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Commercial Real Estate Black Hole

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Residential real estate is nowhere near a bottom and commercial is staring over the abyss.

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Bloomberg is reporting Blackstone's (BX) Profit Misses Estimates; Shares Decline.

Blackstone Group LP, manager of the world's biggest leveraged buyout fund, reported third-quarter profit that missed analysts' estimates as real estate fees fell, sending its shares down the most since going public in June.

The firm had a net loss of $113.2 million, or 44 cents a share, including costs of $802.6 million, mostly from compensation related to the IPO. That compared with a loss of $165.5 million, or 65 cents, a year earlier. Blackstone said at the time of its IPO that it may continue to have net losses "for a number of years" because of the cost of buying stakes from executives.

Blackstone may have net losses for years. Imagine that. And people were clamoring to get into this turkey.

Forbes is calling Blackstone a Black Hole.

Blackstone's chief operating officer Hamilton James said Monday the sagging private-equity market might not make a comeback until major Wall Street banks get a better handle on the credit crisis.

My comment: We might have a better handle on the credit crisis sometime on or around January 1, 2012. That number was not plucked out of the air. It is based on historical new home sales, historical starts, and mortgage rate resets in conjunction with a consumer-led recession. See When Will Housing Bottom? for more details.

"The mortgage black hole is worsening ... it is deeper, darker, scarier than what the banks originally thought," he said. "My sense is they don't have a clear picture of how this will play out, and their confidence is low."

My comment: You ain't seen nothing yet. Residential is nowhere near a bottom and commercial is staring over the abyss.

James believes the market for leveraged loans, which buyout funds use to finance deals, appears to be picking up after a crippling summer.

My comment: False hope springs eternal.

This was Blackstone's first full quarter as a public company after debuting on the New York Stock Exchange on June 22 at $31 per share. It surged 13.1% to close at $35.06 on its first day. But the year's most anticipated IPO has failed to hold on to even that modest pop.

Blackstone reported a loss of $113.2 million, or 44 cents per share, compared to a profit of $372.5 million when it was a private company last year. The loss included the impact of $802.6 million in non-cash charges for compensation and other charges related to its IPO.

My comment: For more on the beauty of non-cash charges please see Implications of GM's Non-Cash Writeoff.

After it reported its second-quarter results, James said he believed the debt market crisis could help Blackstone by pushing weaker rivals out of business.

My comment: Countrywide Financial (CFC) CEO Mozilo said exactly the same thing.

Blackstone's corporate private equity unit, which buys companies and then takes them private, logged a 42% jump in revenue. But the real estate business' revenue tumbled 44% to $109.1 million because of tightening in the subprime residential lending market, which has spilled over into the commercial real estate market.

My comment: A spillover into commercial real estate? How shocking! Who could possibly have figured that out? For more on commercial real estate please see Commercial Real Estate Abyss.


666 Fifth Avenue

The New York Times is reporting Financial Ground Has Shifted Under a Record Deal:

The record price paid in January for the 41-story aluminum-clad office tower at 666 Fifth Avenue - $1.8 billion - was breathtaking, even by the standards of the heady Midtown Manhattan commercial real estate market.

A group of lenders led by the real estate unit of Barclays Capital agreed to provide an interest-only first mortgage of $1.215 billion based on an annual cash flow of $114 million, or 1.5 times the debt service, according to a document filed with the Securities and Exchange Commission.

But a footnote pointed out that the cash flow from existing rents would actually cover only 0.65 percent of the debt service. Mr. White [president of Real Capital Analytics] calculated that the building's shortfall amounts to $5 million a month. A $100 million reserve fund was included in the debt package to cover the shortfall.

My Comment: Let's do the math. At $5 mln a month, the $100 mln reserve fund will be wiped out in 20 months (1.75 years). Do you think lease rates and occupancies will be rising over the next two years? Think again.

Like many buyers, Kushner relied on high-cost short-term financing to make up most of the gap between the first mortgage and the purchase price for 666 Fifth.

My comment: It's staggering how many dependent on short term financing have blown sky high. For proof, look at asset backed commercial paper. It's now a dead market.

The Kushners are thought to be much better off than Harry Macklowe, the New York real estate investor who also faces a deadline for repaying a bridge loan. Many real estate professionals say Mr. Macklowe could lose control of the seven Midtown Manhattan office buildings he bought this year as part of the Blackstone Group's purchase of Equity Office Properties as well as his prized General Motors Building on Fifth Avenue between 58th and 59th Streets.

My comment: Anyone who thinks they knew better than Sam Zell as to what commercial real estate is worth needs to think again. Blackstone bought at the tip top of the market in a bidding war that went far beyond silly. More on this in just a bit.

Marketing the retail space at 666 Fifth Avenue as a condo has posed a major challenge for Mr. Michaels [chief executive of the Carlton Group]. The space is leased to Brooks Brothers; Hickey-Freeman, a men's clothing retailer; and the National Basketball Association. Though the annual rents are $600 to $700 a square foot, well below the market rate, the leases have another seven years or so left.

Faith Hope Consolo, the chairwoman of retail sales and leasing for Prudential Douglas Elliman, said annual rents in some nearby stores are $1,700 a square foot or more. But those levels cannot be reached unless the current tenants can be induced to move.

My comment: Blackstone has long term lease rates below what it needs to pay the bills. In a turndown, it will be the higher laying leases that leave, not the lower paying ones.

Still, Mr. Michaels said, "I'm confident that we have some very good proposals and that something is going to happen."

My comment: I am confident you are going to burn through cash far faster than you think.


Sam Zell Sells

Here's a flashback to February 7, 2007: Blackstone's Equity Office deal OK'd.

Blackstone increased the per share value to $55.50 in cash from $54. Excluding debt, the deal is estimated to be worth about $22.3 bln.

IYR Weekly Chart

Click here to enlarge.

The big boys made some major mistakes here. And smaller strip malls are everywhere right as we head into a recession. The more I look at these deals the more convinced I am that commercial real estate is not about return on capital. It is about return of capital.

No positions in stocks mentioned.
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