months lowering its prices, even as buyers balked. It has sold some complexes but not as many as it hoped, according to a person familiar with Archstone. Prices are now likely to soften. In markets with apartment buildings that compete with Archstone, "there is no question that if you need to sell assets, you will try to get ahead" of the Lehman selloff, said Jeffrey Spector, a real-estate analyst at UBS. "Every day that goes by there will be more pressure on pricing." For most of this year, commercial real-estate debt has held up better than housing-related debt. Commercial property values haven't deteriorated as much as homes, thanks to the still-healthy cash flows of most properties, lack of overbuilding and low default rates. Delinquencies have been mounting in loans tied to construction and land development, a major commercial real-estate category. At the nation's largest construction lender, Bank of America Corp., about half of its $13 billion home-builder portfolio are loans that "we are watching and paying special attention to, because there could be structural deficiency or a market deficiency," said Gene Godbold, president of Bank of America's commercial real-estate banking, in an interview. Mr. Godbold emphasized that the bank has adequate capital to offset possible losses from its home-builder portfolio. Last spring, securities firms and banks were able to sell commercial real-estate debt for discounts ranging from 5% to 20%, small compared with many residential mortgage securities. But that discount has been widening. For instance, Ashford Hospitality Trust Inc., a Dallas real-estate investment trust that invests in hotels and commercial real-estate loans, in July paid Wachovia Corp. $98.4 million for a $164 million mezzanine loan, or 60 cents on the dollar, according to UBS research. The debt helped finance Lightstone Group LLC's $8 billion purchase of Extended Stay Hotels from Blackstone Group LP in June 2007. Wachovia, one of the lead lenders to the deal, still is trying to sell some of the $3 billion it lent to Lightstone. Meanwhile, the investors who are still buying commercial real-estate debt are flexing their muscles more. Consider a $980 million CMBS offering being planned by Morgan Stanley. The so-called B-piece buyer -- the investor buying the riskiest portions of a CMBS issue -- is Goff Capital Partners. Goff was able to make Morgan Stanley throw out more loans from the pool than it would in normal times, according to people familiar with the offering. A spokeswoman at Morgan Stanley declined to comment. It was in this climate that Lehman tried to save its neck by putting its $30 billion portfolio on the block last week. Lehman was hopeful because more than 70% of its whole loans were used to finance the relatively strong part of the real-estate market, such as offices, hotels, apartments and retail properties. But the firm also had large amounts of debt tied to residential land, where values have been decimated. The firm negotiated into the final hour to sell the assets, but never reached a deal because it wouldn't cut its price enough, according to people familiar with the matter. And now comes the expected liquidation.