December 26, 2007

Credit Downturn Hits the Malls

Centro Properties' Woes Underscore the State Of
Commercial Market
By KEMBA J. DUNHAM and JENNIFER S. FORSYTH
December 26, 2007; Page C1

The credit crunch triggered by the downturn in the

housing market is creating problems in commercial
real estate, driving down prices of office buildings,
shopping malls and apartment complexes, and
leaving some owners scrambling for cash.

One victim is Centro Properties Group, the fifth-

largest owner of shopping centers in the U.S. The
Australian real-estate company saw its share price
fall by 90% in two days last week as it struggled to refinance short-term debt it took on
to fund its $6.2 billion acquisition of New Plan Excel, one of the biggest owners of strip
malls in the U.S.

Centro had planned to pay off the short-term loans by selling long-term debt via the
commercial mortgage-backed securities market, but the lack of buyers forced it to get a
two-month extension from its creditors. Commercial mortgage-backed securities, or
CMBS, are pools of loans that are sliced up and sold to investors as bonds.

Residential mortgages are packaged and resold much the same way, but so far the
CMBS market hasn't had any significant problem with defaults.

In another high-profile case, the clock is ticking for Harry Macklowe, the New York
developer, who is struggling to raise financing by February to replace $7.1 billion in
short-term money he borrowed to finance his heavily leveraged acquisition of seven
Manhattan office buildings this year.

The predicament facing Centro, Mr. Macklowe and numerous others underscores the
state of the once-unflappable commercial real-estate market. For the past few months,
the sector has been in a state of near-paralysis, as financing has nearly dried up. The
number of major properties sold is down by half, and many worry that the market will
continue to deteriorate as property sales remain slow, prices continue to drop and deals
keep falling apart.

Where the Fog Is

"Where we're really in a fog is on the capital markets side," said Michael Giliberto, a
managing director of J.P. Morgan Chase & Co., on a conference call last week about

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 the state of the commercial real-estate market.

The CMBS market was the engine that drove the commercial real-estate boom. Over
the past few years, the issuance of CMBS allowed banks to get rid of the risk on their
books, lend with cheaper rates and looser terms and that made it easy for private-equity
firms to do huge real-estate deals.

Between 2002 and 2007, CMBS issuance rose to an estimated $225 billion from $52
billion, according to Commercial Mortgage Alert, a trade publication that compiles its
own statistics.

Real-estate investors aren't the only ones feeling the pain. Many big banks issued short-
term loans to buyers and planned to sell them off later, much the way they do with
loans made to private-equity buyout shops. But the banks have gotten stuck with an
estimated $65 billion in fixed- and floating-rate loans on their books, according to J.P.
Morgan. Some of the largest issuers have been Lehman Brothers Holdings Inc.,
Credit Suisse Group and Wachovia Corp.

Lehman has said that about half of the $79 billion in mortgage debt it was holding at
year-end is CMBS-related. Wachovia and Credit Suisse declined to comment.

'Cognitive Dissonance'

Prices, however, haven't appeared to fall, though much like residential real estate, there
is often a period where buyers stop buying but sellers refuse to lower prices.

There is "cognitive dissonance" between buyers and sellers, says Dennis Russo, a real-
estate attorney for Herrick Feinstein. "There's a period of time in which the seller
cannot psychologically move his price down. They haven't accepted what's happening
in the market."

According to Real Capital Analytics, sales of significant office properties plummeted to

$7 billion in November, a 55% drop compared with November 2006. So few deals are
getting done that many market experts say they don't know how to put a value on many
buildings right now -- but almost everyone is in agreement that the valuations are
dropping.

Often, deals aren't done because financing either isn't available or is so expensive that
buyers are insisting on price reductions that sellers won't accept.

For example, Ackerman & Co., a brokerage, just pulled a suburban Atlanta office
building off the market after bids came in below estimates. Developer Michael Reschke
has so far been unable to get financing for a J.W. Marriott planned down the street from
the Chicago Board of Trade, despite his willingness to put more cash into the deal than
originally planned.

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 The commercial real-estate market was still soaring in early 2007, long past the peak of
the residential real estate market. But a combination of frenzied deal making, high
prices and credit worries combined to sink the sector.

First, private-equity firm Blackstone Group LP made its record-breaking $23 billion
purchase of Sam Zell's Equity Office Property Trust, the nation's biggest owner of
office buildings. Then it turned around and sold off many of the properties at even
higher prices. The frenzied deal-making surrounding the EOP portfolio came to
symbolize frothy valuations, which triggered a backlash in the lending markets.

In April, Moody's Investors Service said lenders' underwriting standards had become
too lax during the run up in prices. The warning scared investors and prompted bankers
to raise interest rates and required borrowers to put in more of their own money into
deals.

Timing of the Hit

The subprime-mortgage downturn hit last summer, prompting fears that the problems
plaguing the residential market would spillover to the commercial side. Banks were
caught holding debt on their books, making them less willing to lend.

Centro Property got caught in the crunch. Its billion-dollar acquisition of New Plan
Excel, a U.S. shopping center real-estate investment trust, came in February -- a
moment many experts believe was the height of the commercial market.

Now its lenders, primarily Australian banks, are pressuring Centro to sell assets before
they will consider refinancing.

"Certainly the private-equity players played that game for a time, and they could have
been caught in a similar situation but they were very quick to turn around and sell their
assets," said Paul Adornato, a real-estate analyst with BMO Capital Markets Corp.
Centro's chief executive, Andrew Scott, didn't return calls for comment.

Credit was so plentiful when Mr. Macklowe purchased his Manhattan office buildings
from Blackstone, he only needed to put in $50 million of equity to secure $7.1 billion in
debt, which included a bridge loan and the senior mortgage, people familiar with the
deal say.

He is now looking for an equity partner, people said. A spokesman for Mr. Macklowe
declined to comment.

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