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Extend and Pretend Traps Commercial Real Estate in USA/Fredericksburg

Posted in: Investment Analysis
By SAGE - Premium Texas Real Estate
May 4, 2012 - 9:20:03 PM

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Pertaining to Commercial Real Estate (CRE), Texas has seen some of the "extend and pretend" phenomena as described in the Tierra Grande Publication from Texas A&M University's Real Estate Center.  Maybe for commercial real estate in little ole Fredericksburg TX, lenders pretend less frequently than in Florida, Arizona and California.  

Nonetheless, there are Fredericksburg commercial properties and more throughout Texas Hill Country real estate-distressed CRE-just waiting to be snatched up by investors.  High-net-worth investors, private equity firms, private and public real estate investment trusts and publicly traded homebuilders have raised billions of dollars of investment capital to purchase commercial properties that are underwater.  Yet, banks and lenders are not releasing them into the market where investors wait to buy them up.  

Between January 2001 and the peak of the commercial real estate boom in 2008, cheap mortgage money, poor underwriting, and little-to-none down payment policies drove commercial real estate properties up almost 90 percent in price, according to Moody's REAL commercial Property Price Index.  Then, in summer 2007, the credit markets for commercial real estate began shutting down.  Since then, Institutional quality real estate declined 40 percent, submerging many property owners.

A report by Mark G. Dotzour entitled “Extend and Pretend Implications for Real Estate,” published in the Tierra Grande Magazine explains what is going on.  During traditional times, if a property value falls below the loan amount at the time that a commercial real estate loan matures, then the owner must produce more equity.  Without that extra collateral, the lender forecloses and then sells the property to another buyer.

However, instead of following these traditional practices, today's lenders are opting to extend the defaulted loans, "pretending" that they are performing.  They amortize them for additional years and lower payments.  If the borrower pays that lower amount each month, then the underwriter ignores the fact that the property is underwater.

Until they can absorb the loss of a foreclosed property, lenders continue pretending to avoid immediate insolvency with some of the larger commercial loans.  Huge volumes of bad residential loans already overwhelm lenders.  They fear insolvency and the fear is real.  The FDIC has closed 315 banks and another 860 are struggling.  Those banks are prime culprits for the "extend and pretend" amortizing.

So the extend and pretend wave will continue indefinitely until banks build up enough loss reserves to cover the losses involved with foreclosure—or they go under in the natural cycle.  Even the FDIC, the supposed insurer for these transactions, is seeing red.  It is $8 in arrears.  

For a brief moment in 2008, banks did foreclose and offer properties at low prices.  Then the powerful, though private, Federal Reserve intervened.  By stopping the selling of commercial real estate at fire sale prices, the Federal Reserve started the era of "extend and pretend."

It is a trap.  According to Dotzour, chief economist with the Real Estate Center at Texas A&M University, "As long as extend and pretend continues, sales volume will be severely retarded."  Investors will line up to spur the commercial real estate market as soon as the properties are let out of the trap.

For expert guidance in your personal search for the ultimate piece of the Hill Country, please call Dale E. Cook, MBA and owner of SAGE- Premium Texas Real Estate at (830) 992-0056.

Map of Fredericksburg Commercial Properties



Dale E. Cook, MBA, Broker/Owner

Sage - Premium Texas Real Estate
405 N. Llano St.
Fredericksburg, TX 78624

830-997-1035 office
830-992-0056 cell

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