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Commercial Real Estate in Crisis Mode

Written By Brian Hicks

Posted February 24, 2009

It was February 2007 when we called the top of the residential real estate market, as subprime began to wreak havoc. And we were right.

Nowadays, though, the commercial real estate market is just beginning to mirror the 2007 residential real estate market.  And as the recession takes hold, commercial delinquencies are only beginning to rise.

The meltdown at some of the biggest commercial REITs will be another blow to a financial system teetering on the brink of disaster. And nothing may be able to stop the slide.

And the Fed is signaling worries about commercial real estate. From the minutes:

A number of participants expressed concern that the commercial real estate sector could deteriorate sharply in the months ahead. They noted that a large number of commercial real estate mortgages will come due at a time when banks likely will still be facing balance-sheet constraints, the ability to securitize commercial real estate mortgages may remain severely restricted, and vacancy rates in commercial properties could well be climbing.
Some participants worried that the outcome could be an increase in defaults on commercial real estate mortgages and forced sales of commercial properties, which could push prices down further and generate additional losses on banks’ commercial real estate loan portfolios.

And there’s growing fear that a lack of credit and the economic recession will further depress commercial real estate. Says Lawrence Yun:

“The credit crunch has especially hammered down some components of NAR’s commercial leading indicator. A lack of commercial credit is a serious threat to the overall economy. The Federal Reserve needs to use the Term Asset-Backed Securities Loan Facility (TALF) to provide liquidity and support for commercial mortgage-backed securities.”

Worse, vacancies in commercial properties are skyrocketing. And millions of square feet of commercial real estate is currently under construction, and ready to flood the market. And about $171 billion in loans backed by offices, shopping centers, hotels and other buildings are coming due this year, according to Union Tribune. Experts are fearful there may not be enough “credit capacity in the system to refinance them.”

For months, many have been warning that commercial real estate will be the next shoe to drop. One reason for concern is that CMBS (commercial mortgage backed securities) has just about dried up. And if buildings can’t be refinanced, we could see further distress, driving real estate values even lower.

Things are bad… and they’ll only get worse before we see sustainable improvement.

Here’s more from Forbes:

Next Crisis: Commercial Real Estate

“Atlanta Fed president sees U.S. housing troubles spreading to office and retail segments.”

Word of another wave of mortgage-related pain added to investor unease Monday after a top Fed official warned that American real estate troubles will go commercial this year. Nearly all asset classes took a hit for the day, with only the dollar showing appreciable gains.

Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said he was concerned that U.S. banks remain “pretty heavily exposed” to commercial real estate. “It is the one domestic factor that keeps me up at night,” he said.

So far, the U.S. mortgage morass has been largely confined to the residential part of the market, but delinquencies on commercial real estate loans and mortgage-backed securities are expected to increase as businesses suffer the effects of a slowing economy. If 2007 and 2008 can be thought of as the peak of residential real estate issues, Lockhart told the Association for Financial Professionals after a speech, then “it is possible to think of 2009 as the year of commercial real estate.”

Commercial values have fallen 16.0% from their peak in October 2007, according to the Moody’s ratings agency, which expects further declines over the next 12 to 24 months with delinquencie rising as macroeconomic pressures take a toll on property cash flows.

Still Lockhart, a voting member of the Federal Open Market Committee, said that actions by U.S. government to end a year-long recession will restore growth in the second half of this year. He added that economic forecasts tend to be overly optimistic as the economy goes into a recession, but overly pessimistic as it recovers. “Perhaps we should take some comfort from that,” he said.

Investors didn’t on Monday. The stock market tumbled toward 12-year lows on recession worries.

“There’s just uncertainty about what stance the government will take, whether there’s bank nationalization or not, or some form of it that we’re in currently,” said Peter Boockvar, equity strategist at Miller Tabak. “But it doesn’t matter, the economy remains weak, the market is worried about earnings,” he said.”