Commercial RE Next to Fall?

NATIONAL NEWS - Two years after fissures in the residential housing market gave way to a national collapse of home prices and sales, experts warn the next shoe to drop is the commercial real estate market, bringing more woes to the battered economy.

Thousands of commercial mortgages valued at hundreds of billions of dollars are approaching a renewal date. By some estimates, two out of every three will no longer meet the original loan conditions and won't be able to refinance. With prices for commercial properties expected to plunge, a vicious cycle might unfold as it has in the housing market.

"It's the next wave to hit. It's the next round of bad news," said Scott Talbott, the senior vice president of government affairs for the Financial Services Roundtable, a trade group for big banks and other financial institutions who are collectively concerned about the coming problems.

A commercial mortgage meltdown is likely to prolong the nation's economic recovery. The falling prices in commercial real estate will lead to additional bank losses at a time when banks are sapped by home mortgage defaults and soaring credit card defaults. This could lead to additional taxpayer assistance for the banks.

The reality is already on display. On April 16, the nation's second-largest mall developer, General Growth Properties, filed for bankruptcy protection. The Chicago-based company owns more than 200 malls across the U.S., including Carolina Place Mall in Pineville and Valley Hills Mall in Hickory, and was unable to renegotiate its debts as they came due.

Six days later, a 40-story office tower on New York's Avenue of the Americas was seized by its creditor, a Canadian-owned pension fund. The tower's owner, Macklowe Properties, couldn't meet loan terms.

"On the street, the rumor is it is coming and it's going to come fast and furious. Some people are predicting September," said Paul Waters, a New York-based executive vice president of brokerage operations in North America for NAI Global, a top-five commercial real estate brokerage with operations across the globe.

In Mecklenburg County, commercial building permits issued by the county plummeted 63 percent in the first quarter of 2009 from a year earlier. For developers, brokers and investors, the statistics paint a dismal picture of a market stymied by dwindling demand for office and retail space and a dearth of financing.

Just like the housing meltdown, the commercial real estate crunch is likely to begin as a slow bleed that gains momentum. It's likely to be spread evenly across the nation, in large part because of an outgoing economic tide that has spared few companies anywhere.

"There's going to be a lot of trouble on Main Street with some of these commercial and industrial buildings. The biggest impact will be on some of the smaller owners," Waters said.

How bad it gets will depend on the speed of economic recovery. Office space and multifamily apartments, two huge components of commercial real estate, are highly dependent on employment. Even if the economy begins growing again late this year as forecast, the number of unemployed people is expected to keep rising well into next year.

"The translation is that office vacancy rates would continue to rise until mid- to late 2010," said Christopher Cornell, an economist specializing in commercial real estate for Moody's Economy.com, adding that "it's a drag on the recovery" well into next year.

The last crisis in commercial real estate – which includes office space, malls, industrial parks and multifamily apartments – came in the early 1990s. The problem then was an oversupply of new properties. Today, the driver is a deep economic downturn, with the economy contracting by more than 6 percent in each of the last two quarters.

As in the housing meltdown, weakened lending standards are a big part of the story for commercial real estate. And as in housing, many commercial properties have mortgages that were bundled together in pools, sliced and diced, and instead of being held by banks were sold to investors as bonds and securities.

Unlike housing, however, the ill effects from weakened commercial lending standards have been camouflaged to date because they've had a longer horizon than housing did over which to implode.

"If you take a look between 2005 and 2007, the underwriting standards on both the consumer side and the commercial side were spinning out of control," said Kevin Blakely, the president of the Risk Management Association, a Philadelphia-based trade group for financial risk managers. "I think it is a bigger issue than we like to admit."