Walter J Kassuba Realty

To describe what happened to Walter J Kassuba Realty, we first need to highlight a little further the role played by the newly developing Real Estate Investment Trusts, REIT's, at this time. Thomas (Lords of the Land, page 283) gives a good discussion of this and it is worth quoting him at some length:

"The concept behind the trusts was both sound and useful. It was... a vehicle which would allow the nation's smaller shareholders to invest in a diversified portfolio of real estate ventures while providing a substantial new source of capital for large-scale developments like urban renewal. What made the trusts especially intriguing was the role they were designed to play in periods of tight money. When the pressure is on the commercial banks to cut down their business loans, the first borrowers to feel the pinch are typically real estate builders who are the riskiest customers. When the banks withdraw, a wide-open opportunity is provided for a trust to move in and build its portfolio of construction and development loans. So thought the pundits.

The trust concept became the hottest property on Wall Street. Analysts gleefully called them 'perpetual moneymaking machines.' The effect of leverage on their earnings could be amazing. For instance, if a trust were earning $1.50 a share and its stock was selling at 20, it would go to the public market to obtain new capital cheaply and expand its lending operations. Suppose it sold a hundred thousand shares for $2 million; it would put these funds immediately to work in construction and development loans that yielded, in a period of tight money, 14 percent, generating for the trust new earnings of $280,000. In short, the hundred thousand shares of new capital would return $2.80 a share, boosting overall earnings as well as book value. Then the trust would come to Wall Street for still another public stock offering at an even higher price, boost its earnings again-and so on and on. That, at least, was the theory.

Not surprisingly...the potential of the trust excited the imagination and the greed of Wall Streeters. Borrowing cash at 10 percent and lending it at 14 percent, returning at least 90 percent of their tax free profits as dividends to shareholders, while the price of their stock continued to soar to increasingly higher multiples-how could an investor go wrong with them? A crowd of wheeler-dealers, outside the real estate field as well as in it, rushed headlong to set up their own trusts. "People with no background whatsoever in the business came to me and demanded that I raise fifty million to start an REIT," reported one leading underwriter in Wall Street. "I asked them what they knew about real estate; and their answer was that they didn't have to know a damn thing about it. They could always hire a mortgage man from a bank." Most underwriters in those euphoric days needed no further persuasion. Some of the latter got involved in promoting trusts of their own.

By 1969 the trusts were by all odds the glamour equities of Wall Street. The stock of almost any new REIT that came to the market was snapped up and a cinch to climb 100 percent or more in price without scarcely a pause. A huge rash of trusts were launched on the premise that the boom in real estate - in shopping centers, commercial buildings, residential apartments - would go on indefinitely. Within a period of six years, industry volume rose from a mere $1 billion to almost $20 billion. By the early 1970s the trusts were accounting for over 20 percent of all the construction and development loans to the real estate industry."

As the number of REIT's exploded, the pressure to loan out more money increased. The risks increased in direct proportion to the quality of the borrowers demanding ever more funds. Problems were building in other areas too. Sometimes, an REIT not only lent money to the builder, but then also subsidized the builder for the interest payments due on the loan, often right up until the final payment when the builder had to pay back not only the interest but the principal as well. Meanwhile, that same REIT accounted for the loan income in its books as if it was actually receiving each monthly instalment. (Looked good for the share price.) This became a problem since by law (as noted elsewhere) the REIT had to distribute 90% of its income each year to shareholders to maintain its tax exempt status; so some REIT's were in effect distributing profits before actually receiving them. Continued Thomas (page 287) about such practices:

"With practices like this prevailing, it was inevitable that the first major downturn in real estate would bring down the REIT industry with a crash. In December 1974, the collapse of a major builder who had borrowed heavily from a number of trusts started the dominoes tumbling. Walter J. Kassuba Realty, a Florida - based corporation, which had a $550-million investment in 119 properties around the nation, including 35,000 apartment houses and a wealth of offices and shopping centers, suddenly filed for bankruptcy under Chapter XI. Caught up in the tight money squeeze, beset by shortages of materials and cost overruns, thinly capitalized and dangerously overextended, the thirty-nine- year-old Mr. Kassuba ran out of cash, stranding over two thousand secured and two hundred unsecured creditors, including some of the nation's biggest mortgage bankers and insurance companies. In addition to such victims as John Hancock, Connecticut Mutual Life Insurance, Northwestern Mutual Life Insurance Company, and Chase Manhattan, which was a trustee for clients who lent Kassuba money, no less than a dozen real estate investment trusts were stuck with $110 million in bad loans."

"Real estate has historically thrived on cheap money like a lighted match on Kerosene," noted Thomas in that same book somewhat earlier. And so it is. The party turns into a hangover when the interest rate - the cost of money - is tightened. Leveraged players, like the REIT industry of the time, feel these effects first.

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