The Lembi Real Estate Empire Falling Apart

The Wall Street Journal property report has a fascinating article today detailing the current woes of the Lembi Group, one of San Francisco's largest owner of apartment buildings.  The Lembi Group, (led by Walter Lembi, son of Frank, the company's founder) recently handed over 51 buildings to UBS and is currently working to refinance approximately $1 billion in short term loans, some of which are securitized (Hello CMBS?  I'd like to introduce you to some more defaults.)  The various loans come due within the next six to twelve months, leaving Walter Lembi, managing director of the firm, scrambling to find solutions that don't involve losing the fortune that his father accumulated over 60 years.  Handing over the 51 properties to UBS released Mr. Lembi from a $400 million personal guarantee, although he is subject to other guarantees.  According to the article, Mr. Lembi will not be able to strike similar deals with other lenders (deed in lieu of foreclosure) as the UBS transaction has used up corporate losses that offset tax liabilities.  If he cannot negotiate extensions on the other loans, he will more than likely lose the buildings to foreclosure. 

   

The story about the Lembi Group is a fine future business school case study in everything that was wrong with the insane lending environment of 2004-2007.  I wrote about the Lembis in March 2008 in a post entitled "Is Frank Lembi the Next Harry Macklowe?"  (apparently so) where I marveled at the insanity of borrowing up to 95% of a building's purchase price to buy $1 billion worth of property that would yield negative cash flow for a significant period of time.  The company's strategy relied on converting rent controlled units to market rate units and then refinancing or selling at a higher price.  For those unfamiliar with San Francisco tenant laws, converting rent-controlled properties to market rate units is about as easy as finding a commercial real estate lender who will give you a 95% LTV loan TODAY.  In other words, if you are a landlord with a deadbeat tenant who is operating a well-known crack and prostitution ring out of his rent-controlled apartment and he hasn't paid rent in seven years, you would still face serious obstacles getting him evicted in San Francisco. 

If you ignore the many minor yet foolish components of the Lembi Group's plan for San Francisco multi-family real estate domination, there was only one major glitch to the strategy:  Since the Lembis outbid most competitors by roughly 20% for nearly every multi-family property on the market in San Francisco from 2003-2007, they were mostly responsible for pushing up multi-family property prices to unsustainable levels (i.e. prices no sensible investor who uses actual math would pay as opposed to a ponzi schemer).  When you are the only bidder at a 2% cap rate, and your lenders come knocking, who do you expect to outbid you for your crappy rent-controlled building?  Why any lender ever agreed to hand over so much cash on such ridiculous terms is a whole other story; one which I seem to tell nearly every day in my postings.

The funny part is that the San Francisco rental market is actually fairly strong.  Vacancy rates are low, and rents are expected to remain somewhat stable.  Owning a multi-family property in San Francisco shouldn't have to end in foreclosure and won't for those property owners who didn't pay too much and aren't suffering from the deathtrap that is negative cash flow.  But if you're leveraged out the wazoo and need to sell something into this market, then frankly, this was a disaster of you and your lenders' own making.  Nevertheless, Mr. Lembi blames everything on "the disturbance in the marketplace.  Nobody could've predicted this train wreck" he is quoted with in the article.  Except that many people did predict it.  Even a random blogger.  Most predictable train wreck ever!