MOVING TOWARD CLARITY ON TERROR COVERAGE ISSUE

With the economy in recession, it has been hard to identify real estate projects might have been delayed solely because of a lack of terrorism insurance.

But with the economy apparently on the mend, the situation may soon be easier to read. Any clarity would be welcome, as views among industry players remain mixed, and political spin is stuck in overdrive.

Some commercial real estate executives are contradicting the message their trade associations are spreading in Washington -- that Congress needs to pass terrorism insurance legislation to prevent an economic crisis.

Their point:The industry could be helped in the long run if Congress created a federal reinsurance backstop -- at least a targeted one. But even in the absence of one, not only would banks continue to lend to commercial projects, as much as 90% of the projects in the market right now would be essentially unaffected. While stressing that terrorism insurance is a "very important issue," Malcolm Griggs, a senior vice president and the director of risk policy for Wachovia Corp., said his company would continue to lend money regardless of what Congress does.

"Without a resolution it will have a drag on the economy -- as well as lending in general, but the credit spigot will not be turned off," Mr. Griggs said.

Several real estate industry players said the current lull in the commercial real estate business has more to do with the recession than the availability of affordable coverage. The reason few office, retail, or hotel projects are being funded or moving forward is because there is little demand, several sources said.

A. Eugene Kohn, the president of Kohn Pederson Fox Associates, an architecture firm in New York, said his company, which designs office buildings around the world, is currently conducting many feasibility studies and evaluations for developers and clients for potential projects. However, "nothing is moving ahead at the moment, because the demand is really not there in most American cities."

And even though Mr. Kohn said he is skeptical that the growing concern over terrorism insurance is warranted, and argued that "trophy buildings" carry almost all the risk, he said the mere fact that the issue exists means that Congress should get it resolved.

He suggested a targeted approach that could be focused on the most high-risk properties. "If you think about it statistically, the number of buildings that terrorists would want to attack has to be very minimal," he said. "Is it one? Is it 10? Maybe, but it's not thousands, and for everybody to be carrying terrorism insurance would make no sense. It's too expensive."

A government-backed program would be the best way to deal with the buildings that terrorists would most likely target, he said. "It seems there should be a fund that covers those few buildings where it may happen."

Dan Kirby, a principal at CapMark Services, an Atlanta commercial loan servicer, agreed with his idea and said legislation would put the government at relatively low risk. In many cases the price for terrorism insurance is unreasonable, and buying such coverage could turn profitable properties into underperforming assets, he said.

"Why do that when the risk of losses from terrorism is so small?" he asked. "The cost of thousands and thousands of businesses in the country of providing their own coverage is uneconomic. This is a case where the government probably needs to provide that level of support."

Some observers, such as John B. Levy, a principal at John B. Levy & Co. Inc., a Richmond, Va., real estate investment banking firm, say their businesses so far have not been affected by the issue. In addition, as many as 80% to 90% of the deals currently in the offing are not affected at all, Mr. Levy said.

There is a question of whether very large deals can obtain adequate coverage at prices that are "less than usurious, and until that is resolved, there will be a difficulty in financing these large, trophy assets," he said.

Moody's Investors Services this month said it is evaluating the impact of the limited availability of terrorism insurance on building loans and commercial mortgage-backed securities. The ratings agency said it is looking closely at "a limited number of high-profile buildings" to determine what effect the lack of insurance would have.

To conduct this analysis, Moody's is using a new method that judges a building's relative likelihood of being a terrorist target, as well as the property diversity within a CMBS deal.

Most industry players agreed that the issue must be resolved in some way, either by the industry or the government, for the commercial real estate sector to help the economic recovery.

Mr. Kohn said the dearth of insurance will become a problem when demand for commercial properties picks up. That demand increase may come early next year, he said.

Yet some say a resolution is urgently needed, particularly for existing properties losing their insurance, a problem that some say is just starting to pick up steam. Losing terrorism insurance can have an impact on refinancing, buying or selling activity, and the overall profitability of a property, these observers say.

Legislation to establish a government insurance system remains stalled in the Senate, which is divided over how much victims of attacks should be allowed to seek in punitive damages. Proponents of the legislation say they expect the Senate to take it up after the spring recess, which ends April 8.

The legislation got a boost last month when Federal Reserve Board Chairman Alan Greenspan and the General Accounting Office said government insurance was necessary.

Clifton Rodgers, a senior vice president at the Real Estate Roundtable in Washington, said the effects of the lack of terrorism coverage is becoming more visible every day as more policies roll over and have to be renewed. Most new policies will not offer terrorism coverage, and a policy that does will be "generally a deficient product," he said.

"Massive amounts" of policies will roll over in April, June, and July, he said.

If properties cannot get terrorism coverage, it could be devastating for the commercial lending business, Mr. Rodgers said.

"In a post-Enron environment, is a bank going to be comfortable having a portfolio of assets that are uninsured for terrorism coverage?" he asked. If the buildings do not have such coverage, banks run the risk of being in the property/casualty business and will have to hold more capital against those assets, he said.

"If you have those additional capital drains that decrease the profitability of those loans, then suddenly real estate lending is not going to be a viable business," Mr. Rodgers said.

The issue is also having an impact on the commercial mortgage-backed securities market, a large source of capital for commercial real estate, he said. "Most of the buyers of that paper are fixed-income buyers, and if they perceive a risk to the collateral that's not covered, that could stop that market."

Stacey Berger, an executive vice president at Midland Loan Services Inc., a loan servicer and technology provider for the commercial real estate finance industry, said that new issuance of large-loan CMBS has basically "come to a standstill."

Issuance of commercial mortgage-backed securities so far this year has dropped 75% from the same period last year, he said. "There may be an industry fix, but somebody's got to do something."

Most players agreed that the industries involved are grappling with an unprecedented and unexpected debate, where overreaction and hyperbole are bound to rear their heads.

(One trade group executive said he had heard that several lenders and life insurance companies had stopped lending money to commercial real estate projects because of the problem, but when asked for specific companies, he said he could not remember the companies' names.)

Despite his prediction that credit would not be shut off, Mr. Griggs said that lenders would have to reevaluate their loan risk assessment if the industry or the government do not resolve the issue.

"Bankers have some fundamental questions that they're going to have to answer over the next six months," he said. "How do we want to revisit some of the tried and true underwriting and deal structuring guidelines that we've been operating under for years? ... Let's face it, a bank's capital base was never intended to cover this type of risk for our borrowers."

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