Commercial Real Estate Market May Soon Bulldoze Green Shoots

Commercial real estate [CRE] delinquency rates are exhibiting severe deterioration and may soon bulldoze the ‘green shoots’. Since October of last year monthly delinquencies rates have increased at a pace that is without precedent. According to the Congressional Oversight Panel (COP), a group of academics focused on corporate and CRE lending, the coming wave of defaults on loans to developers of condominiums, office buildings and malls could do considerable damage to the already fragile and deflating U.S. economy.

From Time: That was the overwhelming concern expressed at a public hearing of the COP [this week] that focused on corporate and commercial real estate lending.
…
Richard Parkus, an analyst at Deutsche Bank, said he thought two-thirds of all commercial real estate loans due in the next few years — hundreds of billions of dollars’ worth — could go bust. Jeffrey DeBoer, president of trade group the Real Estate Roundtable, fretted that problems in the lending business could cost the nation thousands more construction and real estate jobs. Next up, Congressman Jerrold Nadler of New York expressed worry that the country was headed for a lost decade of economic stagnation.
…
A number of the panelists thought the government’s TALF and PPIP programs meant to boost lending were helpful but not the answer. Parkus said he thought extending the terms of commercial loans set to default would only delay the problem and make it worse. As more and more bad loans pile up, he predicted, it will become progressively harder for any of them to get refinanced.

[Parkus] expects that a little over $1 trillion in commercial real estate loans will be up for refinancing in the next four years. Because of falling real estate prices and lower rental incomes, he said, as many as two-thirds of those loans may not be eligible for refinancing and could end in default…“There are very large losses embedded in the system,” [Parkus] said.

emphasis added

Given, among other factors, the renewal dates on maturity defaults and extension risks that a large number of commercial loans valued at billions of dollars are approaching, and more importantly, the deterioration in office rates, and retail rates in particular — which given the declines in consumer spending and the spike in retail bankruptcies constitute a serious and worrisome problem — is only logical to assume that as valuations on cross-sectional differences in property prices decline while the disconnect between supply and demand persists, CRE will be hit rather hard as a segment. How bad it gets will depend on speed of economic recovery.

CRE prices made HH in October 2007 after appreciating 90% from 2001.

Comments

[Dave Wrixon:]

It is tough trying to pass off an elephant in the room as a little flatulence.

May 31 07:34 AM

[Trane250:]

This situation is a consequence of the notion that you can destroy your industry on the alter of unfettered free trade and then make up for the loss of industrial wealth by building upscale shopping malls, resort condominiums, luxury office towers and 10,000 square foot luxury penthouses.

May 31 11:07 AM

[CautiousInv...:]

This is a big story that has been lingering beneath most radar screens.

Apartements, office buildings, industrial space and retail space share three things in common: rising vacancies, growing defaults and plunging values. The $1 trillion that is up for refinancing over the next few years is easily underwater by 20% or so, making virtually impossible for borrowers to successfully refinance the debt.

Aware of this precarious situation, the Fed identified CMBS as a loan category eligible for TALF but S&P has recently reviewed a number of tranches by vintage and noted the following:

S&P noted:
Our preliminary findings indicate that approximately 25%, 60%, and 90% of the most senior tranches (by count) within the 2005, 2006, and 2007 vintages, respectively, may be downgraded.

Since that comment some $75 billion of capitalization has been lost and it is estimated that only half of the CMBS universe may be eligible for TALF unless the Fed changes the requirement that it hold AAA collateral and/or new, more user friendly ratings agencies are created.

Without TALF, the market for CMBS will crater.

May 31 11:30 AM

[Mad Hedge F...:]

No doubt. The imminent demise of General Motors (GM) will be a nail in the coffin for the commercial real estate market, which I believe will be the financial crisis of 2009. Some 2,000 dealers are being axed, dumping hundreds of millions of square feet on to a market that least wants it. These were the guys who sponsored the local baseball team and Girl Scout cookie sales, and their absence will rip the hearts out of hundreds of American communities. Much of this is prime space, near dense populations, with great frontage, adjacent retail space, completed site work, mitigated environmental work, and already zoned for commercial use. Some might get turned into mini malls, but I’m afraid more will end up as indoor climbing walls and paintball battlefields. Commercial real estate sales are off 73% this year, while vacancies have catapulted to 16.7%. Banks have seized 464 properties so far in 2009, including $7 billion worth in March alone, and thousands more are on the brink.

May 31 12:10 PM

[Dave Wrixon:]

These guys are going to end up with a bigger share of the overall economy than the Soviets.


On May 31 11:30 AM CautiousInvestor wrote:

> This is a big story that has been lingering beneath most radar screens.
>
>
> Apartements, office buildings, industrial space and retail space
> share three things in common: rising vacancies, growing defaults
> and plunging values. The $1 trillion that is up for refinancing over
> the next few years is easily underwater by 20% or so, making virtually
> impossible for borrowers to successfully refinance the debt.
>
> Aware of this precarious situation, the Fed identified CMBS as a
> loan category eligible for TALF but S&P has recently reviewed
> a number of tranches by vintage and noted the following:
>
> S&P noted:
> Our preliminary findings indicate that approximately 25%, 60%, and
> 90% of the most senior tranches (by count) within the 2005, 2006,
> and 2007 vintages, respectively, may be downgraded.
>
> Since that comment some $75 billion of capitalization has been lost
> and it is estimated that only half of the CMBS universe may be eligible
> for TALF unless the Fed changes the requirement that it hold AAA
> collateral and/or new, more user friendly ratings agencies are created.
>
>
> Without TALF, the market for CMBS will crater.

May 31 01:13 PM

[johnthebears:]

It is amazing to me that IYR continues to hang in there in spite of falling rents and values! It would appear that mark- to- market accounting for commercial real estate will be delayed indefinitely, with dividends paid out of stock sales to new investors at many REITs.

Do you think REIT investors will catch on in time to save their hide?

May 31 10:50 PM