Posted by: BayAreaComRE | March 18, 2010

The Lehman Collapse – What Not To Do In Commercial Real Estate

Bravo to Mark Heschmeyer of Costar for summarizing the findings in Brothers Holding’s scathing review of the Lehman Brothers collapse (comprised of nine volumes, spaning thousands of pages). If you haven’t read the article, you can find it here.

What is most striking about Mark’s and Brother’s recount is the internal decisions by Lehman to grow their commercial lending business amidst a blatantly deteriorating real estate market. “Lehman was slow to recognize the developing storm and its spillover effect upon commercial real estate and other business lines. Rather than pull back, Lehman made the conscious decision to “double down,” hoping to profit from a counter-cyclical strategy,” according to the Brother’s report.

Locally, we’ve seen the underpinnings of Lehman’s mistakes finally coming to market as both 50 Beale and One Sansome are in the hands of special servicers at this time (which we detailed in an earlier post). The “money” behind these assets were all cross-collateralized* commercial mortgage backed securities** that Broadway Partners utilized from Lehman Brothers. We all know how it ended, and it’s widely apparent that these lessons will prove invaluable for up and coming real estate professionals as we grow our careers.

*Cross-Collateralization – A provision in a mortgage or deed of trust by which the collateral for one mortgage also serves as collateral for other mortgage(s). Thus, should the collateral on the one mortgage fall short in repayment of the debt, the collateral of the other mortgage(s) could be claimed as well (but only in the event of such a shortfall). CMBS backed by cross-collateralized properties have reduced delinquency risk; cross-collateralization (in theory) adds value to the structure. It can also provide an unknown default risk for a portfolio of assets.

*CMBS- Securities collateralized by a pool of mortgages on commercial real estate in which all principal and interest from the mortgages flow to certificate holders in a defined sequence or manner.

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