You probably saw the news today that the famed Hancock Building in Boston sold for $661 million today — about half of what it was bought for in 2006.
It’s easy to look at this and conclude that the commercial real estate bust has officially arrived, and that it’s only a matter of time before this crushes the banks.
But wait: It turns out that this 50%-off sale produces enough cash to make AAA-rated tranches on CMBS completely whole.
A friend who trades mortgages at superstar level observes, “So how you interpret the John Hancock Tower situation basically comes down to this : the original debt was approximately $ 640 million (contributed to CMBS deal GCCFC 07-GG9) and a $470 million mezzanine loan held outside the trust. The appraised value at originiation was approximately $1.28 billion (these appraisers were smoking some serious stuff). The ‘winners’ of the auction are reported to be assuming the first, meaning no loss to the GG9 trust yet, while the mezzanine holder gets wiped out with new value of around $660 million.”
This example is consistent with the 50% recovery rate on foreclosure in most residential real estate markets. There are entire tracts that will be left for the junkies, to be sure, but for the most part, the California market is clearing quite nicely at levels sufficient to avoid impairment on the AAA-rated tranches of subprime and Alt-A loans. If valuations hold at around these levels, the position of the banks should be quite survivable.
This is just one datapoint, and we’re open to alternate interpretations, but it could explain why valuations on commercial real estate CMBS haven’t yet collapsed, even though everyone sees a major trainwreck coming.
And as Goldman notes, if these values hold — 50% haircuts — it would have the surprise implication that securitization, which left banks only exposed to the AAA tranche, turned out to work very well in this case.