Monday, March 30, 2009

AIG Delays Funds on Land Ventures, Wreaks Havoc on Developers

AIG has cut or delayed payments to some AIG real-estate ventures, potentially leaving shopping centers and apartment complexes across the US short on cash to pay lenders and fund repairs and renovations.  Developers who have partnered with AIG are crying foul.  "Wait a minute!"  they proclaim "how come foreign banks and Goldman Sachs can use AIG as an ATM, via the government, and we can't?"  Naturally, a frenzy of lawsuits are in progress.

AIG's real-estate business, using its insurance premiums and working with third party investors acquired property on its own or via developers totalling over $23 billion.  When the unit joined with developers in the past, AIG's stature allowed it to close deals quickly.  Once the portfolio was acquired, AIG would provide money for renovations and would cover cash shortfalls.  What I find interesting about these deals is that AIG was responsible for covering cash shortfalls.  Developers more than likely thought these deals were lay-ups when the commercial property market was booming.  If AIG would cover the cash short-falls, then there was very little liquidity risk from doing a deal, and a developer probably didn't need to pay attention to silly little things like making sure cash flows covered debt service or coming in under budget on a deal.  I suspect AIG did many stupid real estate deals during the boom that only added to the commercial property bubble.  

The partnership with Mitchell L. Morgan is a prime example.  According to the Journal's account of the story, AIG teamed up with Morgan in 2007 after it had missed out on closing a "mega real estate transaction."  My hunch is that the deal-makers in AIG's real estate group were paid commissions based on transactions and not on how well the properties performed, otherwise, why would they rush into doing deals just because they missed out on closing a mega-deal?  In any event, the purchase of 16,800 apartment units with Morgan required that AIG pony up $120 million to renovate the properties.  After the government's $150 billion bailout in November, AIG's payments were delayed, wreaking havoc on the project.  According to the lawsuit filed by affiliates of the developer, if the partnership can't pay contractors, it could file liens on the properties which would trigger a default with the banks that provided the partners money to buy the apartments.  The Journal names Wachovia (now owned by Wells) as one of the lenders.  Affiliates claim they were told by AIG's top real-estate executive that "the current Federal Reserve funding arrangement with AIG does not provide for funding of AIG Global's commitments to its joint venture partners."  Geez, talk about unfair.  I can't believe the government isn't going to continue financing a bunch of crappy under-water commercial real estate deals.  

In Alabama, AIG halted payments it had made in the past as part of a 16-year partnership with Alex Baker, a Birmingham developer.  The partnership, AIG Baker, developed 20 million square feet of shopping centers, some of which (surprise surprise!) have struggled recently.  AIG's exit created uncertainty about whether payments would continue to be made on bank loans used to buy properties.  The Journal claims that if AIG isn't there to provide cash flow shortage payments to cover the $600 million in loans on the properties, it is going to be difficult for the partnership to cover its costs.  Apparently, some shopping centers are lacking tenants and are cash flow negative.  AIG is offering restructuring options but is not willing to continue funding the shortages.  Thankfully, AIG never contractually agreed to cover the cash flow shortfalls, it had only done so in the past so out of [multiple choice quiz] a.) broken calculator b.) good-natured disposition c.) Too much money flowing in from CDS premiums  d.) all of the above.  

What's funny (and yet also incredibly depressing) about this story is that clearly developers knew they could cram any deal through with AIG as a partner.  If you can partner with a deep-pocketed investor that agrees to cover cash flow shortfalls, why bother with looking at whether properties were cash flow positive?  For awhile, I marveled at how and why so many commercial real estate deals were getting done at ridiculous cap rates implying negative cash flow during the past few years.  I now have part of the answer: AIG was a giant ATM that provided capital for many financially dubious real estate investments.      


1 comment:

Real Estate in Toronto said...

"AIG was a giant ATM that provided capital for many financially dubious real estate investments."

It sure did, and not they're paying for it greatly. Thanks for the article.

Take care, Elli