The eagerly anticipated and long-awaited sequel for the commercial mortgage backed securities (CMBS) lending saga is a sure blockbuster in a commercial real estate industry starved for debt capital. As the banks and Wall Street prepare for another romance, investors should expect fewer thrills. This plot will have less to do with the supply of capital and more to do with the supply of property that can conform to more conservative underwriting criteria. In addition to normal market transactions, we might see some recapitalization of existing CMBS loans. The real suspense will lie in whether the fundamentals that drive CMBS, such as hungry institutional bond buyers, low interest rates and pent up equity demand, will prevail over any potential drag caused by the $40 billion in CMBS and $300 billion in non-CMBS maturing in 2011-2012, prolonged recession and joblessness that impact vacancy, rising treasury rates, and a global capital markets liquidity crisis.
Triple Net leased retail properties such as restaurants, drug stores, dollar stores, auto part stores and banks, remain one of the healthier sectors of commercial real estate due to continued strong demand by private investors seeking 1031 exchanges, and by various funds. Investment sales volumes increased in 2010 over 2009, compressing cap rates 50-100 basis points, particularly for Class A product. Causes of this boost in demand included the impending expiration of the Bush-era tax cuts that would have increased the capital gains tax rate, stiff competition among various funds hunting scarce Class A properties, low yields in most competing sectors, and a growing attraction toward the long-term stability and low management of these investments. Bank ground leases and drugstores top the demand list, with a preference for primary markets followed by a desire for strong credit properties in secondary markets. Fifteen year leases still command a small premium, but ten year leases have become the norm.
Effective January 1, 2011, California’s newest anti-deficiency statute applies to short sales. Newly enacted Code of Civil Procedure section 580e prohibits a deficiency judgment where: (1) the obligation is a note secured by a first deed of trust; (2) the property is a dwelling of not more than four units; (3) the short sale is made with the written consent of the note holder; and (4) the borrower/trustor is not a corporation or a political subdivision of the state.
Except for situations involving borrower fraud or waste, the statute provides the following protection: “Written consent of the holder of the first deed of trust or first mortgage to that sale shall obligate that holder to accept the sale proceeds as full payment and to fully discharge the remaining amount of the indebtedness on the first deed of trust or first mortgage.”
This new statute is particularly noteworthy in the following respects: (a) by fully discharging the debt, in addition to precluding a deficiency judgment, it may preclude any recourse against a third party guarantor; (b) it excludes application to a trustor corporation, but not to a partnership or limited liability company (an odd distinction); (c) it includes no requirement that the dwelling be owner occupied; and (d) it only applies to notes secured by a first deed of trust. Legislative intent with respect to some of these issues might be clarified by future amendment.
As for a second trust deed, if the anti-deficiency statute in CCP section 580b does not apply (for a seller’s note secured by a deed of trust, or a purchase money loan on an owner occupied dwelling), because section 580e does not address the issue, the borrower should make clear that any shortfall on repayment is waived as part of the short sale, or the lender should make clear that it reserves its rights to recover the deficiency.