Commercial Real Estate: 'Ticking Time Bomb'

Commercial Real Estate
Commercial Real Estate

I don’t know why all the wires are leading with the quote from Rep. Carolyn Maloney, D-NY today, that “The commercial real estate time bomb is ticking.”

I’d venture to say it’s exploding all over the place.

She made the comment at a hearing she chaired of Congress’ Joint Economic Committee.

The first witness to speak was Jon Greenlee, Associate Director, Division of Banking Supervision and Regulation, Board of Governors of the Federal Reserve System (phew). His lackluster delivery almost managed to cover the nasty stats inside his written testimony, as he made such statements as, “As economic conditions have deteriorated we have devoted more resources to assessing the quality of commercial real estate portfolios at institutions with large concentrations, and we have also enhanced our training efforts.”

More important was his final mention that, “We are mindful of the potential of bankers to overshoot in their attempts to tighten lending standards and want them to understand that it is in their own interest to continue making loans to credit-worthy borrowers.”

Commercial lending is basically non-functional right now. Tighter underwriting standards are making it difficult for even well-performing loans to refinance, and falling commercial prices are only adding to the issue. Commercial real estate financing is largely closed for loans in excess of $30-50 million, according to the experts. The expectation is that in the coming years, the amount of capital from traditional sources, like banks, pension funds and insurance companies for commercial real estate will dry up.

So, Mr. Greenlee, tell us all something we don’t know.

Commercial Real Estate
Photo by: Luca Masters
Commercial Real Estate

Like perhaps that “it’s hard to imagine fundamentals improving in an environment where we already see massive increases in defaults occurring now.”

That’s Richard Parkus of Deutsche Bank, on the same panel of witnesses.

“Commercial real estate is kind of between a rock and a hard place. The rock is the very, very real quick pickup in current defaults, where buildings that are under severe cash flow constraints cannot meet their current mortgage payments. This is happening right now at an alarming rate. Then you look down the road somewhere between 3-7 years and you find at the maturity of these assets potentially even greater problems with the assets failing to qualify for refinance,” Parkus told Sen. Sam Brownback, R-KS, who had asked him when commercial real estate would recover.

The answer: Beyond 2012.

Parkus noted commercial property price drops of 35-45 percent across all markets, with greater pain in areas like New York City office space (50 percent!).

Commercial Real Estate
Photo by: Nathan Guy
Commercial Real Estate

He also focused on a much overlooked fact, that CMBS has roughly a 25-30 percent market share, while banks have about 50 percent, with life insurance and pension funds making up the rest.

“The view that commercial real estate loans in bank portfolios are likely to under-perform those in CMBS is supported by the fact that delinquency rates for bank loans have for many years exceeded those for CMBS loans. As of the end of the first quarter of 2009, delinquency rates on core CRE loans at banks was approximately 2.5 times that for fixed rate CMBS loans.”

So yes, banks, once again, will be the epicenter of the commercial crash, which, by the way, isn’t “the next shoe to drop.”

It’s the shoe that’s currently stomping all over these precious “green shoots” that so many in our government seem to think signal then end to the nation’s economic woes and the beginning of the fine-and-dandy-phase of recovery.

Questions? Comments?