It’s not just the mom and pop buyers who are looking at onerous mortgage resets on the poorly underwritten loans giddily funded back during the recent  bubble.

The smart money in commercial real estate is not the Wall Street Firms that bought in at top dollar in 2007.

The smart money is the guys who sold to the clueless Wall Street Firms.

That would be Sam Zell, who sold his Equity Office portfolio to Blackstone (who in turn immediately lined up buyers to pay even more for chunks of the holdings).  Proving that even  the big fools can find even bigger fools.

Then there is Richard Rainwater, the legendary Texas investor who helped bulk up the Bass Brothers fortune, who sold his Crescent Properties to Morgan Stanley.

Both Zell and Rainwater could sense that valuations had been divorced from their traditional tether to rental income, floating upward only on fumes, long since having run out of fuel.

The Wall Street guys have no problem, traditionally, with overpaying.

Their ultimate recourse is to unload their holdings on their institutional and retail clients, who naively expect that their investment broker is acting in their best interests.

That’s exactly what Morgan Stanley tried to do…to roll out the pricey properties in one of their endless limited partnership offerings.  Only this time, the buyers had already been whacked across their head with a 2 by 4, and were bleeding red ink on properties previously acquired.

So they balked at the new offering.  The music stopped playing, and Morgan Stanley found there were no more chairs to sit on.

Now they are faced with a $2 billion balloon payment owed to Barclays Bank, who helped finance the 2007 acquisition.

The irony is exquisite.  One banking behemoth lending to another.  Each in the desperate expectation that the other guy might know what they were doing.

Like any homeowner facing this dilemma, the choices facing Morgan Stanley are few and unappetizing.

1. They can plow additional funds into their cost basis to meet their obligation.  This is colloquially known as throwing good money after bad.
2. They can try to force more favorable terms on Barclays.  This might work, given that Barclays will not be any more adept at managing these properties than their former owner.
3. They can send the keys over to the lender, walking away from whatever nominal equity they might still possess. Jingle mail.

I’m betting they will walk away from this mess.

This thirties-era wannabe recession/depression is going to bite long and deep and the pain will endure far longer than anything in the living memory of the participants.

Companies have learned to pare payrolls ruthlessly and squeeze productivity out of the surviving workers.

We will have double-digit office and commercial vacancies for as far as we can reasonably see into the future.

And the ultimate buyers, the retail investors, hedge funds, and public partnerships are bruised and bleeding…not anxious to step up to the plate.

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Posted: 10|28|09 at 6:46 am. Filed under: real estate, recession.
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