THE US DEBT MARKETS and the ALL CASH BUYER

By Matt Zarlengo
Acquisitions
Commercial real estate lending came to a grinding halt in the third quarter of 2007 and even with the tens of billions of dollars that have been been thrown at the problem by our elected officials in Washington, the commercial real estate debt markets have yet to unthaw or show any signs of doing so. Year to date, there has yet to be a single issuance of new CMBS paper in the US and a paltry $10 billion was issued in all of 2008 (as compared to $270 billion in 2007). Big banks continue to hold toxic mortgages on their balance sheets while the so called US banking regulators simply turn a blind eye to the very likely possibility that some of these massive banks are simply insolvent. Until the federal government begins to force banks to take the write offs that we all know are there and mark the loans to market, the commercial real estate recovery will be anemic at best.

You might be asking yourself the following question “why does a company that plays in the all cash arena care about what is happening in the debt markets?” As an acquisitions officer with Baceline I am tasked with finding suitable investment opportunities that meet our investor return thresholds. This has been extremely difficult due to the complete lack of transaction volume over the past 18 months due primarily to the frozen debt markets. Most real estate investors don’t operate on a cash only basis and require debt to make acquisitions. With the debt markets frozen, this makes it impossible for the majority of investors to do any deals. This has resulted in a lack of pricing guidance which has further hindered transaction volume. There remains a significant, albeit slowing shrinking, bid/ask spread between what investors are willing to pay for assets (stabilized, distressed or in between) and what sellers (investors, banks, CMBS special servicers) are willing to sell those assets for. With no transactions to gauge pricing off of, values are anyone’s guess.

We at Baceline remain steadfast in our efforts to establish meaningful relationships with the decision makers who will ultimately be in charge of liquidating troubled assets. Those relationships are being forged with local, regional and national banks as wells as CMBS special servicers. By establishing these relationships we are confident that our work efforts will prove fruitful and put us in great position to act once the current logjam is removed and transactions are once again closing.

The Search for Distressed Real Estate Continues …

After having spent most of the first half of the year traveling to a number of our target markets and talking with as many lenders, brokers, and real estate professionals as possible to understand each market's distressed commercial real estate, it has been interesting to see common themes across the country as investors of all sizes try to figure out solutions to their distressed properties.

In nearly every market, lenders were first hit with the collapse their loans backed by vacant land and vacant single-family lots. In any market, it is awfully difficult for a borrower to persuade a lender that a piece of vacant, no-income producing land can be made to perform when the market for vacant land and lots has all but vanished. So the vacant land and lots were the first products taken back by the lenders and made available at distressed pricing. These products have dominated the distressed market in terms of sheer volume of offerings for the past 9 months.

Over the last few weeks, we have started to see signs of the next stage: vacant buildings being sold by lenders, and under-performing, occupied property being sold by owners at or slightly above their respective loans. The problem is that many of the vacant buildings are vacant for a reason. In some cases they shouldn't have been built in the first place, or they are inherently an inferior product compared to the immediate submarket. In other cases there truly is an unexpected reason for why a building has become vacant. Baceline is searching for these unique situations.

The other trend we are seeing is owners offering their properties for sale right at or slightly above their loan amounts, recognizing that they will lose the bulk of their equity and wanting only a clean exit. The problem is that much of this product is not worth the amount of the loan in its current, low-occupied, under-maintained state and will require additional equity, which the current owner does not have in hand and cannot access through increased loans. So, while buying commercial real estate at a discount to the equity in the property sounds good, the price usually doesn't correlate to the type of returns needed to attract those who do have the necessary capital to take on the risk associated with turning a distressed property around.

I believe the next stage to come will be the delivery by lenders of foreclosed, underwater assets, offered at a discount to their initial loan amount. I also think that until this 'good stuff' comes out, the vacant land, vacant lots and vacant buildings will not trade because, while there is a significant amount of 'distressed' equity waiting for opportunity, that money will not be unleashed until there are better 'distressed' opportunities in the market.

With that said, there are select distressed opportunities in the market that make sense depending on an investor's investment parameters. Baceline is well-positioned to see its fair share of the distressed product. First off, we are an all-cash buyer, so we are uniquely able to get the attention of the finance and brokerage community involved in selling distressed product. Also, while many of our competitors are doing everything they can to keep their own properties afloat and rework their lender arrangements, we have been out in the market widening and deepening our network. We now have a database of over 1,800 lenders, brokers and other real estate professionals in our select target markets with whom we stay connected through continuing personal visits, phone calls, and web-based marketing. To each of them, we drive home our basic story: we are an all-cash buyer, familiar with their market, able to close quickly and looking for distressed real estate in their particular market. One thing is clear from the past 9 months of searching, we are ahead of the curve and in prime position for any distressed opportunity meeting our acquisition parameters.

Distressed also includes "Property Management Companies"...

Baceline Investment's Asset Management team is experiencing a new "twist" with the meaning of the word "distressed". Today's economic conditions have now trickled down to the property management front. Baceline is seeing a majority of our 3rd party management companies "tighten their belts" with respect to personnel; more specifically accounting staff and property managers. Some of this downsizing is caused by Management Companies losing portfolios to Owners who have decided to "tighten their own belts" and manage their portfolios themselves. Another cause - simply put, "maximizing their current staff".

As Baceline has seen this trend start to take effect, we have had to rely on our evaluation methods for our management companies. Those that are meeting our requirements and who are performing are remaining in place. Those which are starting to fall behind in performance and accuracy are being replaced.

While we sympathize with today's economic struggles, we at Baceline are determined not to let this "domino effect" affect our performance on the Asset Management front. Currently our processes and procedures are effective with regard to the accuracy and performance required for our 3rd party management companies. In today's tough economic times, we will continue to modify and upgrade our procedures to keep ahead of the curve on Asset Management.

| blog by |
Terri Tantum
Director of Asset Management
Baceline Investment

The Entrepreneurial Spirit

On the leasing front, we are certainly seeing the realization of many pundits predictions that when larger companies layoff many talented workers a common strategy is for those individuals to seek out independent careers by starting their own businesses. Franchise trade groups are reporting record numbers of inquires by potential franchisees. ICSC, the premier retail, real estate trade organization is predicting franchises will be the most significant driving force in filling the large retail vacancies around the country.

At Baceline, we are educating our leasing teams on the opportunities to work with new franchisees. As you might expect one of the biggest challenges these talented entrepreneurs face in today's environment is financing the significant upfront costs associated with opening a location. Hefty franchise fees, FF&E, advertising, working capital all add up to an enormous hurdle when there is very little financing available. We tell our leasing teams that for a new franchisee with strong management skills, a good plan and support of a strong franchisor we are willing to take a chance on their success by being more creative with our lease structuring.

Even non-franchised entrepreneurial concepts have been popping up throughout our portfolio. Specifically we have seen interests from individuals starting a glass blowing retail shop with supportive classroom training, lingerie shops for plus-sized women, homemade cakes and of course, only in Texas, a 35,000 square foot combination movie theatre and microbrewery. Interestingly it is not only our retail portfolio that is seeing some of this entrepreneurial spirit but it in our industrial portfolio the most active prospects are start-ups looking for small suite spaces on short term leases.
Another benefit of these local businesses is, in our experience, it is rare for them to request a lease restructuring unless they have come upon very hard times. Whereas the national tenants as a matter of course request lease restructurings regardless of store performance.
For this Fourth of July here's to the American spirit may it grow and prosper.

ICSC Las Vegas

Baceline sent two team members to this year's annual International Council of Shopping Centers (ICSC) Spring RECon gathering in Las Vegas, NV. This normally over-crowded retail conventional was significantly different than previous years - attendance was down approximately 50 percent. This is evidence of the rough waters that the retail industry is currently navigating. However, there was still plenty to see and participate in. Some of the highlights and trends reported by Baceline representatives include:

• 80% of the retailers present were either fast food/quick serve restaurants or discounters of some sort
• Retailers are generally at a standstill as far as store expansions go, with some notable exceptions: quick serve restaurants, gaming stores and value teen fashion.
• Luxury retailers are taking the biggest hits to profits because of higher ticket prices and less consumer spending. Some will be forced to reduce prices.
• Retail landlords will need to work with struggling tenants and decide whether to work with and keep those they think will make it, or cut the cord and let those go they think won't make it.
• Continued layoffs will continue to impact the sector.

Baceline is well positioned on both the landlord front and the acquisition front. Baceline's assets are well positioned to attract and retain the active retailers mentioned above. Our properties are mostly in-fill locations with attractive demographics. These desirable locations result in healthier bottom lines for both the tenant and the owner.

On the acquisition front, Baceline is seeking acquisition prospects through numerous avenues. As motivated sellers continue to see declining property performance, Baceline is poised to benefit from discounted prices and re-position opportunities.

We're in this together

More so than any other product type, retail requires a partnership between the landlord and tenants for mutual success. As compared to office space, a retail tenant’s location and fellow tenants are directly linked to the company’s profitability and therefore a justifiable lease rate. If I am an international bond trader does it really matter a great deal who the tenant is next to me or if I am on the second floor or the twentieth? Not so with retailers – location, location, location and neighbors, neighbors, neighbors. Maybe that is why the experts classify the type of retail centers Baceline owns as Community Centers or Neighborhood Centers.

And with the challenging economy for most retailers AND landlords now is the time to make the most of the “partnership.” Neither party has any dollars available for aggressive marketing yet there is opportunity for both to capture market share from nearby, disgruntled customers. The same local tenant down the street whose customers could also boost revenues for our tenants if they were a closer neighbor, may be a friend, supplier, competitor or complementary business to one of our tenants. Our existing tenants are one of the best sources for not only identifying new tenants but closing the deal.

Let’s do some low cost, creative marketing campaigns together, providing more time and resources than thousands of dollars in print advertising. As a landlord we can provide vacant space and signage for a community event, the tenants can provide discounted merchandise for giveaways and personnel to work the event. The community event sponsor can provide the much needed foot traffic and public relations buzz to the retail center. Let’s be a neighbor in the community.

Maybe like my nephew, who manages a YMCA in Eugene, Oregon, we can announce that all unemployed get free memberships. That little well intentioned, community supportive idea ended up being shown on the Today Show for the whole nation to see, much less the unemployed in Eugene…who of course showed up in droves. And of course the Y was overwhelmed. Seems like it is always the smallest, well intentioned actions that get all the attention and the mega campaigns bomb. We could only be so lucky.

Misery may love company but certainly retailers and landlords certainly love company. We’ll all feel better in the long run and hopefully make it there!

Only Time Will Tell....

Last week, General Growth Properties ("GGP"), the second largest U.S. mall
owner, filed for bankruptcy. Laden with too much corporate and property
debt, they could not longer fend off their creditors. Interestingly, it
was their smaller, in terms of dollars, creditors at the property level
that applied the most pressure. Now the bankruptcy court will have to
sort out the mess and most likely GGP will have to sell under-performing
properties at distressed prices. This will be a more straight forward
task than what happened at the end of 2008 when another large real
estate sponsor went bankrupt.

When DBSI file bankruptcy at the end of last year, they left many
investors twisting in the wind, particularly those who owned assets that
were underperforming. Because of the Tenant in Common structure of the
DBSI ownership entities, and the master leases that were dissolved, the
eventual outcome for the investors is much more muddled than GGP
shareholders (who will retain their passive investor roles). DBSI Tenant
in Common owners, on the other hand, now have to give up their passive
roles and operate real estate assets, most without the benefit of
previous commercial real estate experience.

We have been receiving many calls from frustrated Tenant in Common owners (as well as their lenders)
to lend a hand to the process and in some cases we will see a way to
provide a liquidity event that can resolve a difficult situation. Only
time will tell how many of these properties can be saved.