The other big shoe to drop? "Commercial real estate loan defaults skyrocket"

[kstar]

Hang on, tightly.

My emphasis added in bold.

Commercial real estate loan defaults skyrocket

The Associated Press
Thursday, March 26, 2009

WASHINGTON: With loan defaults rising, analysts say the struggling commercial real estate industry is poised to fall into the worst crisis since the last great property bust of the early 1990s.

Delinquency rates on loans for hotels, offices, retail and industrial buildings have risen sharply in recent months and are likely to soar through the end of 2010 as companies lay off workers, downsize or shut their doors.

The commercial real estate market's fortunes are tied closely to those of the sinking economy, especially unemployment, which hit 8.1 percent in February.

"Until jobs start coming back and industry starts doing better we don't see performance increasing" among landlords, said Christopher Stanley, an associate with research firm Reis Inc.

While the commercial real estate industry's woes led to the recession of nearly 20 years ago, this time the industry is "the victim of the economic and financial crisis," said Hessam Nadji, managing director at Marcus & Millichap Real Estate Investment Services in Walnut Creek, California.

Vacancies at retailers, Nadji forecasts, will shoot up to 11 percent by year-end, matching the peak of the early 1990s. Office vacancies are likely to hit 18 percent by year-end, he said, short of the 1990s-era peak of more than 20 percent.

The commercial real estate market is "at the precipice," a report by Detusche Bank said earlier this month. So far this year, delinquency rates are up to 1.8 percent of loans in March, more than four times the year-ago level.

Faring worst were retailers, office building owners and apartment buildings. Hotels and industrial properties posted more moderate increases.

Deutsche Bank's Richard Parkus projects delinquency rates will keep soaring to more than 3.5 percent by year-end and as high as 6 percent by late 2010. He says the industry's woes will be "at least of a similar magnitude as those that the commercial real estate faced in the early 1990s."

Drops in property values of 45 percent from a peak in late 2007 are possible, Parkus said, exceeding those of the early 1990s, as demand for office, retail and other commercial space plummets amid a worsening economy.

Adding credence to those gloomy predictions, the government said Thursday that the U.S. economy shrank at a 6.3 percent annual pace at the end of 2008, the worst showing in a quarter-century.

Funding for commercial loans virtually shut down last year as the financial system unraveled.

There was $12.2 billion in commercial mortgage debt issued last year, the lowest figure since 1991 and down 95 percent from 2007, according to a report by Reis.

Making matters worse, about $216 billion in loans are coming due through 2012.

That is putting landlords in a squeeze.

About $11 billion of distressed commercial property is currently up for sale, compared with a lackluster $2.7 billion worth of properties that were actually sold in February, according to Real Capital Analytics.

A growing imbalance between supply and demand is likely to push down prices in the coming months, analysts say.

Similar to the residential property market, foreclosures and defaults are surging, with nearly $19 billion in commercial real estate loans in default, foreclosure or bankruptcy so far this year, according to Jessica Ruderman, a senior analyst with Real Capital.

More than 20 metropolitan areas nationwide now have at least $1 billion in troubled commercial loans, she said, up from five at the end of last year. Landlords in Las Vegas, Manhattan and Los Angeles are struggling the most.

As the industry's troubles worsen, disputes are breaking out. The Dubai developer helping build the $8.6 billion CityCenter complex on the Las Vegas Strip said Monday it is suing struggling partner MGM Mirage over concerns about the project's viability.

One major shopping mall owner, Chicago-based General Growth Properties Inc. has been struggling to avoid bankruptcy for months. It faces a Friday afternoon deadline to get permission from lenders to avoid penalties for late debt payments.

http://www.iht.com/articles/ap/2009/03/26/business/NA-US-Commercial-Real-Estate-Defaults.php

[cl8ton]

Hay just bring it on

The over building of commercial in my neck of the woods is mind boggling!
Makes you wonder, WTH are you doing building all this OS that nobody in the near future will ever rent?

Dunno maybe they know sumthun I do not

[kstar]

Originally Posted by cl8ton

Hay just bring it on

. . . snip . . .

Want some more?

"Is California Going Bust?" from Forbes

I've read both the commercial property and California headlines a few times in my life.

Take care,

[cl8ton]

Kurt, I have a friend in a family construction biz…

His words are, the office space will be needed eventually and now is the best time to build it
out with the low labor/material costs in today’s economic crisis.

If I look inside any of his buildings, it’s all dirt floor just waiting for a tenant to fill it out!

[kstar]

Originally Posted by cl8ton

Kurt, I have a friend in a family construction biz…

His words are, the office space will be needed eventually and now is the best time to build it
out with the low labor/material costs in today’s economic crisis.

If I look inside any of his buildings, it’s all dirt floor just waiting for a tenant to fill it out!

I wonder if the low labor/material costs cover the carrying costs! Man, that scares me just thinking about it! LOL

[cl8ton]

Yea he claims it's a gamble, but stacked in his favor...
He does OK, not Bill Gates type of OK...but better than my type of OK

Originally Posted by kstar

I wonder if the low labor/material costs cover the carrying costs! Man, that scares me just thinking about it! LOL

[Porsche-O-Phile]

There was a heck of a lot of speculation in the commercial/retail market as well, driven indirectly by the speculation in residential (both due to "copycat" mentality and due to lots of retailers making "easy money" off of house flippers and other individuals with lots of "paper profits" being flush with cash). A lot of these retailers were luxury or pseudo-luxury types with mediocre business plans, largely just opportunists hawking goods with obscenely high markup rates, because during the good times, "rich" buyers were relatively easy to come by and were relatively indiscriminate in their shopping.

So basically I observed two things: (1) conventional retailers built like mad, creating a massive overcapacity in the retail sector and (2) "new" or unconventional/luxury retailers snapped up available "B" and "C" tier retail space, or created demand on shopping center developers to build new centers or expand...

The multiplier effect of this is bad - lots of new stores = lots of new jobs, which is a good thing for a while. But now that those stores are having to face the reality that they never should have been built in the first place and were the result of either lousy RE deals, lousy catchment area analysis or both they're realizing they can't keep their doors open. Obviously this means vacant stores (bad for SC developers and communities) and naturally job losses.

Retail as a sector is going to be D-E-A-D for a long time to come. In the words of an architect I worked for many years ago (who specialized in retail work & speculative shopping center developments): "...it's always the first to go and the last to come back..." This won't be any different. I sort of qualitatively think that retailers that have good business practices and models and sell a variety of products (not just overpriced "upscale" crap) will probably hang on if they can make it through this year. Generally speaking. But we're going to lose a TON of the high-mark-up "luxury" and "pseudo-luxury" retailers and it'll take a while for this to all shake out.

There are going to be LOTS of shopping center vacancies for a good long time. Get your business plans ready for when the turnaround starts in a year or two - it'll be a good time to consider opening a small shop then I think...

[turbo6bar]

Originally Posted by cl8ton

Kurt, I have a friend in a family construction biz…

His words are, the office space will be needed eventually and now is the best time to build it
out with the low labor/material costs in today’s economic crisis.

If I look inside any of his buildings, it’s all dirt floor just waiting for a tenant to fill it out!

Hehe, the classic,"Build it and they will eventually come" strategy. See page 38 of the automaker's playbook for more details.

The only way this works is if carrying costs and reduced build cost are offset by appreciation in property value. That's a very risky wager, particularly in a climate of declining/stagnant rents and cap rate expansion.

The guy has balls, I must admit.

[jyl]

I do not have exact numbers. But I think the commercial real estate debt market is much smaller than the residential real estate debt market.

Oh, here: http://money.cnn.com/2009/03/04/news/economy/lockhart.reut/

So, on a whole economy basis, a downturn in CRE should be much less damaging than a downturn in housing. True, every additional downturn still hurts.

Another difference - I think banks tended to keep CRE loans on their books rather than securitize them. If you look at what's happened to residential loans, values of the mortage-backed securities have been crushed w/ subprime and near-subprime written down to 30 cents, while the whole loans have been written down to only 80-90 cents. This is a very rough/ballpark average, for those banks who are actually doing mark-to-market.

So if CRE follows the path of residential RE whole loans to date, I think the damage to financial institution balance sheets should be quite limited compared to what we've seen with securitized residential mortgages. Obviously it will vary by institution - some of the smaller banks may be relatively more exposed to CRE.

I'm not an expert on debt markets so don't take above as gospel, just my opinion.

Edit: One thing I have not considered is the need to roll over maturing CRE debt - if this could precipitate a crisis.

BTW, think about the 30 cent valuation mentioned above. Averaged over all tranches of the debt, that implies 70% of the houses go to foreclosure and the loss on foreclosure is 100%, or 100% go into foreclosure and the loss is 70%, or something in between. All of those scenarios seem very unlikely to me. That 30 cent valuation seems oversold.

[daepp]

While I remain bullish on commercial r/e in the long run, I have often worried about the effect of irrational purchasing driven by the 1031 exchange. Folks are often willing to overpay/pay top dollar in order to avoid taxes - not always rational IMO. And then that property becomes a comp...

[ruf-porsche]

Can't be great with BIG BOX stores like Circuit City going bust, and Office Depot scaling back their stores.

[Zeke]

Originally Posted by ruf-porsche

Can't be great with BIG BOX stores like Circuit City going bust, and Office Depot scaling back their stores.

I have a feeling that Home Depot is not far behind. Sometimes the hit in the wallet doesn't hurt until much later. Of course, the damage is already done. We have few hardware stores like Ace and True Value left. And only 2-3 independents. This goes for old line lumberyards as well.

Office occupancy is pretty low right now in the OC where all the silk suits used to be.