Real estate, to a large extent, drives
Orange County’s economy. It is our
biggest and most valuable commodity, and it affects local businesses on many
levels.
So it is not good news that real-estate-related bankruptcies have recently surged
— especially among mortgage lenders who
specialize in the sub-prime market.
“There is more fallout from what is happening in the real estate market every day,
and it seems to be spreading through the
local business landscape,” says James
Bastian, partner and head of Insolvency
and Reorganization Practice at Shulman
Hodges & Bastian LLP.
Smart Business spoke to Bastian about
what business management should do to
cope with the prevailing Orange County
real estate downturn.
Please explain in detail the current Orange
County real estate market.
For several years, the real estate market
here was booming, due in large part to the
sub-prime lending market. Many people
qualified for loans that were based on the
value — or perceived value — of the real
estate, rather than on the borrower’s ability to repay.
With property values escalating so fast,
lending practices got more and more
aggressive. Lenders avoided many of the
normal underwriting procedures, like verifying the borrower’s income or scrutinizing
tax returns. They could — and did —
charge higher-than-prime interest rates.
Anybody with a pulse was getting a huge
mortgage, and it was sometimes even more
than the value of the home.
The local real estate market, fueled at
least in part by these kinds of loans,
surged. Big and small mortgage companies
grew. Financial institutions then paid large
premiums for the loans they originated,
and many people got wealthy. Everybody
was happy. The brokers were getting their
cut, and the banks were getting their cut.
But many homeowners soon found that
they could not afford the monthly payments. When they started defaulting —
sometimes in the first month — the big
banks got nervous. What you have been
seeing in the last several months is that the
funding sources, called warehouse lenders, are demanding to be repaid from the mortgage companies, who have responded by
cutting staff, shutting down or filing for
bankruptcy.
The whole market was destined to eventually unravel because the loans should not
have been issued in the first place. If a
prospective borrower could not make the
payment, he or she should not have been
given a huge mortgage.
So the once-robust mortgage business in
Orange County now appears to be dying.
The market is tapped out. Executives are
being laid off, as are loan processors,
appraisers, title people — anybody associated with the chain of documenting a mortgage. As a consequence, these businesses
do not need as much office space, so the
commercial real estate market will suffer
as well. It is a domino effect, and the first
dominoes have fallen.
Why are businesses that are not related to
real estate so concerned?
Anybody who watches Orange County
business should be concerned. When you
have a large segment of the local economy
that is very frenzied and that business
starts to go away, the region’s economy will
be negatively affected.
Executives should be concerned because, on a personal level, their home values are going down. Their employees’
home values are going down. If their
employees face foreclosure or have to go
into bankruptcy, there may be potential
distractions. It is all linked.
How should business executives react?
Businesses that are thinking about relocating or acquiring more commercial space
should watch and wait. There might be
space becoming available and deals to be
had for space that was occupied by a player in the mortgage arena. In the near future,
there might be opportunities to purchase
commercial real estate in a somewhat distressed environment.
Right now, executives need to be concerned and sensitive to employees who
may be suffering financial hardships. They
need to understand the issue and figure out
the impact on their business, if there is any.
The problem can potentially affect virtually anyone, including friends, neighbors and
colleagues.
Sure, opportunities can be found in a
downturn, like purchasing investment
property or a new house at lower prices.
But because there is a lot happening on the
national level — the war, a presidential
election — I would be careful about making any immediate decisions that have an
impact on your financial well-being.
This could be the beginning of a significant downturn in our local economy or just
a cooling-off period, but one thing is obvious: There is more real estate development
— both commercial and residential —
being undertaken on a strictly speculative
basis than any other time since the late ’80s
and early ’90s. This may be history repeating itself or just an opportunity to enter the
market before it takes off again. Either
way, we are living in an interesting time.
Executives have to devise an effective
strategy for protecting themselves while
capitalizing on this situation. It is always
easy to play Monday morning quarterback,
but the focus must be on being proactive
and either avoiding a problem or taking
advantage of an opportunity.
JAMES BASTIAN is a named partner and head of Insolvency
and Reorganization Practice at Shulman Hodges & Bastian LLP.
Reach him at [email protected].