Securitization and Lax Mortgage Lending

The Chain of Fools is the title of The Economist's Economics Focus column. The article points to the increasing evidence that securitization lead to lax mortgage lending in the United States.

The column is based largely on the study by Atif R. Mian and Amir Sufi of the University of Chicago's Business School: The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis.

In the end the problem was severing the origination of mortgage loans from their ongoing management and servicing. The originators were motivated to increase the flow of mortgage paper, not necessarily to increase the quality of that mortgage paper. As evidence, you can look at the increase of NINJA loans (No Income, No Job or Assets) on the residential side of mortgage lending and the light covenant loans on the commercial side of mortgage lending.

Mortgage lenders farmed out the mortgage origination to brokers. The mortgage lenders in turn packaged the mortgage loans and securitized them. As a result, the broker and the lender were focused on the short term origination and not on the long term value of the mortgage debt.

In representing the borrowers of loans to be securitized, I often heard that the statement: "I can't sell that in the market." I never heard, "that will be affect my ability to manage or service the mortgage loan."

The underlying economic problem is that the originating lenders did not keep any "skin in the game." Nearly all of their economic return was in the origination, not the long term success.

REITs and Joint Ventures

Arleen Jacobius of PIonline.com reports on institutional investors entering into joint ventures with REITs to as an alternative to direct real estate investments: Joint Ventures Emerging as New Vehicle for REITs.

The nice match of pension funds and REITs is that they are both used to dealing with the complexities of the tax code and other regulatory schemes that affect their investments in real estate. The rules for REITs on their income tests and asset tests are similar to the UBIT rules in compliance.

The pension funds get the benefit of a large professional REIT manging and operating the portfolio, but the additional control rights they would expect if they own the real estate outright. In exchange for the convenience of not having day-to-day management of the asset, they trade a piece of the upside on the real estate by giving the REIT a promote on the increase in value of the property.

I see that the article also quotes Steve Lyons of Reed Smith. Steve and I have worked together on a few REIT joint ventures.

Macklowe and his Capital

According to the Wall Street Journal, Harry Macklowe is still battling his lenders and his lenders are battling each other over his New York skyscrapers: Macklowe, Lenders Seek a Deal. At stake are: 717 Fifth Avenue, Worldwide Plaza, 1301 Avenue of the Americas, Park Avenue Tower, 527 Madison Avenue, 1540 Broadway, 850 Third Avenue and Tower 56 with about 6.5 million square feet of space.

It looks like his senior debt with Deutsche Bank is due shortly. Given the state of the debt markets he is no position to refinance that senior loan. On top of that, he needs to satisfy his subordinate lenders in mezzanine and other higher tranches of debt. According to the article, there are 20 other lenders holding subordinate debt.

I would assume that Mr. Macklowe is trying to turn over the buildings to Deutsche Bank, but the subordinate lenders (who have the most to lose) want to control the sale process.

My guess is that the lawyers for the lenders and Macklowe are working around the clock trying to evaluate who can do what to who in the process. According to Square Feet Blog, Macklowe personally guaranteed $1 billion of that debt and is putting his trophy GM Building up for sale to make good on the guaranty.

It seems that Blackstone's acquisition of Equity Office was the high-water mark of the real estate capital markets. Macklowe's acquisition of these 7 properties was a flip from Blackstone as part of the large acquisition of Equity Office Properties. [Blackstone Makes Quick Cash]

Legos and Real Estate

I admit that my first exposure to real estate was building houses out of Lego bricks. Today, January 28, 2008, is the 50th anniversary of the Lego brick. Even the Google logo has been lego-fied today.

Some facts I found interesting:

• There are about 62 LEGO bricks for every one of the world's 6 billion inhabitants.
• The LEGO bricks sold in one year would circle the world 5 times.
• More than 400 billion LEGO bricks have been produced since 1949
• 40 billion LEGO bricks stacked on top of one another would connect the earth with the moon.

[Gizmodo]

Closing Protection Letters - New Forms

The American Land Title Association (ALTA), recently approved three new form closing protection letters. These new forms took effect on January 1, 2008.

• Closing Protection Letter
• Closing Protection Letter - Limitations
  
• Closing Protection Letter - Single Transaction Liability

Jon Anderson, Senior Title Counsel for CATIC wrote an article on these new forms and how they clarify the underwriter's liability.

The Closing Protection Letter is the broadest form. The Closing Protection Letter - Limitations imposes a specified dollar limit on the liability, although this limitation is not applicable to mortgage loan transactions for individual one-to-four family residential properties. The Closing Protection Letter - Single Transaction Liability is limited to a single transaction with funds not in excess of a specified dollar amount.

I always ask for a closing protection letter when using an agent to issue the title policy and handle funds (as opposed to using an officer of the the title company.)

The trouble with these new forms is that they limit the protection to damages relating to the status of title to an interest in the land or the validity, enforceability or priority of the lien of the mortgage. You are protected if the deed or mortgage is not recorded.

With these new forms, you are not protected for the closing or settlement services being provided by the title agent. Clearly, an over-funding of the purchase price will not fall under the protection of these new closing protection letters.

Toronto's Land Transfer Tax

From Bruce McKenna at the Canadian Commercial Real Estate Law Blog, is this piece on the increase Toronto's Land Transfer Tax. Here is a copy of the Municipal Land Transfer Tax By-law from Toronto.ca.

I spend a fair amount time structuring transactions to avoid triggering the payment of transfer tax. Massachusetts has proposed closing some of those loopholes, but not taken any action. Maryland has a new law effective later this spring that extends the reach of that state's transfer tax.

Financing the Construction and Acquisition of Your Real Estate Development Project

Below is my material from Real Estate Development From Beginning to End in Massachusetts.

The document is hosted on a site called Docstoc.

University Designation for a Training Program

We are revamping some aspects of the real estate group's training program. We are using the concept of a college catalog, with numbered designations for each course and summary of what the course is about. We also wanted to give it a brand element. We were thinking of something like: Goodwin Procter Real Estate University.

Unfortunately, we came across Massachusetts General Law, Chapter 266, Section 89:

"Any individual, school, association, corporation or institution of learning, not having lawful authority to confer degrees, using the designation of “university” or “college” shall be punished by a fine of one thousand dollars."

So, you cannot use a "college" or "university" designation in Massachusetts unless you are actually a college or university. I guess that leaves: Goodwin Procter Real Estate Academy.

[cross-posted from my KM Space blog on law firm knowledge management.]

Trimming Trees in Massachusetts

After this latest snowstorm in Boston, I had to drag some fallen limbs into my compost pit. I thought this would be a good time to post on Massachusetts law on trimming your neighbor's trees.

A neighbor may remove branches extending over a shared property line onto his or her own property. See, e.g., Levine v. Black, 312 Mass. 242 (1942); Michalson v. Nutting, 275 Mass. 232 at 233-234 (1931). Also, the neighbor has no liability for roots growing into your yard and causing damage. The ability to cut back limbs and roots is limited by Mass. Gen. Laws ch. 87, § 11 that provides: "Whoever wilfully, maliciously or wantonly cuts, destroys or injures a tree, shrub or growth which is not his own, standing for any useful purpose, shall be punished by imprisonment for not more than six months or by a fine of not more than five hundred dollars." You can trim the branches and roots back, but you cannot kill the tree. This is the "Massachusetts Rule."

Massachusetts law does not allow a person to cross or enter a neighbor’s property for these purposes without the neighbor’s consent, nor to remove any branches or other vegetation within the confines of the neighbor’s property. Mass. Gen. Laws ch 242 §7 A party is liable for triple damages for entering the property of another and cutting down trees or branches.

There is also a Massachusetts statute that prohibits cutting, trimming or removing of public shade trees. Mass. Gen. Laws Ch. 87. Under this statute public shade trees are defined as “All trees within a public way or on the boundaries thereof…” Mass. Gen. Laws ch. 87 § 1.

The Massachusetts Rule is followed in most states. However, the Washingtonpost.com
is reporting that Virginia just adopted a new rule: Virginia High Court Breaks New Ground on Tree Liability. Apparently in Virginia a tree owner can now be held liable for damage caused by their tree and can forced to cut back roots and limbs if the tree poses a risk of actual harm or an imminent danger. Fancher v. Fagella (9/14/2007):

"Accordingly, we hold that encroaching trees and plants are not nuisances merely because they cast shade, drop leaves, flowers, or fruit, or just because they happen to encroach upon adjoining property either above or below the ground. However, encroaching trees and plants may be regarded as a nuisance when they cause actual harm or pose an imminent danger of actual harm to adjoining property. If so, the owner of the tree or plant may be held responsible for harm caused to [adjoining property], and may also be required to cut back the encroaching branches or roots, assuming the encroaching vegetation constitutes a nuisance. We do not, however, alter existing . . . law that the adjoining landowner may, at his own expense, cut away the encroaching vegetation to the property line whether or not the encroaching vegetation constitutes a nuisance or is otherwise causing harm or possible harm to the adjoining property. Thus, the law of self-help remains intact . . . ."

New York and London Office Markets

With the fall-out of the sub-prime loans, there is continuing good news in the commercial markets.

London has surpassed Hong Kong to hold the position of having the world's highest office rents. According to the NAI Global Market Report, the Mayfair submarket in London's West End reached $265.31 per square foot. That was an increase of $40 per square foot over the prior 12 months. Hong Kong was close behind at $263.20 per square foot.

New York's midtown market was up to $225 per square foot. That makes Boston's $90 per square foot look very affordable. Boston came in third in the United States.

The New York market appears to still be strong. According to Cushman and Wakefield's year end report, 22.2 million square feet of office space was available at the end of 2007, which is down form the 26 million available at the end of 2006. Manhattan’s overall vacancy rate improved for the year, finishing at 5.7%, down from 6.7% at the end of 2006.