Posted on 04/03/2009 9:42:28 AM PDT by ex-Texan
Money Morning/The Money Map Report
Stock prices have rallied for much of last month. The housing market has shown some early signs of life. And some of the latest economic reports haven’t been the disasters that many experts feared.
While this is hardly a portrait of an economy on a roll, there are enough bright spots to nurture a feeling that the U.S. economy is finally on a path to recovery - especially given the upbeat response the latest elements of the Obama administration’s fix-it plans have received.
But there’s a dark cloud in this picture. And it’s big - big enough, in fact, to potentially finish off the U.S. banking sector, blotting out the U.S. economy’s new dawn.
That dark cloud is the commercial real estate sector. With rent prices falling and vacancies rising due to the recession-weakened economy, delinquencies on commercial mortgages are already escalating steeply. And the credit crunch bred from the recession is often making it impossible for property owners to avoid deeper trouble by refinancing.
“It’s a one-two punch combination: First, soaring vacancies take the wind out of positive cash flow; then the credit crisis hits like a rabbit punch, snapping off the main arteries to refinancing,” says Money Morning Contributing Editor Shah Gilani, a retired hedge-fund manager and expert on the U.S. credit crisis who predicted the implosion of the commercial real estate sector several years ago. “This is like Samson hitting the ground. The giant asset class we call commercial real estate is not going to get up any time soon.”
Here in the U.S. market, commercial real estate is worth about $6.5 trillion, and is financed by an estimated $3.1 trillion in debt.
And that debt is going bad at an escalating rate. In March, the delinquency rate on about $724 billion in securitized debt reached 1.8%. As percentages go, that’s a pretty small number. In fact, it’s less than a quarter of the housing market’s record-breaking mortgage-delinquency rate of 7.88% for the fourth quarter, according to the Mortgage Banker’s Association.
But don’t let that 1.8% rate fool you: The delinquency rate on commercial-real-estate debt has more than doubled just since September, according to a new Deutsche Bank AG (DB) report called “Commercial Real Estate at the Precipice.”
With that increase, experts say the delinquency rate on commercial real estate has already almost equaled the rate achieved during the last U.S. economic slump, which took place at the beginning of this decade. And forecasts now call for the current downturn in the commercial real estate market to rival - and perhaps even exceed - the plunge of the early 1990s, when nearly 8% of all commercial real estate loans went sour. Banks and thrifts took nearly $50 billion in charges, and nearly 1,000 lenders failed, The Wall Street Journal said.
The fallout this time could be much worse - for three key reasons:
“Any bank that has a sizable book of commercial real estate loans could have serious problems in 2009,” Jamie Peters, a bank analyst at Morningstar Inc. in Chicago, told The Minneapolis Star-Tribune.
This time around - compared to the early 1990s - banks left themselves no margin of safety in the form of “Tier I Capital” - a measure of how well a lender can navigate serious levels of losses. The higher the ratio, the less likely a lender will be able to work its way through a stretch when loans start going bad.
In 1993, less than 2% of U.S. banks and thrifts had an exposure to commercial real estate that was more than five times their Tier I capital. By the end of last year, that ratio had spiked to 12%, involving about 800 banks and thrifts.
As Money Morning reported, the U.S. Treasury Department and the U.S. Federal Reserve are working on a program that would induce private investors to buy into debt backed by such income-producing commercial properties as office buildings, retail stores and hotels. The program - the Term Asset-Backed Securities Loan Facility (TALF) - is seen as a way of breaking the toxic-asset logjam, and to bring capital to debt that can’t be refinanced because of the ongoing credit crisis.
This is an attempt to avoid the [dangerous] “repeat of what happened on the residential side: A complete choking up, foreclosure disasters and increased stress on the banking system,” Jeffrey DeBoer, chief executive of the Real Estate Roundtable, told The Journal.
What has real estate executives really worried is the looming surge in commercial real estate loans coming due. Until now, delinquencies on commercial real estate loans have stayed below historical levels (due mostly to the limited amount of speculative construction that’s taken place in recent years. But delinquencies are now surging - in a big way - just as the volume of loans coming due is also spiking - and just as the few remaining lenders willing to make the kind of loans needed to refinance this debt are exiting the market.
“The credit crisis has got so bad that refinancing of even good loans may be drying up,” says Richard Parkus, head of commercial-mortgage-backed securities research at Deutsche Bank, and the author of the afore-mentioned “Commercial Real Estate at the Precipice” report.
Commercial real estate loans differ from their residential-loan counterparts, which borrowers repay after a set period of time - usually 30 years. Commercial mortgages usually are underwritten for five, seven or 10 years with big “balloon” payments due at the very end. At that point, the property owner usually turns the loan over and refinances it. A borrower’s inability to refinance could force it to default.
All of a sudden, scores of experts are warning federal lawmakers that hundreds - or even thousands - of resort hotels, retail malls and shopping center properties and commercial complexes of all sorts are headed for, on the verge of, or are already in default, a Memphis Daily News report stated. The reason: About $530 billion of commercial mortgages will be coming due for refinancing in 2009-2011 - with about $160 billion maturing this year - even as credit for refinancing remains non-existent, and cash flows from rents and leases are way down due to the recession, property researcher Foresight Analytics concluded.
What’s not clear is how soon the crunch will come - or if it will come at all.
The Real Estate Roundtable, a key trade group for the industry, late last year predicted that more than $400 billion of commercial mortgages will come due through the end of 2009. Foresight Analytics estimates that $160 billion of commercial mortgages will mature next year.
“Unfortunately, the commercial real estate market is even more vulnerable to economic cycles, and here I’m talking about deep recession, than residential real estate,” Money Morning’s Gilani says.
The current recession - which started in December 2007 - could be the wild card, Gilani says. If the U.S. economy continues to improve, as it seems to be, and as many experts predict will continue to, cash flows from properties won’t keep declining, and defaults won’t escalate. Unfortunately, there’s an inertia that takes hold during a downturn: Companies continue to slash jobs, shutter plants, close stores and otherwise cut expenses - often even after the broader economy shows early signs of new life. This inertia could be enough to keep commercial real estate vacancies to rise and defaults to escalate.
If that happens, it’s possible the commercial real estate sector becomes the “tipping point” that could keep the U.S. economy ensconced in its current recession, or if the recovery is truly under way, push the U.S. market into a “double-dip” downturn.
Time will clearly tell.
Wait until the end of 2010. Obama may be facing huge crowds in the street and bull horns on street corners by then. Unemployment figures are faked in D.C. to build confidence ratings. Check all my posts. I have discussed these fake statistics before on FR. Government has been faking statistics for a very long time. They are very good at it. Our mainstream media laps up this rancid pablum and vomits it on cue.
They are all as crooked as dogs hind legs: Politicos, political aides, spin doctors, and news media. They are paid by the same corrupt source.
If you want to learn more, you may check my freeper page. Or Yada, Yada This is still a free country or should I say only, 'At least we still have free speech. For the time being.'
Yea, there is a boatload of commercial properties empty in my small city of 40,000. With the Obama economy the way it is, there will be no one leasing these properties either, and there will be more going out of business.
This was in our local paper this morning....glut of commercial real estate:
http://www.tampabay.com/news/business/realestate/article989353.ece
We’ve outgrown our current shop and were shopping around town late last year for a new place. The owners were pretty proud of their properties, I must say. Then a double-sized unit right next to us opened up. It was the perfect place—warehouse+office, heat, air, the move was just right next door. Well, I started negotiating with the landlord and he too was really proud of his place. It came down to spending a few bucks to paint the walls and he balked—told us the he didn’t think there was anything wrong with them (imagine that—he knows better what we require than we do!). I killed the deal and we remodeled our current place to make it more space efficient.
Get an e-mail yesterday from the landlord’s secretary. Seems that several units have opened up (including the unit next door, which is still vacant) and they’re wondering if we’re interested. They’re even willing to put in a few amenities! Imagine that. I’m still contemplating the greatly reduced rent I’m going to offer them.
Non-res construction has been collapsing for 6+ months. Forecasts are in the -15% to -18% range already. This should not be a surprise to anyone following the numbers.
Will the Dark Cloud of Commercial Real Estate Blot Out the U.S. Recovery ?
LOL! No. Other than the dead cat bounce, there is no recovery.
In a NORMAL recovery, a bad commercial real estate market could create opportunity by lowering rents making start up costs for a new business cheaper and enabling expanding businesses to move from a smaller locale to a larger one without adding additional costs.
Of course with the present administration, this will NOT be a normal recovery......
A great analysis of the numbers is right here:
Even though we know that adjustable rate mortgages were a major cause of the financial crisis, the storm has not passed.
Just because the problem is obvious, doesn’t mean it is not a problem.
The chart from T2 Partners produced about one year ago shows that we are now in a lull for adjustable rate mortgage resets.
There will be another crescendo of resets in 2010 and 2011. When banks ask for more taxpayer money to sure up their balance sheets in 2010, Timmy Geithner will be wearing his best “shoulda guessed” face when he gets the call from Citicorp.
Commercial, non-residential real estate and construction loans total 40 percent of bank loan portfolios.
These loans will provide the next leg down in this death spiral.
Anyone who can’t see this coming is just not looking.
The Escalator of Life is Going Down
http://seekingalpha.com/article/126971-the-escalator-of-life-is-going-down-part-1
Yep 750,000 jobs lost last month and unemployment rate at 8.5% is not a disaster. 4 trillions dollars in wasteful spending in the first 70 days of Obama administration is not a disaster. As long as the socialists are creating some gimmicks to make the market feels good and rally it up then everyhting is OK. (extreme sarcasm).
What will be interesting is to see how the relaxation in mark-to-market rules affect this “death spiral”...
I was glancing at that myself, but I can't for the life of me understand why anyone would be for that idea.
Kind of like not being able to make a bridge with proper engineering principles, so we will just “relax” them a bit.
Why not just “relax” balance sheets directly?
After all, it could depend on what your definition of “addition” is.
The tag line came from Ed Koch...
That's a pretty astonishing turn of events, if true.
Obviously. My point remains.
Banks finally learned that they are not in the business of turning real estate. What they had been doing was taking the property ==> seeking a distress sale which lowered property values ==> which forced more foreclosures ==> causing them to take more properties...
Not sure I get your analogy then...help me out.
“This is like Samson hitting the ground.”
As an aside, I wonder if he really meant “Samson”, or “Goliath”.
"CRE (Commercial Real Estate) has its own vicious cycle. Unemployment increases, demand for office space decreases, rents fall, and then commercial property prices fall. CRE prices have already fallen and the next leg down could make the subprime crisis look like a cakewalk."
Maybe they can also delude themselves into pretending that the property is still worth $X for accounting purposes — rather than foreclosing on it and selling it for a huge discount.
The new mark-to-market rules allow for asset valuation in an “orderly sale” not in a “distressed sale”. Vague as most FASB statements are...
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