Commercial real estate is bad… How bad is it? Some have suggested even if it is a problem, it is much smaller than the residential crisis. Some people have even questioned if it even impacts them. Many are calling it a ticking time bomb. What is the status of commercial real estate?
Let me start by saying that I am not an expert on commercial real estate. The things that I do know I have learned by reading and listening. Let’s start with some facts. Currently, 26 percent of all loans in FDIC insured bank portfolios are backed by the commercial real estate market. Residential and other nonresidential real estate loans make up about 40 percent. So the commercial real estate sector is a bit smaller, but not by a lot. It still comprises over $3 trillion in outstanding loans. Obviously this entire $3 trillion is not at risk, but how much is?
Unlike many home mortgages, commercial real estate mortgages are not fixed for a long term. Often they have a 5 or 7 year balloon payment due from the date of origination. As consumer spending continues to decrease (and remember consumer spending is approximately 70% of our economy), as more buying is done online, and as businesses have shed millions of workers much less retail and office space is required. This overcapacity problem is severe. The Wall Street Journal had an article today that Maguire Properties (a public Real Estate Investment Trust) is planning to hand over control of seven buildings with about $1.06 billion in debt to creditors. This is clearly a signal that rising vacancies and falling rents are causing problems for commercial real estate. Imagine being one of the lenders and getting these seven buildings dumped in your lap. Based on the article, all of these buildings are underwater. This means that the debt on the properties is more than the actual value.
This may be a worse case scenario and the buildings are located in California where the real estate crisis is much worse. But how many properties in other parts of the country are underwater? How many office buildings and malls are already highly leveraged and if they lose another key tenant will now need to be going back to the bank to refinance that pending balloon payment in a much weaker position? As you can suspect, many banks will not want or be able to refinance these mortgages.
To date, 71 banks have been taken over by the government this year. In 2008, that total was only 25. The total cost to the FDIC for these failures is approximately $16.5 billion. As this commercial real estate crisis unfolds, I look for many more banks to fail. What does all that mean? Well for starters, it could deplete the FDIC insurance fund. If that happens, they simply go back to the government and tap into a line of credit. But would that not have a physiological impact in the marketplace? Then the government would have to take more debt to the auction to bail out more banks. I hope this does not happen as it will not be seen as a positive.
I would like to hear your thoughts on this subject. What are you seeing in your communities? Have you reviewed the financial statement of your bank? What is their exposure to highly leveraged commercial real estate?
Awesome post. It seems that every cost cutting measure that businesses or individuals take inherently hurts another market. For example, as you mentioned, many companies have cut excess office space in an attempt to improve their bottom line. This may be a great measure for their people, but it hurts the commercial real estate market. Similarly, families have cut back drastically on spending and obviously that has hurt the retail market.
My humble opinion is that our economy pre-2008 was so inflated that it required businesses and people to over-spend just to sustain itself. Maybe the conservative spending by our businesses and families is shrinking the economy back to a more healthy and sustainable size?
Posted by: Dan Matarrese | August 11, 2009 at 08:23 AM
Scott,
I love how you don't pretend to be an expert on every issue. You do realize that makes you incredibly special, right? (as if you need another reason!)
That being said, did you catch my Going Concern article on the FDIC having to seize itself? http://goingconcern.com/2009/08/editors-note-adrienne-gonzalez-1.php the numbers speak for themselves.
Not having inspected the banks' books in question, I can only report what I see. CRE in San Francisco is dismal. Last I heard the city is at a 60% occupancy rate (comm/res) though that number could be entirely made up, who knows? All I know is the strip of the city I see M - F on my commute from the Inner Richmond to Fisherman's Wharf and it does not look good.
Of course, San Francisco is still over-inflated from dot com and we never came back down.
The spool is wound too tight, CRE is just one component and sadly one that has yet to break.
The fact that the Fed saw the pending issue and jumped in *before* it blew up shows that they realize just how serious an issue this promises to be. At least that's how I interpreted their move, and you know by now that I am fluent in Fed :)
CRE is going to hurt.
But at the end, we will be sufficiently deleveraged and can move on with all of our lives... until the next bubble at least!
Posted by: Adrienne | August 11, 2009 at 03:46 PM