Forgiving Partners

INVESTMENT

An ancient financial adage holds that businessmen with mountainous debts do not merely have creditors: they have partners with a high stake in their survival. Rarely has the truth of the saying been better proved than by the current troubles of the nation's real estate investment trusts. A glittering investment innovation of the 1960s, REITS enjoyed congressionally mandated tax breaks similar to those of mutual funds. They collected money from various sources--bank loans, sales of stock to the general public--then made loans to builders to finance the construction of condominiums, motels, office buildings, even single-family homes. But two years ago, inflation and high interest rates ripped through the real estate industry like tornadoes. Construction projects were halted, slashing REIT revenues and preventing many REITs from repaying their own debts.

Last week one of the pioneer REITS, Boston-based Continental Mortgage Investors, the nation's second largest, provided the latest example of how bad things have become in the REIT industry. It announced that it would default on $551 million in interest and principal payments now due on its borrowings. Caught by shrinking revenues and interest rates of 12% and more, Continental raised rates to builders to 16% or 17%. The builders could not afford such rates and simply walked away from projects. At one point, more than 60% of Continental's loans to builders had either been foreclosed or were yielding no interest. Ultimately, Continental defaulted on its own bank debts.

New Terms. Still the default is not likely to force Continental into bankruptcy. Its creditors--no fewer than 103 banks and 33 institutional investors --forgave Continental in April, when it defaulted on $652 million in obligations. They began complex negotiations to refinance the debts. Those negotiations could not be completed by the Dec. 1 deadline, so Continental last week was forced into a second default.

With little to gain and enormous sums to lose by pressing for their money, Continental's creditors are again ignoring the deadline and some are negotiating new terms--such as deferring interest payments for three years. There is ample precedent: Chase Manhattan Mortgage & Realty Trust, the biggest of all REITs, sponsored by Chase Manhattan Bank, recently refinanced $761 million in bank loans, and got the interest rate reduced to as little as 2%.

A serious question exists about how long the REITs and their creditors can hold out, though banks could write off many of their REIT loans as uncollectible. The case for waiting is powerful. In all, the nation's 200-odd REITS owe U.S. banks $11 billion.

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