Rent Relief Requests Take New Form as Tenants’ Focus Shifts to Long-Term Health

As consumers start heading back into stores, retail landlords are finally getting some relief from widespread rent concession requests from struggling tenants, according to industry insiders.

In the past year, many retailers have improved their financial standing or disappeared from the landscape altogether. Instead, landlords now face a new trend in negotiations; healthy tenants are asking for permanent changes to their leases in exchange for signing longer contracts or for giving up restrictive clauses.

It’s a different dynamic from last year. Then, most requests for changes came from retailers on the edge of financial ruin. Such tenants had little to offer landlords and instead needed relief in bids to ward off store closures, bankruptcies and liquidations, says Rick Burke, founder of Lease Administration Solutions, a Marblehead, Mass.-based lease administration and auditing firm, and founding member of the National Retail Tenants Association.

Those sorts of requests have subsided. For instance, J. Scott Fawcett, president of Marinita Development Co., a Newport Beach, Calif.-based development firm with a portfolio of about 15 grocery-anchored shopping centers, notes that he has received just one rent relief request in the past few months, from a dry cleaning business he believes is not being run properly. By contrast, at this time last year, Marinita received rent relief requests at least once a week and granted temporarily concessions in about 50 percent of the cases. Executives from retail REITs have also noted that they’ve seen a dramatic cutback in tenants asking for rent reductions and deferments.

Today, the requests that do come are much more likely to be from healthy national players who see an opportunity to work out a mutually beneficial deal with the center’s owner.

“The stage of it being a major crisis is slowly dissipating,” Burke notes. “You don’t have that ‘We are going to have rent reductions or we are going out of business’ mentality anymore. There is more optimism in the market, so you can’t cry poverty as much. You need to come to the table with some strategies, some leverage.”

Among the best options tenants can offer landlords right now is a lease extension, according to Michael Jackowitz, principal and New York director with Reduce Your Rent LLC, a nationwide rent reduction consultancy. With vacancy rates at record highs and many owners facing upcoming mortgage maturities, ensuring a healthy tenant is locked in for a few more years makes refinancing more viable, Jackowitz notes. But even those landlords who don’t have loans coming due know that a longer lease might be a fair exchange for more affordable lease terms, givens that rents continue to trend down.

Jackowitz brings up a client Reduce Your Rent recently represented in Long Island City, N.Y. The retailer had a lease for a warehouse/showroom space that was scheduled to expire in February of 2014. After the tenant agreed to enter into a new lease, with an expiration date in 2019, the landlord agreed to a 20 percent reduction in rent. According to Jackowitz, “everyone was happy. The landlord has obviously taken a hit, but locking this tenant in stabilized the asset.”

Some tenants might also be willing to give up co-tenancy clauses or offer their landlords more personal or corporate guarantees if they’d like to get a reduction in their long-term occupancy costs. The hitch, according to Jackowitz, is that these kinds of arrangements are viable only in those cases where the tenant signed the original lease prior to September of 2008, when the real estate market began its freefall.

“I don’t think any new leases will have a basis for restructuring because those were done on a completely different set of assumptions,” he says.

—Elaine Misonzhnik

Congressman Calls for Second Lien Write-Downs

By: Carrie Bay, DSNews.com

As servicers step up efforts to modify loans and keep borrowers in their homes, many are tripping over stumbling blocks in the form of home equity loans and other second lien mortgages. House Financial Services Committee Chairman Barney Frank (D- Massachusetts) has sent out a petition to some of the nation’s largest junior lien holders demanding that they take “immediate steps to write down second mortgages” to create a clear path for sustainable loan restructurings.

Reducing a homeowner’s overall debt so that modified payments are within their capabilities can be hampered when there is also a second home equity mortgage hanging in the balance – pushing the borrower further underwater in the wake of falling home prices. In such situations, reducing the borrower’s outstanding mortgage balance requires cooperation from both the first and second lien holders.

In a letter to the CEOs of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo, Frank wrote, “Many homeowners are eager to save their homes despite being ‘underwater,’ but find that lenders and servicers are unable or unwilling to make necessary modifications. These homeowners are increasingly deciding to walk away.”

The committee chairman says many investors in first-lien mortgages have indicated that they are willing to accept significant losses in order to move on and use their money for other purposes, rather than having it locked in underwater mortgages with a high likelihood of foreclosure. With the interests of homeowners and investors aligned in this way, Frank says it should follow that large numbers of principal-reduction modifications can be made relatively quickly.

“That is not happening,” Frank wrote. “According to investors, administration officials, and other experts I have consulted…the problem of second-lien mortgages standing in the way of successful principal reduction modifications has reached a critical stage and requires immediate attention from your institutions.”

Frank argues that most of these second liens have “no real economic value,” since the first liens are well underwater, and the prospect for any real return on the seconds is “negligible.”

But he notes, “Because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans, which would allow willing first lien holders to reduce principal and keep borrowers in their homes.”

Frank is demanding a quick response from the four banks in his line of sight. “I will be calling you within the week to discuss what your institutions plan to do to remove the second liens you own or control as impediments to principal reduction modifications,” he said in the letter.

“To save homes on a large scale, we must move past temporary modifications in interest rates or terms and focus on permanent principal reductions that result in truly sustainable mortgages,” Frank wrote. “There is no more important priority for me in our efforts to restore stability to our mortgage market.”

The administration has incorporated a second lien component into its Home Affordable Modification Program (HAMP), which is slated to begin within the next few weeks. It includes a payment schedule for extinguishing second mortgages and the automatic modification of a second lien when a first lien is modified. Bank of America signed on to the program in January, but none of the other major servicers have agreed to participate.

Second liens can also prove to be an obstacle for short sales, the focal point of the administration’s Home Affordable Foreclosure Alternatives program set to take effect April 5. Although the first lien holder may agree to the sale of a home for less than the outstanding mortgage balance in order to circumvent a foreclosure, if there is also a second lien on the property, the sale can fall through if the junior lien holder will not relinquish their claim.

Is It the Beginning of the End for Housing Crisis?

By Amy Hoak

RISMEDIA, March 8, 2010—(MCT)—A smaller percentage of mortgages were delinquent and the rate of those entering the foreclosure process slowed in the fourth quarter of 2009, possible signs that the foreclosure crisis that has gripped many of the nation’s housing markets is finally starting to ease, a trade group has reported.

“We are likely seeing the beginning of the end of the unprecedented wave of mortgage delinquencies and foreclosures that started with the subprime defaults in early 2007,” said Jay Brinkmann, chief economist of the Mortgage Bankers Association, in a written statement.

The delinquency rate for mortgages on one- to four-unit residential properties was a seasonally adjusted 9.47% of all mortgages outstanding in the fourth quarter, down from 9.64% in the third quarter and up from 7.88% in the fourth quarter of 2008, according to the MBA’s quarterly delinquency survey.

Delinquencies include mortgages that are at least one payment or more past due but not yet in foreclosure.

Meanwhile, 1.2% of outstanding mortgages entered the foreclosure process in the fourth quarter, down from 1.42% in the third quarter and up from 1.08% in the fourth quarter of 2008. The percentage of mortgages at some point in the foreclosure process at the end of the fourth quarter was 4.58%, up from 4.47% in the third quarter and 3.3% in the fourth quarter of 2008.

The MBA survey covers about 44.4 million loans on one- to four-unit residential properties, or about 85% of all first-lien residential mortgage loans that are outstanding in the country. No doubt, the foreclosure nightmare isn’t over yet.

The percentages of loans 90 days or more past due and loans in foreclosure process set record highs in the fourth quarter, according to the report. Many of those loans more than 90 days past due are in loan modification programs, and some of them have been seriously delinquent for months waiting for modifications to get finalized.

But the good news is there are fewer problem loans actually entering delinquency—likely a result of fewer layoffs, Brinkmann said. “We normally see a large spike in short-term mortgage delinquencies at the end of the year due to heating bills, Christmas expenditures and other seasonal factors. Not only did we not see that spike but the 30-day delinquencies actually fell by 16 basis points from 3.79% to 3.63%,” he said. He added that the non-seasonally adjusted 30-day delinquency rate has only dropped three times in the past between the third and fourth quarter—”and never by this magnitude.”

Depending on the fate of seriously delinquent mortgages—whether they are cured with modifications or ultimately enter foreclosure—the percentage of mortgages somewhere in the foreclosure process could start to see a gradual decline in the second half of the year, he said during a conference call with reporters.

If normal seasonal patterns hold, there could be a bigger drop in the 30-day delinquency rate in the first quarter of 2010, Brinkmann said. That would be a positive sign for the months and years ahead. “The continued and sizable drop in the 30-day delinquency rate is a concrete sign that the end may be in sight,” he said. “With fewer new loans going bad, the pool of seriously delinquent loans and foreclosures will eventually begin to shrink once the rate at which these problems are resolved exceeds the rate at which new problems come in. “It also gives us growing confidence that the size of the problem now is about as bad as it will get,” he said.

According to the MBA data, Florida was the most problematic state, in terms of delinquencies. Twenty-six percent of Florida mortgages were one payment or more past due at the end of the year, and 20.4% of mortgages in the state were 90 days or more past due or already in the foreclosure process.

(c) 2010, MarketWatch.com Inc.

City Dweller’s Guide to the Purchase and Maintenance of a Country Home

by Jim Glomb of Geotechnical and Environmental Consulting, Inc.

City dwellers usually don’t have to think about where the water in their faucets comes from or where their wastewater goes after it leaves the bathroom. Other concerns not generally felt by the city dweller are homesite drainage and the detrimental effects of surface and subsurface water. Many of the country homes in Sonoma and Marin County are self sufficient in terms of domestic water from a well and wastewater disposal in septic systems. These amenities generally operate efficiently but occasionally need attention or replacement.

Water Wells

Water wells have openings or a screen at depth within the groundwater zone that allows water to flow into the well casing or pipe. An electric pump brings the water to the surface where it generally flows into a pressure tank. From the pressure tank the water flows into the home for use. The parts and machinery at each step will eventually wear out and may need to be replaced. In some cases the groundwater source or aquifer has limited capacity for water to flow into the well or the capacity may lower over time. Limited capacity can translate to a temporarily dry well and stoppage of flow to the home. A low capacity well can have the available groundwater supplemented with a holding tank that fills slowly during times when domestic use is not required. A well expert is generally hired during escrow to evaluate the condition and anticipated longevity of a domestic well.

Wastewater Septic Systems

Domestic wastewater generally flows from the home into an outdoors septic tank where solids separate and remain in the tank. The tank is intended to catch and hold solids and required periodic pumping to maintain storage capacity. In most cases liquids flow from the tank into a leach field with one or more underground trenches filled with gravel and capped with soil. The wastewater seeps into the ground surrounding the trenches. Over time leach fields may lose their ability to receive wastewater and new lines may need to be constructed in fresh ground.

A septic system consultant is routinely engaged during escrow to evaluate the condition of an onsite septic system and may recommend upgrades to an inefficient septic system. Periodic inspections are recommended to keep the septic system functioning properly.

Drainage

Most hillside and some flat land lot problems are associated with water drainage. Uncontrolled water from broken pipes, septic systems or wet weather is generally the primary cause of slope damage. Therefore, drainage and erosion control are the most important aspects of home site stability. Drainage and erosion control devices must not be altered without competent professional advice, and maintenance must be carried out to assure their continued operations. When erosion features, ground soaked conditions, or foundation distress have occurred, the services a geotechnical expert are typically engaged during escrow. The country property owner will have an ongoing responsibility to monitor his property's drainage conditions on a regular basis.

The following is a checklist of recommended procedures for the homeowner:

1. Check roof drains, gutters and downspouts to be sure they are clear. If you do not have roof gutters and downspouts, you may wish to install them. Without gutters and adequate drainage, water falls from the roof eaves and collects against the foundations and basement walls which can be undesirable.

2. Clear surface and terrace drainage ditches and check them frequently during the rainy season, using a shovel, if necessary. Ask your neighbors to do likewise.

3. Surface drainage ditches and subdrains must be properly designed and constructed so that a constant downward gradient of not less than two percent is maintained. Drains must be watertight. Joints must be secure and leaks need to be fixed as soon as they are found. Be sure that all drainage ditches and subdrains have outlet drains that are open and completely unobstructed. Subdrains should be tested during dry weather. Usually this can be done simply with a hose. If blockage is evident, you may have to clear the drain mechanically.

4. Monitor the use of hoses and sprinklers. During the rainy season, little, if any, irrigation is required in the North Bay. Over-saturation of the ground is not only necessary and expensive, but can cause damage.

5. You should be aware of what is occurring on neighboring properties. Water backed up on adjacent areas or uncontrolled offsite drainage may eventually affect your property.

6. Water should not be permitted to collect or pond on your home site. Ponded water will tend to either seep into the ground, weakening fill or natural ground, or may overtop slopes and cause erosion. Once erosion is started, it is difficult to control and severe damage may result rather quickly.

7. Roof drains and gutters or downspouts should not be connected to subsurface drains. Subdrains are constructed to take care of ordinary subsurface water and cannot handle the overload from roofs during a heavy rain.

8. Loose soil or debris should not be left on or dumped over slopes. This could lead to a slide or mud flow that may clog terrace drain or cause damage to the slope or structures on or adjacent to the slope.

9. Water should not be discharged into subsurface “gravel and pipe” blanket drains close to slopes. These drains are sometimes used to contain and transport excess water when other ways of disposing of water are not readily available. Overloading these drains saturates the ground and, if located close to slopes, may cause slope failure.

10. Surface water should not be discharged into Septic tanks or leaching fields. Septic tanks are constructed for a different purpose. Overloading a septic system artificially during the rainy season may cause a malfunction which may in turn pose a health hazard.

11. Slopes should not be over-irrigated.

12. Hoses and sprinklers should not be left running on or near a slope, particularly during the rainy season. This will increase ground saturation which may cause a slope failure.

13. Water should not be allowed to pond against foundations, retaining walls or basement walls.

14. Groundsoaking can also lead to activation of clayey soils with shrink/swell potential. Such soils may undergo damaging volume changes upon wetting and drying that can damage foundations and concrete flatwork.

15. Swales that have been graded around your house or the lot pad should not be blocked and the grade should not be modified without the advice of a geotechnical consultant.

Jim Glomb of Geotechnical and Environmental Consulting, Inc. can be found at 152 Weeks Way, Sebastopol, CA 95472 • Phone 707/237-2703, Fax 707/237-2659

U.S. Industrial Property Review: Sector outperforms other property types

Global Real Estate Monitor

It may not be considered the sexiest or most exciting property type, but industrial real estate’s stability and growth opportunities in 2010 put the sector head and shoulders above other types of commercial property.

“There was less overbuilding in the industrial sector and overall vacancy is below that of retail and office properties, so fundamentals are better and perhaps more appealing,” says Micheal Palmer, senior managing director with Studley’s Houston office. “When the economy truly picks up, industrial users are at the forefront of activity to meet demand and landlords may be able to increase rates at that time, likely in advance of office and retail owners.”

Wall Street analysts and industry professionals expect the industrial property sector to show marked improvement this year, driven by improvement in the manufacturing and import/export industries.

“Industrial is likely to be one of the first, if not the first commercial property type to bottom out and embark on a recovery,” says Ross Smotrich, REIT analyst with Barclays Capital, adding that occupier demand for industrial space is less dependent on job creation – which is a lagging economic indicator – compared with the office, retail and apartment markets.

Larry Harmsen, president of ProLogis’ U.S. and Canada business, says the industrial REIT is seeing some signs of stabilization and increased customer activity. “While industrial demand is still soft, occupancy declines are slowing and activity levels appear to be picking up,” he notes. “However, market rents are still lower than they were a year ago, and we’re seeing some signs of declining cap rates.”

Growing demand drivers

Smotrich notes that the drivers of demand for industrial space – production activity, freight shipments and global trade – have bottomed out and begun to grow again, at least tentatively. “This is reflected in the steady moderation of vacancy increases and negative absorption in recent quarters,” he says. “The trend line suggests that industrial vacancy could peak as early as mid-2010 and embark on a gradual, multi-year recovery cycle late this year or early 2011.”

There is a close historical correlation between industrial demand and economic activity. The ISM (Institute for Supply Management) index, which measures business activity for both manufacturing and non-manufacturing, is a key indicator of an expanding or contracting economy and is an especially relevant metric for the industrial sector. Since bottoming in November/December 2008, both the ISM manufacturing and non-manufacturing indices have increased, indicating an economic expansion.

In February, for example, the ISM index was 56.5 percent, and a reading over 56 percent is consistent with strong growth in manufacturing and growth in the economy of about 4.9 percent, according to the ISM.

“The February ISM index provides further evidence the recession is over and the increase in manufacturing activity during the first quarter is likely to be sustained at least at a moderate rate in 2010,” wrote Joe Liro, an economist for Stone & McCarthy Research.

In addition to the ISM index, global economic trends are key metrics to watch in order to forecast industrial demand. Because tenants that occupy industrial space are global, and the goods housed in the warehouses tend to be shipped globally, it’s important to keep an eye on global gross domestic product (GDP), not just U.S. GDP.

Historically, global GDP has grown faster than U.S. GDP, especially since the early part of this decade. In 2008, global GDP grew at 3 percent, outpacing the 0.4 percent U.S. GDP growth; global GDP turned negative in 2009, however, but is expected to fall less than U.S. GDP (–1.1 percent versus –2.7 percent).

Looking forward, the International Monetary Fund expects global GDP growth to exceed U.S. GDP growth by 150 to 200 basis points annually. This year, the IMF forecasts global GDP growth of 3.1 percent, versus 1.5 percent for the United States.

Global trade, which may have a more direct impact on industrial fundamentals than pure economic direction, has an interesting historical relationship to global GDP. When the economy is expanding, global trade growth exceeds global GDP growth; conversely, when the economy is contracting, global trade falls by a larger amount than global GDP.

In 2007, when global GDP was growing at a strong pace of 5.2 percent, global trade grew at 7.3 percent; in 2008, when global GDP started to slow but was still positive (3.0 percent), global trade started to fall faster (also growing 3.0 percent). In 2009, when global GDP is expected to fall 1.1 percent, global trade is expected to fall 11.9 percent.

While the IMF does not forecast global trade, one can expect that if the historical relationship holds going forward, global trade will exceed the mid-single-digit growth expectation for global GDP, according to Barclays.

In fact, analysts are anticipating a rebound in container traffic through U.S. ports during 2010.  After having contracted about 10 percent during 2009, U.S. container traffic is expected to grow about 6.5 percent in 2010 to 41 million TEUs. However, traffic is not expected to regain its 2007 peak until next year.

Noticeable green shoots

Green shoots of improving fundamentals in the industrial real estate sector are beginning to emerge. In Houston, for example, KDC has inked four new lease deals in the past couple of months including 40,600 square feet to Goodman Distribution Inc. and the Houston Chronicle at Ellington Trade Center. Goodman Distribution Inc. will occupy 25,300 square feet and the Houston Chronicle will take 15,300 square feet.

“We’ve got good activity at our properties in Houston and Austin,” says Randy Touchstone, executive vice president of Dallas-based KDC and director of the firm’s industrial program. “It feels like companies are looking up, and saying ‘let’s take advantage of the market and try to lock up these low costs to benefit our business.’ They’re making decisions and moving forward.”

Although the U.S. industrial real estate markets finished 2009 on a weak note, they showed a marked improvement compared with the previous three quarters, according to Ross Moore, executive vice president of research for Colliers International. 

During the fourth quarter, U.S. warehouse markets continued to lose tenants – but at a reduced rate – and supply continued to be constrained. Fourth quarter absorption was again negative, but showed significant improvement over previous quarters. Rents, however, fell again and continued an eight-quarter-long series of declines.

In 2009, industrial absorption was 160.7 million square feet, and the U.S. industrial warehouse vacancy rate increased by 18 basis points during the fourth quarter to register 10.92 percent, according to Colliers International’s most recent industrial report. This was the smallest quarterly increase since vacancies started rising two years ago, but it does represent a decade high number, up 307 basis points from the low point in the fourth quarter of 2007.

Of the 51 markets tracked across the country, 38 saw vacancies increase while 13 registered declines, according to Colliers International. “Primary markets’ infill sectors fared substantially better than non-infill markets in either primary or non-primary regions,” says Michael Frankel, managing partner, Rexford Industrial, a Los Angeles-based industrial property owner, pointing to Southern California as an example. Vacancy topped out at 3 percent to 5 percent, on average, across the infill markets of greater Los Angeles, while vacancy ranged from 9 percent in the Western Inland Empire to the mid-teens in the Eastern Inland Empire.

In fact, nationwide vacancy remained lowest in land-constrained Los Angeles County at 3.3 percent and was highest in economically depressed Detroit at 22 percent, according to Grubb & Ellis. Vacancy increased most sharply last year in San Diego, Las Vegas and Palm Beach County, Fla., all of which recorded gains of 400 to 500 basis points. Only the Oklahoma City industrial market saw vacancy tighten slightly in 2009. 

Scarce construction financing and weak rents have halted almost all speculative warehouse development. This was reflected in quarter-end construction activity, which registered just 15.4 million square feet, a substantial drop from the 153.5 million that was under construction at the end of the third quarter of 2007 and well below previous levels ever recorded, according to Colliers International.

Dallas-Fort Worth led all markets with 1.6 million square feet still to be completed. Five other markets each had more than 1 million square feet remaining in the pipeline: Philadelphia, California’s Inland Empire, Oklahoma City, Phoenix and Houston, according to Grubb & Ellis.

In the upcoming quarters, industrial construction is anticipated to go even lower and stay well below 10 million square feet per quarter for all of 2010 and quite possibly 2011, according to Colliers International.

“In my opinion, the biggest story for industrial is the supply side – we’ve never seen so little industrial construction,” Moore says, pointing out that occupier design-build business has halted.

“When demand returns, the vacancy rate will come down very quickly.”

Meanwhile, fourth quarter 2009 warehouse rents posted a modest decrease, falling 3 percent to $4.99 per square foot. With this latest decrease, U.S. warehouse rents are down 9.7 percent over the past year and 12.3 percent from the peak recorded in the fourth quarter of 2007. While some markets have seen rents remain steady, some metros have seen industrial lease rates fall by more than 25 percent in the last 12 months, Moore points out.

Moore forecasts a further increase in vacancy early this year, although at a much reduced rate, with vacancies reaching a plateau as early as the second quarter. With almost no construction coming onto the market and forecasts for continued economic growth over the next few quarters, occupancies should begin to rise by midyear and show firmer fundamentals by year-end, he says. Rental growth, however, is not likely during 2010, and many markets may have to wait until 2012 before rents start to rise.

“Industrial is clearly on the upswing,” Moore says. “If I had to pick one property type to invest in for the next five years, industrial is where I’d want to be.” 

Has the Commercial Real Estate Market Bottomed?

CNBC Squawk on the Street

Marcus & Millichap President and CEO Harvey E. Green

Top 10 Overlooked Tax Tips for Investment Property Owners

The Government Accountability Office reports that about 25 percent of rental owners overstate income from real estate, by an estimated $2.1 billion dollars.

This year, I want to make sure you're aware of the top 10 overlooked tax tips that can help you save money.

Signs of Hope Seen in Investment Sales Activity

By Mark Heschmeyer, CoStar Group

March 3, 2010

2010 Institutional-Quality Property Sales Showing Year-over-Year Improvement in Many Categories

Large dollar property sales seem to be emitting faint sparks of hope for the commercial real estate outlook so far in 2010, particularly in the multifamily and hospitality sectors.

To be certain, the number of property sales with price tags of $5 million or more still declined 16% in January from the number of sales in January 2009, according to CoStar Group Inc. And that was a steeper decrease than seen in November and December.

However, that decrease in dollar volume can be attributed to fewer deals and smaller properties being sold. The average size of the properties sold this past January was 5% smaller than a year ago, and the number of deals was down 15%. That helped raise, the average price per square foot being paid for institutional-quality properties from $141 per square foot to $149 per square foot January to January, the third month in a row that the average price paid was more than it was in the year-earlier period.

What's more, multifamily sales in the $5 million and up category increased 50% over the year earlier. This was the second month out of the last three that multifamily sales had increased month over month. Apartment sales were up in November and flat in December.

Hospitality property sales also took a huge upward turn in January - up more than 250% over the year-earlier period. Although, it was the first monthly increase since the recession started, the trend over the last four months has clearly been improving for hotel properties. They were down 58% in October 2009 compared to October 2008, but down only 1% in the December-to-December period.

While no one is jumping to the conclusion that the results clearly indicate commercial real estate has turned a corner, they do appear to lend more credence to the belief that a painfully slow rebound may be in progress.

"We’ll see more transactions involving institutional quality property because buyers are beginning to understand that prices for top-quality properties may be at or near a bottom," said Bob Bach, chief economist at Grubb & Ellis. "I think we’ll see a gradual increase in sales this year of perhaps 20% to 30% or possibly considerably more."

"We’ll also see [more activity in] Class B and C troubled assets in secondary and tertiary markets because lenders realize there’s no reason to hang on for better prices because these properties will be the last to recover," Bach said. "Prices are expected to drift moderately lower, more into the strike zone where buyers and sellers will start to make deals. But the pricing correction is [still] probably [only] two-thirds to three-quarters over with."

In addition to attractive pricing and lenders more willing to sell, confidence from the resumption of job growth is also expected to stimulate the willingness among investors to seek outsized returns by taking on greater risk.

As CoStar's Property and Portfolio Research (PPR) noted in its 2010 Predictions white paper, "Once we start getting a couple of months of positive job numbers, particularly if there is an accelerating trend, we’re going to see a lot of investors interested in cashing in on the opportunities that are out there, whether this means acquiring half-empty buildings or taking on assets with big lease-roll exposures."

According to PPR, the best-performing opportunity funds from a vintage standpoint have been those that are executed in the last year of a recession or the first year of the recovery. Looking back to the last downturn, 2001 and 2002 vintage funds were the best-performing opportunity funds over the previous eight years.

Multifamily Investment Sales

"There has undoubtedly been an uptick in transaction velocity in multifamily deals, and I believe it is due to a variety of factors," said Darron Kattan, partner and senior multifamily broker for Franklin Street Real Estate Services in Tampa, FL. "Multifamily is always the top choice of investment dollars and therefore there are a lot of buyers looking for deals. Nothing new in this cycle versus previous where multifamily is the first to recover due in large part to the availability of buyers. Multifamily was actually the first to hit the distressed radar screen, with the shortest term leases (outside of hotels), and therefore became the first to get hit hard by the downturn and land on asset managers' desks at lenders and servicing companies, and therefore are the first working through the system."

In addition, Kattan noted that AIMCO and Equity Residential were large net sellers in 2009 due to balance sheet and stock pricing issues. That, he said, opened the door for attractive deals to hit the market.

Tim Wang, vice president, senior investment strategist for ING Clarion in New York noted that Freddie Mac, Fannie Mae, and HUD have been dominating the multifamily financing.

"This is the only property sector that you can still lever up to 75% loan to value and have positive leverage to juice up investment returns," Wang said. "The Fed plans to end its $1.25 trillion mortgage debt purchase program by the end of next month, which could potentially lead to an increase in GSE mortgage rates. So, there is a rush in the marketplace to take advantage of the attractive financing terms and do multifamily deals before this deadline."

Hospitality Investment Sales

"Hotel demand is highly correlated with economic growth," Wang said. "Historically, it is one of the first property sectors to recover after recession. The sector is definitely improving, albeit from probably the steepest downturn in the U.S. lodging industry history. We are seeing generally stabilized occupancy while the average daily room rate is still declining but at a slower rate. The major difference in this downturn is that there was excess hotel supply delivered to the market in 2008-2009. Consequently, the revenue per available room recovery this time around could be slower than in the past."

Gordon L Wicker, chief operations officer for AXIA Real Estate Appraisers in Tucson, AZ, said, "with respect to the hospitality market statewide, average daily room rates and average daily occupancies remain well off 2007 numbers, so most sales activity in the larger regional/national market appears to be an increase in activity from REITs both as a long-term investment, and also due to a lack of attractive investment alternatives."

Timothy D. Chamberlain, principal at Koda Ventures LLC, and senior director at Lee Kennedy Co. Inc. in Quincy, MA, also noted that hospitality, while still distressed, is becoming appropriately priced.

"Hospitality is discounted enough to start to move and apartments represent stabilized cash flow, which is what the market wants today," Chamberlain said. "All other classes are getting kicked down the road and are not yet priced appropriately for a reasonable risk adjusted return."

Office, Industrial and Retail Investment Sales

"There will be an uptick in volume in 2010, but not much," Chamberlain said. "2011-'12 will be an active years for the industrial, office and retail food groups."

Of the three primary commercial real estate property sectors, 2010 investment sales numbers seem to indicate that office properties have improved the most over 2009. For starters, the pace at which sales have been declining has slowed dramatically. October 2009 sales were 50% fewer than they were in October 2008. That dropped to 24% fewer for December 2009 over December 2008. And in January of this year, office property sales of $5 million and up were off just 6% from what they were a year earlier. Notably, the average price per square foot is down dramatically from what it was a year ago: $158 compared to $202.

Retail and industrial property sales were still way down from year earlier numbers. Retail sales in January totaled 38% less the year-earlier period and industrial sales declined 68% month over month.

"Retail will generally continue to struggle until investors can get a feel for when occupancy rates and net operating incomes will stop deteriorating," said Mac McCall, senior director of Franklin Street Real Estate Services in Atlanta, GA. "With many retailers continuing to see declining sales, especially mom and pops, vacancy rates will continue to tick up without the added boost of increased employment in the overall economy."

"Additionally," McCall continued, "if you factor in the potential of bank-owned retail properties hitting the market in the coming years, buyers of this product will be able to get away with charging lower rents because their acquisition basis is much lower than their neighboring properties which were either built or acquired during the peak of the cycle and therefore have to charge higher rents to justify their mortgage payments. Both of these key factors make it a tough sell to a potential investor to invest in an asset with so much uncertainty regarding future cash flows."

Manish Rajguru, who oversees the evaluation of CMBS and other CRE debt instruments at Red Pine Advisors LLC in New York, said that, "the industrial [property sector] should increase, especially those related to trade (exports in particular). The office and retail property sectors should continue to lag given uncertainty of growth in office using employment and consumer respectively (and General Growth Properties' fallout as some malls will have to be repositioned/closed)."

Buyer Demographics

The buyer profile of institutional quality properties has shifted in the last four months from what it was a year earlier. Developer/owner and investment manager buyers continue to be the primary buyers of properties and, in fact, have increased their outlay year over year. Developer/owner purchases were up to about $7.3 billion in the last four months compared to $6.8 billion in the same period a year earlier; and investment manager buys were up to $5.5 billion from $3.7 billion.

REITs and corporate buyer have decreased their buying activity in the last four months from a year ago. REIT activity was down slightly from $5.4 billion to $5 billion; and corporate buying activity was down from $3.5 billion to $2.6 billion.

Notably, it appears that banks and financial institutions have stepped up their foreclosure activity. Bank/finance firms accounted for $1.9 billion in purchases in the last four months up from $480 million in the same period a year earlier.

Downtown improvements under way in Vallejo, assisted by state and federal stimulus funding

By Sarah Rohrs, Times-Herald

An influx of state and federal money is making it possible for the city to launch a series of downtown Vallejo improvements, officials said.

A new bus transfer station, ferry terminal improvements, and new trees and sidewalks on Virginia Street are some infrastructure projects in the works or waiting in the wings.

"It's kind of exciting that so much is being invested in the downtown," Public Works Director Gary Leach said. "Hopefully, it will provide some impetus for private developers to come in and invest."

The city is also about to solicit bids on the first phase of Vallejo Station, a three-story parking on Santa Clara Street, Leach said. The 740-parking space structure will connect the downtown to the ferry terminal, and also help remove parking from along the waterfront.

Construction on the multi-story building should begin in about three months, Leach said. The $24 million project is being funded mainly through bridge toll money, but no city funds, he added.

Another new project is the city's "streetscape plan" which will target four blocks with new trees, sidewalks, street lighting and pavement.

The plan's first phase targets Virginia Street between Sonoma Boulevard and Marin Street, in addition to Sacramento Street between Georgia and Maine streets, Leach said.

Work began in January with new water lines and a storm drain system. More visible improvements will start to take shape this spring, Leach said.

A $2.3 million federal stimulus grant is making this work possible, Vallejo Associate Civil Engineer Allan Panganiban said. The city is also getting some funding through the state Congestion Mitigation and Air Quality (CMAQ) Improvement Program.

Federal stimulus money is also making it possible for upgrades to the Vallejo Ferry terminal on Mare Island Way. Leach said the work will include a rehabilitation of the terminal, including new bathroom facilities, and relocation of the Vallejo Convention & Visitors Bureau to another part of the building.

The new bus transfer station is another downtown project in the works. Construction began three months ago and should be completed by the end of the year. The new station is being built in the public lot behind the Georgia Vista Center at Sacramento and York streets.

During construction, the former downtown bus transfer station has been relocated to the ferry terminal.

Global Commercial Property Sales Surge 85% In Fourth Quarter, Says RCA

Feb 23, 2010 2:12 PM, By Denise Kalette, NREI senior associate editor

A new report on global commercial property sales $10 million and above shows that quarterly transaction volume has surged for the first time in two years, a clear indication that the market is recovering from a deep recession.

In the fourth quarter of 2009, volume rose to $147 billion, up 85% from the same period of 2008, according to New York-based research firm Real Capital Analytics (RCA). It was the first quarterly increase on a year-over-year basis in seven quarters, according to the report.

From apartments and offices to retail deals, all property types except hotels showed an increase. Office, retail and industrial transactions together registered a 29% gain in the fourth quarter from the same period a year earlier.

Asia led the fourth-quarter surge, with China, Hong Kong and Taiwan providing most of the momentum, while the U.S. and Canada experienced a decline in sales.

“The U.S. is lagging counterpart regions in Europe and Asia. But we fell into the down cycle arguably later as well,” says Dan Fasulo, managing director of RCA. “We like to think that the U.S. will start to recover rapidly over the next six months, basically following in the same path of the recovery we’ve seen in Western Europe and in Asia.”

In the Asia Pacific region, volume rose 240% year-over-year in the fourth quarter, with China showing the strongest gains. And for all of 2009, only China registered a significant increase in sales, with volume rising 139% to $156 billion.

Although European and U.S. governments initiated stimulus programs, they were outdone by China, says Fasulo. “When Beijing told the banks to lend, they went out and lent the money. A lot of that excess debt capital went toward the acquisition of real estate, mainly large development sites.” A number of mixed-use projects were initiated at those sites and projects are under way.

Values begin to rise

The strengthening sales show that the market has bottomed out and begun its recovery, says Fasulo. “I think it’s very easy to say that as far as transaction activity goes, we’re well off the bottom, which as we look back, probably occurred in the first half of 2009.”

Anecdotal and some statistical evidence show that values have also begun to rise, says Fasulo. “In early 2009, you could barely get a quote to buy an office building in Manhattan. And if you did get a quote from a lender, you would be at extraordinarily low loan-to-values and a high interest rate. Now there’s more than a dozen lenders that would give you an honest quote today, at pricing that’s much more attractive.”

In one example signaling an improved market, the iconic, 160-unit Helmsley Carlton House hotel on Madison Avenue in Manhattan drew a flurry of offers after it was put up for auction in January. “There were over 35 bidders — over 100 interested parties and 35 firm bids,” says Fasulo. “Those are greater numbers than we saw at the height of the market.”

Bidding war in Boston

Another sign of an improving commercial property market is the bidding war that erupted over One Brigham Circle, a 200,000 sq. ft. office complex in Boston. Less than a week ago, AEW Real Estate Investment Management, based in Boston, won the competition with a bid reported at nearly $99 million.

Although the fourth quarter saw a dramatic increase in sales activity, transactions for the entire year of 2009 reflected the severe losses of the economic downturn. The global volume of commercial property sales dropped 30% to $381 billion, while the number of transactions fell 40%, RCA reports.

“We got pushed to the brink in late ‘08 and early ‘09, and saw almost the disappearance of the debt capital markets for commercial property,” explains Fasulo. But little by little, the marketplace has improved and property values are in the initial phases of climbing back from the abyss.

Still, not all properties are rising in value and desirability at the same pace. Class-A properties in highly desirable markets will recover their values more quickly, says Fasulo, particularly those with long-term leases in place and strong tenants.

“It’s almost a two-tiered market that’s developing. One is the prime assets that have more bond-like qualities, and the other part is assets that have near-term exposure to the economy — retail centers that have lost major tenants, broken development projects, raw land, a secondary market hotel. Those are the types of assets that are not going to see values recover anytime soon.”

A Class-A office building that stands mostly empty also is unlikely to share in the rebounding market, says Fasulo. But a building net-leased to a major institution such as a pension fund is a different story. “You’d better believe we’re going to see values increase for that type of product this year.”

As for the timing of recovery, Fasulo says he may be more bullish than many analysts. “I would argue that it’s already happening now.”

Shopping Center REITs Report Signs of Improvement, but Expect More Store Closings

Feb 23, 2010 4:02 PM | Retail Traffic

Shopping center REITs turned in a respectable performance for the fourth quarter of 2009, giving credence to the notion that the worst of the downturn may be over. Yet REIT analysts continue to be cautious about the sector’s prospects for 2010, as the year may bring more closings among smaller shopping center tenants and make re-leasing vacant space difficult.

For the three months ended Dec. 31, 2009, two shopping center REITs beat consensus analyst estimates, two were on target and five missed. The outperformers included Kimco Realty Corp. (NYSE: KIM) and Federal Realty Investment Trust (NYSE: FRT), which beat estimates by $0.02 per share and $0.09 per share respectively. Developers Diversified Realty (NYSE: DDR), Regency Centers Corp., (NYSE: REG), Ramco-Gershenson Properties Trust (NYSE: RPT), Acadia Realty Trust (NYSE: AKR) and Urstadt Biddle Properties Inc. (NYSE: UBA) were among those that missed. The misses, for the most part, amounted to no more than a penny.

Developers Diversified Realty missed by $0.47 per share, but according to Rich Moore, a REIT analyst with RBC Capital Markets, the consensus estimate of $0.33 per share represented an error and should be ignored. Developers Diversified’s fourth quarter FFO loss of $0.14 per share was in line with RBC estimates. Results for Kite Realty Group Trust (NYSE: KRG) and Inland Real Estate Corp. (NYSE: IRC) were in line with analyst expectations.

In general, the outlook appears to be brightening for shopping center REITs, as they report an increase in interest from expanding tenants, says Robert McMillan, a REIT analyst with New York City-based Standard & Poor’s Equity Research. “There is more positive sentiment regarding retailers looking for more space and that bodes well and should give them more pricing power,” McMillan notes. “I am looking for an improvement this year in terms of occupancy and rent trends.”

Overall, at year-end 2009, occupancy rates in the shopping center sector stayed above 90 percent, and some firms, including New Hyde Park, N.Y.-based Kimco Realty Corp., reported increasing success in re-leasing spaces left over from the bankruptcies of junior anchors Circuit City and Linen ‘n Things. Through most of last year, those empty big box spaces were among the biggest problems facing shopping center REITs, resulting in widespread NOI declines. Yet while the big box situation may be improving, 2010 might bring with it its own set of challenges when it comes to smaller, mom-and-pop tenants, says Jason Lail, senior real estate analyst with SNL Financial, a Charlottesville, Va.-based research firm. In addition, as retailers continue to keep a close eye on their store portfolios, re-leasing will likely still be a challenge.

“I think this year there is still a little bit of shaking out [left], to be honest,” Lail notes. “As a whole, shopping center REITs have held up relatively well, but I really think the shopping center space is saturated through the next couple of years. I am curious if there will be any major tenant bankruptcies this year and how the supply chain as whole will affect occupancy.”

Some REIT executives appear to share Lail’s concern. During Kimco Realty Corp.’s earnings call on Feb. 4, company CFO Michael Pappagallo gave an estimate for same-store NOI in 2010 that was between flat and down two percent as Kimco expects to see additional fall-out from potential store closings in the first half of the year. The good news, according to Paul Freddo, senior executive vice president of leasing and development with Beachwood, Ohio-based Developers Diversified Realty, is that retailers have learned to use inventory controls and cost reduction strategies to sail through a challenging economic climate.

There’s also been a significant slowdown in rent reduction requests from struggling tenants, according to Dawn M. Becker, executive vice president and chief operating officer with Federal Realty Investment Trust, a Rockville, Md.-based REIT. The requests that do come in are from tenants that were already facing problems last year and need more time to turn themselves around, not from new retailers. Now, the REITs are waiting to see tenants show sustained top line and earnings growth that will be a good predictor of future expansion.

To date, shopping center REITs that have yet to report their fourth quarter 2009 results include Cedar Shopping Centers(NYSE: CDR), Equity One Inc. (NYSE: EQY), Saul Centers Inc. (NYSE: BFS) and Weingarten Realty Investors (NYSE: WRI). Weingarten is scheduled to report after the market closes on Feb. 24. Cedar Shopping Centers and Equity One will release their results on March 3 and March 4 respectively. Saul Centers has not indicated a reporting date.

—Elaine Misonzhnik,

No Real Commercial Recovery Before 2011

Although the economy has been growing lately, fallout from the recent recession continued to negatively impact commercial real estate sectors in the fourth quarter, but there is hope for some improvement next year, according to the National Association of REALTORS®.

Lawrence Yun, NAR chief economist, said commercial real estate almost always lags the economy. “Because of the lingering impact from the deep recession over the past two years, vacancy rates will trend higher and many commercial property owners will need to make rent concessions,” he said.

“With the job market expected to turn for the better later this year, we’ll see rising demand for office and warehouse space, but that isn’t likely before 2011,” Yun said. “At the same time, improved consumer  confidence would help sustain the retail sector and encourage more people to enter the rental market.”

Yun notes that commercial vacancy rates remain high in most market areas and are depressing rents.

The Society of Industrial and Office Realtors, in its SIOR Commercial Real Estate Index, an attitudinal survey of more than 700 local market experts, suggests a flattening level of business activity in upcoming quarters with 55 percent of members expecting the market to improve in the second quarter.

The SIOR index rose 0.2 percentage point to 35.5 in the fourth quarter, compared with a level of 100 that represents a balanced marketplace. This is the first gain following 11 consecutive quarterly declines. Although some indicators show that a decline in commercial property values is beginning to flatten, 86 percent of respondents report prices are below replacement costs.

Nearly nine in 10 survey participants said new commercial development is virtually nonexistent in their market areas, and rent concessions are reported almost everywhere.

A Long Way To Go

An independent survey earlier this month showed a couple dozen banks are willing to expand commercial credit this year, which is critical. The lending expansion is aided by the Federal Reserve's Term Asset-Backed Loan Facility (TALF), which is encouraging issuance of commercial mortgage-backed bonds. In addition, regulators are prodding lenders to extend terms for many existing commercial loans.

“We have a long way to go for satisfactory levels of commercial credit, but these are important first steps,” Yun said. “Given that about $1.4 trillion in commercial debt will come due over the next three years, more extensive action is needed and the Fed needs to more actively help resuscitate commercial mortgage-backed securities. The credit improvement will mean more commercial property sales in 2010, even some at deeply discounted prices.”

Looking at the overall market, commercial vacancy rates generally will stay at elevated levels, according to NAR’s latest COMMERCIAL REAL ESTATE OUTLOOK. The NAR forecast for four major commercial sectors analyzes quarterly data in the office, industrial, retail and multifamily markets. Historic data were provided by CBRE Econometric Advisors.

Office Market

With a lot of sublease space currently on the market, vacancy rates in the office sector are forecast to rise from 16.3 percent in the fourth quarter of 2009 to 17.6 percent in the fourth quarter of this year; the longer term outlook is for vacancies to average 17.4 percent in 2011.

Annual office rent is projected to decline 7.2 percent in 2010, following a drop of 12.7 percent last year. In 57 markets tracked, net absorption of office space, which includes the leasing of new space coming on the market as well as space in existing properties, should be a negative 27.3 million square feet in 2010.

Industrial Market

There is proportionately less industrial sublease space on the market than in the office sector, but obsolescence remains a factor. Industrial vacancy rates will probably rise from 13.9 percent in the fourth quarter of last year to 14.9 percent in the closing quarter of 2010; they could average 14.5 percent next year.

Annual industrial rent is likely to fall 9.6 percent this year, after declining 10.9 percent in 2009. Net absorption of industrial space in 58 markets tracked is seen at a negative 93.5 million square feet in 2010.

Retail Market

Retail vacancy rates are expected to edge up from 12.4 percent in the fourth quarter of 2009 to 12.7 percent in the same period of this year, and may hold at that level in 2011.

Average retail rent is forecast to decline 2.4 percent in 2010, following a drop of 4.0 percent in 2009. Net absorption of retail space in 53 tracked markets should be a negative 3.4 million square feet this year.

Multifamily Market

The apartment rental market – multifamily housing – is poised to gain from a rise in household formation. Multifamily vacancy rates are likely to decline from 7.4 percent in the fourth quarter of last year to 6.6 percent in the fourth quarter of 2010, and possibly edge down to 6.1 percent next year.

Average rent is projected to decline 3.4 percent this year, following a decline 3.6 percent in 2009. Multifamily net absorption is expected to be 115,000 units in 59 tracked metro areas this year.

— NAR

Tax Breaks You Don't Want to Forget About

With tax season fast approaching and April 15th around the corner, we figured it would be appropriate to discuss the significant tax benefits that accompany real estate ownership.  Remember when filing your return to take full advantage of the following:


Mortgage Interest Expense
The government allows all of the interest associated with the financing of the property to be written off as an expense of owning the property.  For many real estate investors, especially those with interest only loans, this expense deduction can be substantial.
Depreciation
Depreciation is a method for matching the costs of acquiring property over the properties estimated economic life. The IRS now requires that most properties be depreciated using the straight-line method of depreciation (27.5 years for residential properties, 39 years for commercial properties).  Depreciation will act as an intangible expense and will shelter income from taxes.
Expense Deductions
Many of the costs associated with owning and managing a real estate investment, such as management fees and insurance premiums, are deductible.  One deductible expense worthy of note is  the travel expense.  Many real estate investors acquire real estate in places they like to (or have to) visit, and each time they travel to the property, the travel costs are a deductible expense.  Not a bad deal if the property happens to be in Maui or around the corner from a relative.
Passive Losses
Due to depreciation and expense deductions, it is possible to own a property that is producing positive cash flow, but for tax purposes showing a loss.  These “passive losses” are subject to certain restrictions, but in many circumstances can be used to offset passive income from another investment.  In the event an investor qualifies as a "full time real estate professional" passive losses can be used to offset ordinary income.  Full time real estate agents should have no problem qualifying for maximum passive loss benefits (see recent US tax court opinion).
Leonard Spoto Asset Exchange Company

Foreclosing on Rental Property

Questions have been asked on the rights of a tenant when their landlord loses their property through foreclosure.  Below is an informative Legal Q & A from the California Association of Realtors Legal Department.

-Burt

I. Introduction
When a lender begins a foreclosure, parties involved with the property in foreclosure may be uncertain as to how the process affects them. Not only are lenders often unaware of their rights and obligations, but borrowers (sometimes also referred to as "owner" or “mortgagor”) who are faced with losing ownership of property also are frequently lacking knowledge about the limit and extent of some of their basic responsibilities and rights.
When the foreclosed upon property is a rental, tenants are unwittingly forced into a position of uncertainty concerning their contractual and legal rights and duties. If the rental is managed by a real estate broker, yet another party may feel strained by the tension and possibly competing demands of the property owner, foreclosing lender, and tenant.
This legal article addresses some of the major issues faced by property owners, lenders, tenants and property managers involved with a foreclosure on rental property. Certain topics will not be addressed, such as the steps in a foreclosure, the circumstances under which a deficiency judgment may be obtained (see legal articles, Deficiency Judgments and California Law and Deficiency Judgment Chart), and discharge of indebtedness and other issues involved in a short payoff (see legal article,Short Sales), as these issues are germane to all foreclosure properties. Instead, the primary focus will be to highlight those areas of concern unique to rental properties.

II. Lender Issues

A. Lender Issues with the Owner

1. Rent Skimming

Q 1.  What is rent skimming?

A  Foreclosures typically take place because a borrower does not make required payments pursuant to the loan documents. Foreclosing lenders are bound to be frustrated by an owner who is collecting rents yet not paying a loan. These lenders may want to try and stop the borrower from taking what they perceive as money which is owed to them. After all, isn't this rent skimming? And, isn't rent skimming a crime?

Rent skimming is defined as using revenue received from residential real property any time during the first year after acquiring the property without first applying the revenue to payments due on deeds of trust encumbering the property (Cal. Civ. Code § 890). Criminal penalties of up to one year in jail or up to a ten thousand dollar fine or both exist for rent skimming (Cal. Civ. Code § 892).  Thus, if it isn’t the first year of ownership, this remedy doesn’t apply.

Note:  There is also an “equity skimming” federal law; however, it is limited to residential one-to-four unit properties in default at time of transfer or in default within one year of transfer and those which are HUD properties, have HUD insured loans, or have VA loans. This federal law also requires a “pattern or practice” of purchasing such properties with an intent to defraud. (12 U.S.C. § 1709-2.)

Q 2.  What can a lender do, if anything, to respond to an owner engaging in rent skimming?

A  The decision of whether to pursue criminal action is in the hands of a government prosecutor (and outside the scope of this article). If rent skimming is involved, a lender can bring a civil action against the borrower for damages, costs, and attorney's fees. The court has the authority to also award exemplary (punitive) damages. (Cal. Civ. Code § 891(c).)

If the lender was a seller who carried back a loan (i.e., seller financing) and the borrower has engaged in multiple acts of rent skimming, a court must award exemplary damages of at least three times the actual damages (Cal. Civ. Code § 891(a)). The right to bring a claim based on rent skimming is not limited by either the one-action rule or anti-deficiency laws (Cal. Civ. Code § 891(g)).

2. Before the Foreclosure

Q 3.  Prior to foreclosure, what are the owner’s obligations to the lender?

A  Prior to title transferring at a foreclosure sale, the borrower has a contractual obligation to make the payments specified in the note. Aside from the potential criminal and civil issue of rent skimming, the borrower has no obligation to use the specific rents received to pay off the loan. If the lender wishes to gain access to the property as a mortgagee-in-possession the borrower can deny the lender permission. (Cal. Civ. Code § 2927.)  Similarly, if the lender attempts to peacefully exercise a rents and profits clause without bringing a judicial action, the borrower can prevent this voluntary exercise by refusing permission and instructing any tenants to continue making payments as called for in the lease and not to the requesting lender.

Q 4.  How can the owner defeat an action brought by the lender to appoint a receiver?

A  If the lender brings a legal action to appoint a receiver to enforce a rents and profits clause, the borrower can oppose the action. The appointment of a receiver is discretionary, not automatic (Cal. Civ. Proc. Code § 564(b)(8).) Where a rents and profits clause does not exist and the lender applies to the court for appointment of a receiver, the borrower may defeat the action if the borrower can show the following:

(1)  The property is in no danger of being lost, removed, or materially injured; or
(2)  That even if a condition has not been performed, the property is sufficient to satisfy the debt (Cal. Civ. Proc. Code § 564(b)(2).)

a. Mortgagee-in-Possession

Q 5.  Prior to the foreclosure sale, what are the lender’s rights?

A  A lender who wishes to enter the property for the purposes of collecting rents may do so with the express consent of the owner/borrower in default even without additional consideration or a formal agreement (Cal. Civ. Code § 2927; Hooper v. Young (1903) 140 Cal. 274). A lender who does so is a mortgagee-in-possession. However, a lender who enters the property without the consent, or over the objection, of the owner/borrower in default becomes liable to the owner for forcible entry and trespass. (California Hotel Co. v. Bank of America Nat'l Trust & Sav. Ass'n (1939) 31 Cal. App. 2d 295; Mcguire v. Lynch (1899) 126 Cal. 576).

Q 6.  How does the lender become responsible to the tenant upon becoming a mortgagee-in-possession?

A  A lender who becomes a mortgagee-in-possession enjoys the advantage of directly collecting rent and applying it toward the unpaid debt.  However, the lender is responsible to the borrower and junior lien holder for losses caused by negligence or failure to act in a business-like manner. (Johns v. Moore (1959) 168 Cal. App. 2d 709. )

For lenders who find the advantages outweigh the disadvantages, although not required, a written agreement is advisable in order to avoid conflicts over whether consent was granted or withheld, as well as to have documentation which will support the lender's claim to rents if questioned by tenants.

b. Rents and Profits Clauses

Q 7.  How is the lender legally able to invoke the status as mortgagee-in-possession (i.e., how does the foreclosing lender pursue the direct collection of rent)?

A  Today, most deeds of trust contain a rents and profits clause. This can be an absolute assignment of rents, an absolute assignment of rents conditioned on default, or an assignment of rents as additional security. This last type of clause is typically found in short form deeds of trust recorded in each county and referred to by a short form trust deed.

An example of such a clause appears below:

As additional security, Trustor hereby gives to and confers upon Beneficiary the right, power, and authority, during the continuance of these Trusts, to collect the rents, issues, and profits of said property, reserving unto Trustor the right, prior to any default by Trustor in payment of any indebtedness secured hereby or in performance of any agreement hereunder, to collect and retain such rents, issues, and profits as they become due and payable. Upon any such default, Beneficiary may at any time without notice, either in person, by agent, or by a receiver to be appointed by a court, and without regard to the adequacy of any security for the indebtedness hereby secured, enter upon and take possession of said property or any part thereof, in his own name sue for or otherwise collect such rents, issues, and profits, including those past due and unpaid, and apply the same, less costs and expenses of operation and collection, including reasonable attorneys' fees, upon any indebtedness secured hereby, and in such order as Beneficiary may determine. The entering upon and taking possession of said property, the collection of such rents, issues, and profits, and the application thereof as aforesaid, shall not cure or waive any default or notice of default hereunder or invalidate any act done pursuant to such notice.

Q 8.  Does the existence of a rents and profits clause mean the lender can invoke the mortgagee-in-possession status without doing anything else?

A  It depends.  The collection of rent pursuant to a rents and profits clause does not, in and of itself, impose mortgagee-in-possession status on the lender. (Strutt v. Ontario Sav. & Loan Ass'n (1972) 28 Cal. App. 3d 866.) The lender must take steps before proceeding to collect. However, a demand upon the tenant or borrower to turn over the rents, coupled with their cooperation is all that is needed (Lee. v. Ski Run Apartments Assoc., (1967) 249 Cal. App. 2d 293).

If neither party cooperates or if the borrower objects (even if the tenant agrees) the lender needs to file a judicial action for appointment of a receiver.

The legal action is one for specific performance of the borrower's promise as contained in the trust deed. The request for a receiver is secondary to this specific performance action (Cal. Civ. Proc. Code § 564 (b)(8)). A receiver is an agent of the court, not the lender, and must maintain control of the rents until ordered to pay them out. The order for appointment of the receiver can direct the receiver to apply collected rents:

(1)  First to pay the expenses of the receivership (administrative and management);
(2)  Then to payment of taxes and senior secured debts; and
(3)  Followed by the maintenance of a working capital account before any funds collected are to be made available to the lender. (See, California Mortgage and Deed of Trust Practice, 2nd ed., Roger Bernhardt (hereinafter referred to as "Bernhardt") pp. 259-260.)

Monies collected by a receiver pursuant to an additional security rents and profits clause can be received by a lender following a trustee's sale without violating either the one-action or anti- deficiency rules (Bernhardt, supra Section 5.22).  In the absence of a rents and profits clause it may still be possible to have a receiver appointed, but the burden is much greater on the applying lender than where a rents and profits clause exists (Cal. Civ. Proc. Code § 564(b)(2)).

3. After The Foreclosure Sale

Q 9.  If the borrower is an occupant of the property, and the lender forecloses judicially (not trustee’s sale), can the lender evict the borrower?

A  If the borrower occupies one of the units in the rental property and the lender has foreclosed judicially, then the borrower is entitled to possession throughout the statutory redemption period (either three months or one year depending on the amount received at the judicial foreclosure) (Cal. Civ. Proc. Code §  729.030). The foreclosing lender can charge the borrower rent for this occupancy equal to the value of use and occupation (Cal. Civ. Proc. Code §  729.090(a)).

However, if the occupant/borrower fails to pay rent, the lender probably lacks the ability to evict during the redemption period. After the redemption period, the lender should be able to pursue an action for collection of unpaid rents. (Cal. Civ. Proc. Code §  729.090(a).)

Q 10.  If the borrower is the occupant of the property, and the lender forecloses through a trustee’s sale, can the lender evict the borrower?

A  Yes.  If the lender has foreclosed by way of a trustee's sale, the borrower can be evicted immediately following a three-day Notice to Quit. (Cal. Civ. Proc. Code § 1161a(b).)

B. Lender Issues with the Tenants

1. Before The Foreclosure

Q 11.  Prior to the foreclosure sale, is the tenant required to turn rent directly over to the foreclosing lender?

A  No.  A lender may request that a tenant make payments directly to the lender rather than the borrower in an attempt to create a voluntary exercise of a rents and profits clause or to establish the lender as a mortgagee in possession. The tenant may comply but is not required to do so.

If the lender goes to court and has a receiver appointed with the power to collect rents, a tenant will be obligated to pay the receiver. There is no apparent right in California law permitting a lender, or receiver, to evict a tenant for a breach of a lease. Indeed, there is a danger in doing so if, in fact, the borrower reinstates the loan prior to a foreclosure sale and is damaged by the loss of a tenant.

2. After The Foreclosure

Q 12.  Following a foreclosure sale, what are the tenant’s obligations to the lender?

A  Following a judicial foreclosure sale, the tenant, after receiving notice of the sale, must pay rent to the lender or the appointed receiver from the time of the sale until a redemption by the former owner (Cal. Civ. Proc. Code § 729.090(a), Cal. Civ. Code § 1111).

Following a trustee’s sale foreclosure, the tenant must also pay rent to the lender (or a receiver if one had been appointed) from the time of the sale (Farris v. Pacific States Auxiliary Corp. (1935) 4 Cal. 2d 103, 105).  There is no period of redemption after a trustee’s sale; however, some refer to the right to “cure the default” any time prior to five business days before the date of the trustee’s sale as a “right of redemption” (see Tomczak v. Ortega (1966) 240 Cal. App. 2d 902).

a. When the Lease is Senior to the Lender’s Deed of Trust

Q 13.  If the lease is senior to the deed of trust of the foreclosing lender, what are the tenant’s rights after the foreclosure?

A  When the lease is senior to the deed of trust (i.e., the deed of trust was recorded after the date of the lease) or the lender had knowledge of the tenancy at the time the loan was made, the lender takes the property subject to the rights of the tenant (Cal. Civ. Code §§ 1214, 1215, Dover Mobile Estates v. Fiber Form Products, Inc. (1990) 220 Cal. App. 3d 1494, 1498.) The tenant becomes obligated to the lender as if the lender were the former owner (Cal. Civ. Code §§ 821, 1111).

b. When the Lease is Junior to the Lender’s Deed of Trust or Tenant is on a Periodic Tenancy

Q 14.  If the deed of trust of the foreclosing lender is senior to the lease, (i.e., the deed of trust was recorded prior to the date of the lease) or the tenant doesn’t have a lease, what are the tenant’s rights after a foreclosure?

A  The foreclosing lender or the immediate successor-in-interest at foreclosure (e.g., the purchaser at the trustee’s sale) who wishes to terminate the tenancy must give the tenant the following notice to terminate the tenancy:

3 days:  If the tenant is the mortgagor (borrower), then s/he must receive a 3-day Notice to Quit prior to termination of the tenancy.  Also, if the tenant is a party to the mortgage note, then s/he must receive a 3-day Notice to Quit to terminate the tenancy.  (Cal. Civ. Proc. Code §§ 1161a, 1161b, P.L. 111-22.)

60 days:  If the tenant is the child, parent or spouse of the mortgagor (borrower), then s/he must receive a 60-day Notice to Quit prior to eviction.  If the tenancy is not the result of an arms-length transaction or the rent is substantially lower than fair market rent, then s/he must receive a 60-day Notice to Quit to terminate the tenancy.  (Cal. Civ. Proc. Code § 1161b, P.L. 111-22.)

90 days:  If the tenant is not the mortgagor (borrower) or is not a child/parent/spouse of the borrower or the tenant is on a periodic tenancy and the tenancy is the result of an arms-length transaction and the rent is not substantially lower than fair market rent, then the tenant is entitled to a 90-day notice to terminate the tenancy. (P.L. 111-22.)

Full term of the lease:  If the tenant is not the mortgagor (borrower), or is not a child/parent/spouse of the borrower, and the tenancy is the result of an arms-length transaction and the rent is not substantially lower than fair market rent and the tenant has a lease, then the tenant is allowed to occupy the property until the end of the lease term.  However, if the foreclosed property is sold to a buyer who will occupy the property, then the lease can be terminated with a 90-day notice.  (P.L. 111-22.)

Q 15.  Why is there no 30-day notice option in Question 14?

A  A 30-day Notice to Terminate a Tenancy can be used when the property is not a foreclosure property and the tenant has resided in the property for less than one year (60-day notice if the tenant has resided in the property for one year or longer) (Cal. Civ. Code § 1946.1).

Q 16.  Do the notice periods in Question 14 still apply if the tenant is not paying any rent at all?

A  It depends.  If the lender foreclosed by judicial foreclosure and the tenant is the mortgagor (borrower), the lender probably lacks the ability to evict during the redemption period. After the redemption period, the lender should be able to pursue an action for collection of unpaid rents. (Cal. Civ. Proc. Code § 729.090(a); Bernhardt, Section 5.37.)  For other tenants who aren’t paying any rent, after the judicial foreclosure the lender may give a 3-day Notice to Quit (Cal. Civ. Proc. Code § 1161(2)).

If the lender has foreclosed by trustee’s sale (and, thus, there is no period of redemption), the lender may evict a non-paying tenant or mortgagor (borrower) by giving a 3-day Notice to Quit (Cal. Civ. Proc. Code § 1161(2)).

Q 17.  If the deed of trust of the foreclosing lender is senior to the lease, (i.e., the deed of trust was recorded prior to the date of the lease), can the lender enforce the lease if the tenant wants to terminate it?

A  No.  When the deed of trust of the foreclosing lender is senior to the lease, the lender who finds that the lease is favorable and wishes to continue to enforce it may be disappointed to discover that the tenant has the right to terminate the lease after foreclosure. (Dover Mobile Estates v. Fiber Form Products, Inc. (1990) 220 Cal. App. 3d 1494.)

c.  Security Deposit Issues

Q 18.  After foreclosure, what party is responsible for returning the tenant’s security deposit?

A  Upon termination of the borrower's interest in the property, security deposits which are not returned to a tenant should be transferred to the borrower's successor-in-interest, the lender (Cal. Civ. Code §§ 1950.5 (g), 1950.7(d)).  In the event the owner fails to comply with this requirement, and the rental is residential, the owner remains jointly responsible with the lender for repayment of security to the tenant.(Cal. Civ. Code § 1950.5(i)).

Q 19.  After foreclosure, to whom does the tenant go to get the security deposit back?

A  An owner who is about to lose property through foreclosure is unlikely to either:

(1)  Transfer any security deposits to the foreclosing lender; or
(2)  Return the security deposits to the tenants as is required by law.

(Civil Code Sections 1950.5(g), 1950.7(d).)

In the event the owner who has lost the property through foreclosure has not done either option above, and the rental is residential property, the foreclosing lender is jointly and severally liable, along with the former owner, for repayment of any security to which the residential tenant is entitled (Cal. Civ. Code § 1950.5((i)).

Possibly this express statement of joint and several liability can be used by the lender to bring a legal action against the borrower for recovery of any sums properly paid to residential tenants for security deposit claims by the lender without violating the one action or anti-deficiency rules. (See California Real Estate, Miller & Starr § 19:143 (online).)

Q 20.  Upon foreclosure, must the lender return the tenant’s security deposit?

A  Regardless of the form of foreclosure used, a residential lender becomes obligated to return unused security deposits to any residential tenants unless the borrower returned these sums to the tenants prior to the transfer of title. (Cal. Civ. Code §§ 1950.5, (i) and (j).)

Commercial lenders who acquire the property through foreclosure do not have the same statutory obligation to return deposits to tenants if the lender does not receive the security deposit money from the former owner (Cal. Civ. Code § 1950.7).

III. Owner Issues with the Tenant

A. Before the Foreclosure

Q 21.  After the owner’s default but prior to foreclosure, what are the tenant’s obligations to the owner?

A  The borrower is contractually entitled to receive rent from the tenant even though in default on the note. A default on the note, in and of itself, does not create a breach of the covenant of quiet enjoyment of the leased premises or a denial of possession to the tenant. Thus, the tenant who ceases payment of rent can be evicted by the owner or sued for breach of the lease. (Cal. Civ. Proc. Code § 1161.)

B. After the Foreclosure

Q 22.  Following foreclosure, what are the owner’s/borrower’s obligations regarding the tenant’s security deposit?

A  After the foreclosure sale, the owner must return the security deposit to the tenant or transfer it to the foreclosing lender in order to be relieved of liability for the security deposit to the tenant (Cal. Civ. Code §§ 1950.5 (h), 1950.7 (d)). The owner/borrower who in bad faith fails to return a security deposit to a tenant can be held liable to the residential tenant for up to twice the amount of the security, in addition to actual damages (Cal. Civ. Code § 1950.5 (l)).  For a commercial tenancy, the owner/borrower can be held liable to the tenant for bad faith retention of the deposit in statutory damages not to exceed two hundred dollars, in addition to any actual damages (Cal. Civ. Code § 1950.7 (f)).

V. Property Management Issues

Q 23.  Does the owner’s default entitle the property manager to neglect or deviate from the property management agreement?

A  No, the default of the owner does not entitle the manager to neglect responsibilities identified in the property management agreement. Prior to a foreclosure sale, the property manager has contractual and fiduciary obligations to the owner of the property. If the management agreement provides for the collection of rent, then such activity, consistent with the terms of employment, is done on behalf of the owner. Honoring a request of the lender for disbursements of rents received, without the express permission of the owner would be grounds for breach of the manager's contractual and, possibly, fiduciary duties.

Q 24.  How does a court-appointed receiver affect the property manager’s rights and obligations to the owner?

A  Once a receiver has been appointed by a court, if the power of appointment directs the manager to hand over received rents, then the request of the court-appointed representative should be satisfied. The property manager should request a copy of any court order.  If the receiver collects rents directly, and takes over other management functions from the property manager, this would have the effect of terminating the agency and contractual obligations of the manager and establishes probable grounds for a manager's breach of contract claim against the owner. Monies held by the manager should be disbursed in accordance with the instructions of the owner unless directed otherwise by a receiver who has been granted that authority.

Q 25.  Can the property manager make a breach of contract claim against the owner following the foreclosure sale?

A  After the foreclosure sale, the subject of the agency--the owner's interest in the real property-- becomes “extinct,” thus terminating the agency (Cal. Civ. Code § 2355(b)). As a consequence, the owner may be liable to the property manager for breach of contract damages. However, disbursement of previously-collected sums still requires direction from the former owner or court.

Q 26.  Does the property manager have any obligation to comply with requests from the foreclosing lender?

A  The property manager is the agent of the owner and has no obligation to honor any request for disbursement of rents made by a foreclosing lender. Upon receiving such a request, that agent's duty of full disclosure would impose upon the manager a requirement to inform the owner of the lender's request. If a lender has a receiver appointed, the manager can presumably enter into an agreement with the receiver to continue performing property management functions, for a fee. Such an agreement would affect rents collected and services performed after the date of the agreement.

Q 27.  Following the foreclosure sale, may the property manager enter into a new property management agreement with the lender?

A  Yes.  After the foreclosure sale terminates the owner's interest in the property and the agency relationship between the owner and manager, the manager may enter into a new property management agreement with the lender, just as the manager could with any owner of property.

Q 28.  Does the property manager have the right to release tenants’ security deposits to the lender?

A  No.  Should the lender demand that the manager release previously-held tenants' security deposits, the manager should refuse. These funds are held in a trust account for the benefit of the former owner and are not the property of the manager (Cal. Bus. & Prof. Code §§10145, 10176(e)).

Q 29.  Should the property manager inform tenants that the owner is in default and facing foreclosure?

A  One issue facing a property manager is whether to inform tenants that the property owner is in default and facing foreclosure.  What should the manager do? If during the lease negotiations the manager acted as a dual agent, then the manager's fiduciary responsibilities would require disclosure of the foreclosure. If there is no agency relationship with the tenant, then the manager needs the owner’s permission to disclose the fact of the foreclosure to the tenants.

Q 30.  Following foreclosure, can the tenant establish a claim against the property manager in order to secure the return of their security deposits?

A  Once the foreclosure sale has been completed, tenants whose leases have terminated and who desire a return of their security deposits might try to sue the manager.  Typically, the property manager is not the owner of the property and is acting solely in an agency capacity.  Thus, there shouldn’t be any personal liability.  However, that may not discourage the tenant from suing the property manager.

VI. Conclusion

Unfortunately, many areas of the state are experiencing record levels of foreclosures. REALTORS® in these areas, as well as anywhere else where a foreclosure is occurring, are often asked questions by the principals involved with the property. Owners, lenders and tenants of rental property in foreclosure who are, have been or anticipate having a working relationship with a REALTOR® may seek advice from the real estate licensee. While a licensee should avoid giving legal advice, it is helpful for a REALTOR® to have an understanding of some basic issues facing these principals. Such an understanding can help guide the REALTOR® away from problems and toward solutions.

When a rental property is being foreclosed upon, the duties and relationships between and among the principals and agents change depending on the strategies employed by the foreclosing lender, the needs and desires of the property owner, and the type and priority of the tenants' leases. Another critical factor affecting the relationships is whether or not the default has resulted in an actual sale of the property. This article has identified many of the issues most likely to be faced by a real estate licensee. The purpose is to enable a REALTOR® to identify issues and problems so that appropriate steps can be taken, or appropriate referrals made, to enable the principals and REALTORS® alike to make their way through a difficult situation with as much information and ease as possible.