Famous for its rich American history, sports and overall vitality, Boston is home to more than 30,000 civilian veterans. All of Massachusetts houses more than 425,000 veterans. Veterans who are considering purchasing a home in Massachusetts are entitled to the VA home loan program.

In the Bay State, VA uses two income qualifications to deem veterans eligible: debt-to-income ratio (DTI) and residual income. To qualify, a veteran’s total debt should not be more than 41 percent of his or her total income. The residual income requirement measures whether or not the borrowing veteran can cover daily living costs after taxes, housing, insurance and liabilities (e.g. credit card and car payments) have been made.

With the exception of seven counties with higher VA loan limits, Massachusetts’ counties’ limit is $417,000. Suffolk County, where Boston is, has a $475,000 maximum, and Nantucket’s ceiling goes up to $1,094,625. Qualified veterans can pay no money down to finance 100 percent of the lower of the selling price or appraised value.

In addition to the no money down, VA loan interest rates tend to be lower than those of conventional loans. VA guidelines in Massachusetts curb a handful of fees, such as underwriting and processing fees. Another fee that veterans can get waived is the VA funding fee, which supports VA loan guarantees. If they cannot get it waived, veterans in Massachusetts can finance the fee. Other advantages to VA loans include:

• No private monthly mortgage insurance
• In some cases, sellers paying the closing costs
• No penalty for making loan payments early
• Several refinancing options

The median cost of a single family home or condominium in downtown Boston during 2009 was approximately $475,000, and roughly $350,000 at the sate of Massachusetts level. That’s why the state’s VA loan limits balloon above the norm. But before veterans start looking at homes in Boston and its state, they should check their eligibility for a VA loan.

Veterans who meet one of the three following criteria may be eligible:

• Military members who’ve served 181 days on active duty or three months during war time
• People who have spent at least six years in the National Guard or Reserves
• Spouses of those killed in the line of duty

For more information on VA loans in Massachusetts, visit VAmortgagecenter.com.

The FDIC plans to auction more than $1 billion in assets seized from failed banks next month and this may require write-downs that weaken lenders nationwide. Note that 140 banks failed last year, 26 thus far in 2010, and as of December 2009, over 700 banks are on the FDIC’s watch list. You do the math.

Interestingly, retail sales are up for the third consecutive month, indicating that the worst may be over and an easing of fears about spending. Or, maybe we just can’t take it anymore and we are going to reward ourselves with new stuff; as job prospects still look bleak and personal income has actually shrunk when taking into account inflation.

On the local scene, the battle between the Mayor and the Developer regarding the former Filene’s site seems to be heating up – will be interesting to watch what develops. Can you force a developer to proceed when demand and financing are not available? Just look at values of commercial sites like 230 Congress Street, 10 Milk Street and, the XV Beacon Hotel.

According to a recent Business Week article, cash rich builders are buying land again at huge discounts in the hopes that the market for new homes will turn around soon (note homebuilding is at the lowest point since records have been kept). Of particular attraction are broken subdivisions where most of the infrastructure has been installed – someone’s problem is another’s opportunity.

Last but not least, out of Housing Zone ‘Does Green Help Sell Homes?’ the answer seems to be ‘yes’ but when you survey the major home builders, less than 1/3 are building certified green or high-performance homes and do not advertise these benefits. Is the buying public ahead of the curve on this issue?

The Institute of Supply Management’s January index of non-manufacturing businesses climbed to 50.5, up from 49.8 in December – readings above 50 signal growth. Correspondingly, the Institute for Supply Management’s manufacturing index rose to 58.4, which represented the 6th straight month for expansion.  The Consumer Confidence index increased to 55.9, up from 53.6 in December 2009, and significantly up from 25.3 in February of 2009.  All great news, but…

Changing Landscape of Lending Markets

Banks nationwide stopped raising the bar for borrowers; however, they continue to tighten standards on residential real estate lending.  Most banks believe delinquencies on commercial and industrial loans will decline in 2010 – a position I strongly hope is true (but are you kidding?).  With $1.2 trillion of debt scheduled to roll between now and 2013, and given the limited ability to refinance those loans, not to mention the required huge influx of equity that is inevitably necessary to maintain loan-to-value ratios, do you think this may be problematic? 

Property funds have raised $135 billion along with an additional $30+ billion by REITs; commercial lenders now consider the norm a loan-to-value ratio in the 60% to 65% range with banks making short-term loans on a long-term repayment schedule, while life (insurance) companies are looking at longer-term loans.  Where does this leave our commercial property values? 

There is debt available for core (the best of the best) properties with little tenant rollover; however, at those lower loan-to-value ratios, capitalization rates (valuing an operating income stream) seemed to have bottomed out for those core properties.  Is this because values have reached the bottom in this class of property, or is it because all that money is burning a hole in the fund manager’s pocket.  Are the fundamentals really there? 

Say for example, you financed a project at 80% loan-to-value three years ago, that loan is probably at 110% of value and at today’s terms they might be lucky to refinance at a 65% loan-to-value; the additional money will have to come from somewhere and that is for the loans that meet the more stringent standards.

Tishman Speyer NYC Debacle

Look at Tishman Speyers’ New York debacle, the purchase of two NY apartment complexes for $5.4 billion with $100 million as their equity portion (plus other equity partners money)with loans of approximately $3.6 billion, the value of said purchase is now estimated at $1.8 billion.  And these are very smart guys.

Massachusetts & US Economic Indicators

Massachusetts’s economic activity declined for the sixth consecutive quarter at the end of last year as holiday shoppers were cautious and unemployment spiked.   In contrast, the US economy grew by 5.7% last quarter on top of a positive 2.2% the prior quarter according to the Department of Commerce.  How much of that growth was due to stimulus money and how much was inventory replacement remains to be seen – wait until this quarter to see what is reported.

Home construction figures fell to 557,000 units, still posing a significant risk to economic recovery.  In normal/good times, this figure could be expected to be over one million units of production.  However, applications for building permits rose. The National Association of Home Builders index fell to 15 last month, further indicating poor construction conditions – readings below 50 mean most respondents view the conditions as weak.

Net occupied space in Boston shrank by over 4 million square feet during 2009 (and this is better than the rest of the nation), while vacancy rates approached 20%. State home sales showed their first increase since 2004, however, median prices continue to decline (year to year). The question is how much of this was tax credit driven?  Foreclosures fell over the same period, however, the precursor to foreclosure is ‘petitions’, and despite the widely broadcast news that foreclosures were down 25% in Massachusetts, petitions are up.

Libor versus Labor Rates

LIBOR vs LABOR…the former being so low that it is keeping rates low and commercial debt affordable and maybe even repayable. LABOR on the other hand continues to shed jobs and the future for commercial space looks bleak.  If the LIBOR rate rises, the ability to pay debt and refinance will be significantly compromised. Millions of people have lost their jobs, their homes – the political influence of the financial sector secured a huge bailout and while Wall Street benefited Main Street suffered.  Massachusetts’s employment is back to the same level as two decades ago – where is growth going to come from?

So what does all this mean – conflicting information, some good news, some bad – in times of uncertainty most people/institutions sit on the sidelines and wait.

New distressed debt numbers from the banking sector have recently been published, so it is time again to take a look at the 181 banks that make up our local lending landscape. There is a lot of talk about a very serious forthcoming correction in commercial real estate and the effects that this will have on our financial institutions. New numbers indicate, however, that Massachusetts lenders may be set to dodge this bullet… at least to some degree.

Overall, Massachusetts banks saw an increase in their distressed real estate balances of only about 5% Q2-Q3 2009. I don’t know if this sounds like a lot or a little to you, but  compared to the US totals at 11% its not too bad. Still, distress totals are up 72% over the last four quarters, not a confidence instilling figure.

This quarter is the first quarter that two Massachusetts banks are reporting capital adequacy numbers below those deemed healthy. In lay terms, capital adequacy has to do with the ratio of what you’ve got in the vault to what you’ve got on the street. Tier 1 + Tier 2 capital to risk weight adjusted assets should be no lower than 8%. One of these banks, Mt Washington Bank, recently announced a merger with East Boston Savings Bank, which, while reporting a little less than $20 Million in non-accrual loans and a little more than $2.5MM in (mostly construction) REO, is well capitalized reporting a ratio of 14% compared to Mt Washington’s 6%.

The other bank of note is Butler Bank. Butler reported capital adequacy ratios at 2% and 3%, a far cry from the 4% and 8% that regulators like to see. Butler’s construction portfolio has gone south at a rate of almost 40% (39.59%) and is by every measure the main source of their ills. It has been reported elsewhere that the bank is being closely monitored by the FDIC.

Overall Massachusetts banks saw the following changes from Q2 to Q3.

• 15% increase in residential distress mainly consisting of a big uptick in REO
• 3.26% increase in distressed multifamily
• Unchanged (virtually) commercial real estate distress
• Unchanged (less than 1%) construction distress

The distressed real estate totals are calculated by adding a banks 90+day late loans, non-accrual loans, and REO (bank owned property). It appears that we may be getting over the hump with construction loans both locally and nationally but that doesn’t mean that banks have dealt with the construction problems at hand only that most of the problems are already in the system. For example, while non-performing construction loans with Mass. banks fell by 2% to $222MM construction REO (bank owned) grew from $75.7MM to $84MM.

There are strong indicators that many, if not most, banks (with problems) are postponing inevitable losses as they move paper around internally. At some point that will have to stop and distressed properties will have to be sold. Today, Massachusetts-based banks are holding about $1.33 Billion in distressed real estate loans and property. About two-thirds of that is residential, construction, and multifamily while the balance is commercial. It’s important to remember that the numbers I’m giving you do not represent the whole of the distressed real estate market in Massachusetts. but only the numbers held at Massachusetts based banks. That means Bank of America, Citi, Deutsche Bank, and all of the largest lender’s numbers as well as mortgage backed securities are  unrepresented.

While the recession enders cheer positive signs in the stock market hailing the return of the bulls, everyone else seems to be wondering where the jobs are, and real estate industry folks are pointing at the long shadow being cast by the coming wave of commercial real estate problems. While I don’t have any answers to the employment numbers or the stock market, I do have a little real estate crystal ball and I’ll share it with you.

It is all about the banks. Banks not only control the reigns to capital and reasonable debt, at a time like this when debt positions are the only positions left in real estate, banks control a whole lot more. In fact recent bank data suggests that institutions are in control of hundreds of billions in real estate. How they handle it will affect us deeply. In this installment I’m going to show you what our 180 (more or less) local lenders are dealing with in terms of real estate and what to expect next.

Massachusetts’ banks are generally fairing better than the those nationally when it comes to real estate loans. Approximately 2.2% of all the banks in the US are headquartered in MA, while our banks only hold about .44% of the real estate problems. This is a good start. The most recent consolidated bank reports available show that MA banks hold only about $1.27B in problems. A drop in the bucket compared to the $290B+ in whole loan and REO problems with lenders nationally.

It’s not all peaches and cream though. Our software tracks a number of things, but 3 of those things fall into the distressed real estate pipeline 90 day late loans, nonaccrual loans, and REO. For each of these three columns we track residential, commercial, construction, and multifamily problems. In nearly all cases, and in almost every category, distressed real estate balances are growing nationally and locally.

Dollar Volume of Distressed Assets at MA Banks

Massachusetts based banks are reporting increased real estate problems.

Number of Massachusetts Banks with Distressed Assets

More Massachusetts based banks are reporting problems.

Do you notice a pattern?

Let’s ignore the first column for now because 90-Day-Lates are not as good a forecasting tool as non-accrual or non-performing loans. In nearly every category problems are mounting, not just with individual banks but across a greater number of banks. As the final numbers come in for Q3, I’ll make an update here. If a crystal ball exists though, here it is in the numbers.

I know I’m a bit of a bear but my money is on continued problems across the real estate spectrum, more struggling banks, more struggling property owners and certainly more great deals for those with capital. The next 18-24 months should prove to be very exciting for those prepared.