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Commercial Real Estate Worsening

Written By Brian Hicks

Posted April 16, 2009

It was February 2009 when Options Trading Pit recommended going short commercial real estate. And we were briefly spot on, taking some quick gains on the likes of Simon Property Group (SPG) before getting some brief support.

Nowadays, though, the commercial real estate market is just beginning to mirror the 2007 residential real estate market. They have the same questionable lending practices that brought down residential. 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 February 2009 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.

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.

But today, things are worsening for the group, as General Growth Properties files for bankruptcy protection.

Even Jamie Dimon is bearish, saying the bank industry should brace itself for "rapidly rising" losses related to commercial real estate. "In general, the losses [in commercial real estate] are going up and I think if you talk about the whole system… you are going to see rapidly rising charge-offs in real estate loans."

Even Dallas Fed chief Richard Fisher believes that "problems in the financial industry and commercial real estate have the potential to intensify…"

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."

Rising vacancies, falling rents, and capital issues could push US commercial delinquency rate above 3.5% by year end, as as high as 6% in 2010, according to Deutsche Bank.