GDP Finally Up

• After a full year of wrenching declines, US GDP rose by a seasonally adjusted 3.5% annual rate in the third quarter. The gain was driven by consumer spending, which rose by 3.4% in the third quarter compared with a 0.9% drop in the April-June period of 2009. You can thank our federal government for cash for clunkers, the first time home buyer tax credit, and the piles and piles of stimulus cash showered on the economy. But with unemployment at 10%, and consumers continuing to shed debt, it seems unlikely that this sort of momentum can hold for a sustained period of time. Equity markets are not impressed, posting a meek rally this morning.
• Another hedge fund scandal hits the tape, with the founder of K1 (no relation to K10, I promise) Helmut Klener arrested in Germany amid a fraud probe. The hedge fund is entangled in an international criminal investigation after banks including Barclays, JP Morgan, BNP Paribas and Soc Gen were saddled with $400 million in losses. Apparently the fund of funds deceived the banks when borrowing money to boost returns. Unheard of! In any event, details are forthcoming and likely to be juicy.
• The Fed has finished purchasing its $300 billion in Treasuries, having met its quota, and grown tired of playing patty-cake with Treasury. The program has kept long term interest rates artificially low for the past seven-months, allowing lots of folks to refi into much lower interest rates on their mortgages. Lower rates have also led to a massive spurt of bond market issuance by firms, particularly since it's so tough to get a bank loan these days. The low interest rate mortgage boom, however, will continue as the Fed's much larger $1.25 trillion game of patty-cake with Fannie and Freddie goes on through March. Given how much money Wall Street dealers have made being the middle man between the Fed and Treasury and the Fed and Fannie and Freddie, it sort of makes you wonder why the Fed didn't cut them out and trade directly with the other government entities. In any event, rates are likely to head higher so get your refis done while you still can.
• Here's a quick update on the Lembis, my favorite local real estate mogul family that punted generations' worth of real estate wealth in a few short years. Walter Lembi, managing director of the San Francisco based Lembi Group, is wanted for passing around $298,500 worth of bad checks at Caesar's Palace. Mr. Lembi was about as good at gambling away his money at the tables as he was with gambling away the real estate fortune that it took his family decades to build. Apparently, Mr. Lembi is no longer living in his Burlingame home, the address that was listed on court documents so authorities are having trouble tracking him down. Maybe they should check in one of his old apartments? Although judging from all the lawsuits, his tenants hated him so much, they're likely to rat him out.

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!

Is Frank Lembi the Next Harry Macklowe?

For those who haven't been following the New York commercial property market, Harry Macklowe is the guy who paid the high. He purchased seven properties from Equity Office Properties last year, putting up $50 million in equity and financing the balance of $7 billion with short term loans. He recently defaulted on the loans and is now selling the GM building to raise cash and handing over titles on the seven buildings to his lenders. Why does Harry Macklowe matter? Because he is a perfect example of what was wrong with the lending environment for the past few years that clearly extended beyond residential mortgages. Lenders bent over backwards to give this guy short term loans so he could overpay for properties where the cash flows didn't cover the debt service. You have to wonder, how many more Harry Macklowes are out there on the verge of blowing-out because the credit party is over?

Frank Lembi, founder of Skyline Realty, may be a mini-Macklowe in the making. Skyline has purchased close to $1 billion worth of multi-family properties in the San Francisco market in the past couple of years. The properties were apparently financed with 92% LTV loans (i.e. the company only had to put up 8% of the equity). If you read the two links provided below (one written in 2005, and the other in 2008), you'll see that Lembi's brilliant strategy of outbidding his competitors by about 20% for virtually EVERY multi-family property on the market in San Francisco and then financing the purchases with Wall Street money has paid off huge! Apparently, he is now desperately puking multi-family properties to raise cash to pay the bills. There's that pesky negative cash flow thing rearing its ugly head. 1330 Bush, a property that was financed with a $48.6 million loan from Nomura (according to propertyshark.com) is now on the market for $34.9 million, after being marked down from $39 million a month ago. Any takers? Anyone? Anyone? Tell you what, I'm $1 bid. And I'll even pay cash...

Harry Macklowe

Frank Lembi 2005 article

Frank Lembi 2008 article