Commercial Real Estate Market May Soon Bulldoze Green Shoots

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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.