During the work day I usually keep CNBC on to see if the talking heads are doing something entertaining on any given day. Usually I keep the volume low or muted until a story or person of interest pops up.
As the latter hours of the morning were coming to a close the CNBC “Real Estate Task Force” with Re/Max CEO Margaret Kelly and Charles Cohen from Cohen Brothers Realty popped up. I figured on my way out to lunch I would at least give this motley crew a few seconds of my time. I didn’t listen to the whole thing when I started to realize that lending a few seconds of my time was turning into destroying a few points of my IQ. Lucky for us it didn’t take long into the segment before Diana Olick began to spew pure comical economic ignorance out of her mouth.
Olick was quoted as saying, “We thought that commercial [real estate] was going to do far better because the theory was that commercial didn’t overbuild the way that residential real estate did.”
Here’s a link to the full clip.
Maybe we should give her some credit. It takes real fortitude to go on cable television and show the world your inability to process even the most basic notions.
The notion that commercial real estate wasn’t overbuilt in the same sense that residential real estate was is simply wrong. The commercial sector was overbuilt BECAUSE residential was overbuilt. Diana Olick points this out herself later in the clip. I would think it’s pretty hard to contradict yourself in one 5 minute TV clip.
The artificial growth in the housing sector created a pile of excess liquidity in the consumer’s hands. Rising housing prices gave the “something for nothing” crowd the ability to use the growing home equity as a 4 bedroom 2 bathroom credit card. The money was used to make mortgage payments, eat at fancy restaurants, get that new car, and buy everything else you can imagine. As the pile of liquidity grew, the commercial real estate sector followed suit in order to service the fake wealth.
Like all things that were the result of the artificial Keynesian policies that have been running our nation, the party stopped and the hangover is settling in. Except in this case, all the hydration and Tylenol in the world can’t help.
Commercial Real Estate Now
Many regions around the world are already dealing with commercial vacancies of 15-20%. The suburb of Minnesota in which I live was little more than a McDonalds, grocery store and gas station in the late 80’s. A couple of years back, that same suburb surpassed the Mall of America as the largest conglomerate of shopping and eating facilities in the state (not to be confused with the largest mall in MN; MoA still holds that title). After snatching their #1 ranking, the place where I make my home didn’t stop. The kept building with the last of the mini malls being finished in 2008. Now, vacancy rates in the commercial sector have risen significantly with the most recent developments sitting up to 80% empty. Adding to the fire was the closing of Circuit City and Linens-n-Things, both of which had stores in my hometown.
This particular city is a text book example of the boom and bust caused by the housing cycle. The people who live there are rather comical (hopefully not me) as the stay at home moms drove around in their leased Escalades that their husbands never should have been able to afford in the first place. I digress, because there are some good lessons that can be learned here.
As mentioned, the commercial real estate sector was built to service Greenspan’s bubble. On that intuition, the blame for this particular bubble can also be attributed to Easy Al’s policies. Just one of many I guess. Another aspect to note is the effect that corporate bankruptcies have on the market for commercial real estate. In my hometown, when Circuit City and Linens-n-Things went bankrupt, more supply was added to an already bad situation. This will continue to be a reoccurring theme with not just large corporations, but the mom and pops are having a rough go of things as well.
Many are making claims that this is going to be the equivalent of the collapse in residential housing. Although there will be many similarities, the collapse in the commercial real estate bubble will be a beast of different nature.
Commercial vs Residential
Currently there are about $3.7 trillion in outstanding commercial real estate backed loans. Up until now, a very limited number of these loans have reached maturity. The amount of debt reaching maturity will start to pick up at the end of 2009 and greatly accelerate into 2010 and 2011. I imagine that this will create a sort of refinancing crisis in which the timing couldn’t be worse. Liquidity and willing lenders simply won’t exist.
Also, the process in which this plays out will be much simpler than the residential bubble. Store owners are receiving less revenue as a result of the collapse in consumer spending. Soon the owners will be bankrupt and no longer able to pay their leases. The contracts will be broken. After enough broken contracts and the inability to fill empty space takes grip, property owners will no longer be able to pay their mortgages. There’s no predatory lending, and although the asset backed paper behind the commercial sector has been grossly overpriced, it wasn’t chopped up and repackaged nearly to the extent of residential MBSs. The losses will be just as real, but the timing in which it takes to sort the mess out should be less.
Liabilities of the bubble are also slightly different than that seen in the residential sector. The typical candidates were still involved. Leading the way are the insurance companies, hedge funds, and banks. The difference lies in the last culprit. The investment banks definitely partook in the financing of the commercial real estate bubble, but Wall Street financed the highest quality commercial operations. This time it was the regional banks who have taken on the riskiest assets. One of the main reasons the regionals put themselves in this position is because they financed these local projects, many of which were their own customers. Regardless, their balance sheets are going to have a really tough time absorbing the losses. For that reason, several short investment opportunities will present themselves as a result of the commercial real estate bubble.