The FDIC and Commercial Real Estate Development

Posted on October 12, 2010. Filed under: Uncategorized |

The Federal Deposit Insurance Corporation (FDIC) has been taking over failed banks under a program that was supposed to provide renewed stimulus to the economy, but for some commercial real estate developers the result has been anything but stimulating.

In several cases the FDIC’s actions have caused development projects to stop, idling hundreds of workers and harming local economies at a time when signs of economic recovery are being seen. Oversight, it seems, is desperately needed.

“Big bailouts of Merrill Lynch, Bank of America and AIG get the press attention. Far more corrosive are thousands of unpublicized, self-dealing transactions overseen by bureaucrats,” says Halsey Minor, the founder of the Internet news giant CNET and a commercial real estate developer.

Minor was building a hotel in Charlottesville, financed by Silverton Bank of Atlanta, which cut off financing when its own balance sheet began to tip. The bank was taken over by the FDIC which sold Minor’s loan to eight banks, leaving the hotel project as a see-through concrete-and-steel skeleton.

In another case, work on the Concerto, a major residential-retail project in downtown Los Angeles, was halted, idling hundreds of construction workers, blocking the sale of new residential units and pushing subcontractors close to bankruptcy.

In that case, developer Sonny Astani took out a $190 million construction loan from Chicago’s Corus Bank to build the first phase of the project. When Corus Bank failed last year, it was taken over by the FDIC, which auctioned off the bank’s portfolio of loans on 102 high-end properties across the country including Concerto.

The Concerto loan was sold to Starwood Capital for just 60 cents on the dollar. Much of the purchase price came from the FDIC, which provided Starwood with financing at zero percent interest. With its loan in limbo, work on the nearly completed Concerto was halted.

In a report to the Commercial Real Estate Development Association, Mark G. Dotzour, Chief Economist and Director of Research at the Real Estate Center at Texas A&M University, called the process “cocooning.” It works like this:
• A bad bank can’t sell off troubled commercial real estate loans because they don’t have sufficient capital to absorb the losses.
• A bad bank is sold to a good bank. The good bank acquires troubled commercial real estate loans with an 80-95% loss guarantee that can last 8 to 10 years.
• The FDIC has virtually a zero cost of capital so it cannot be outbid for troubled assets, meaning purchase rates stay low.

Still, Dotzour had some positive news for commercial real estate developers, predicting a recovery in the sector beginning this year as new projects started before the economic downturn are completed, employment rises, rents increase and property values increase.

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