A Mountain Of Commercial Real Estate Debt Is Coming Due

$566 billion in commercial real-estate debt comes due in 2010 and 2011 and already 20% of construction loans are past due. A flood of commercial property defaults could significantly devalue commercial property and put banks in serious trouble. See the following discusses from Moses Kim from Expected Returns.

A lot has been made about the plight of commercial real estate. With prices off over 30% from peak levels, there's not much to be optimistic about: commercial property sales are plummeting, and vacancies are rising along with unemployment. This does not bode well for future bank earnings. From the WSJ, Unfinished Real Estate Projects Weigh on Banks:

For its neighbors in the city's wealthiest area, the Streets of Buckhead is an unfinished eyesore, not the glitzy shopping district promised at the height of the real-estate boom.

For Bank of America Corp., the project's biggest lender, it is a microcosm of commercial-real-estate problems faced by banks nationwide as builders default on loans and valuations tumble.

The project's developer is in talks to raise $200 million to complete the stalled project. As part of the deal, Bank of America is negotiating to potentially swallow a loss on the $160 million loan it made to the developer before construction began, people familiar with the matter said.

The bank is not alone. Lenders across the country are being forced to make unpalatable choices, including putting up more cash, extending loans or agreeing to lower their rights to collect on the debts, as they try to keep projects afloat.

Extend and pretend at its finest. Although certain types of commercial real estate have been firming up, properties under construction are very vulnerable to sustained weakness in the economy. There will come a point when banks will have to face reality and take losses, but of course, not before taking one last dip into the bonus cookie jar.

Non-Performing Loans Rising

Today, Streets of Buckhead is one of many high-profile developments in the country halted by the economic downturn and financing drought. Real-estate developments are among the biggest headaches for banks because they are huge capital drains and, in most instances, demand for space and rents in their markets are falling below projections. As of the fourth quarter, about 20% of $440 billion of construction loans outstanding were more than 30 days past due, according to Foresight Analytics, compared to 11.4 % a year ago.

Delinquencies are still rising for commercial real estate properties. Note that tremendous weakness in commercial real estate is occurring against a backdrop of massive governmental support (TARP). This does not augur a quick recovery in commercial real estate valuations.

Praying for a Recovery

Banks will have their hands full in the coming months. About $566 billion in commercial real-estate debt, the majority of which was provided by banks, comes due in 2010 and 2011, according to Oakland, Calif., research firm Foresight Analytics LLC. The struggling commercial real-estate loan market is increasingly cited by bank regulators as a growing concern. The Federal Reserve's Jan. 13 "beige book" survey of regional economies said commercial property markets remained weak.

The report highlighted loan restructurings, noting, "There is still some concern over how commercial-real-estate loans will be worked out as they come due, given the decline in collateral value."

If the commercial real estate market remains at depressed levels, there will be a cascade of defaults, since loans are collateralized by the value of the property. Rising defaults will further pressure commercial real estate valuations.

Either commercial real estate prices start rising soon, which is heavily dependent on the employment picture, or we are primed for the next leg down in commercial real estate. It will be interesting to see how long banks can hold out before capitulating.

This post has been republished from Moses Kim's blog, Expected Returns.

Leaked Document Shows Fed Preparing For Next Mortgage Crisis

The rising defaults on commercial loans could lead to another banking crisis, although the Fed doesn't seem to be ready to admit the problem. The significant risk is held by financial companies with large commercial loan portfolios and insufficient reserves. In the following post, Glenn Hall from The Street writes that the Fed should be dealing more openly with the threat.

Here we go again with all the regulatory silence and wishful thinking by banks that preceded the first mortgage meltdown. Meltdown part II could be in the making as defaults rise in the commercial real estate sector.

Behind closed doors, U.S. banking regulators appear to be "girding for a rerun" of the mortgage losses that nearly crippled the financial markets last year, according to a report in the Wall Street Journal citing an unpublished Federal Reserve report.

The Fed report concludes that U.S. banks are slow to take losses on their commercial real estate loans , the Journal reports, adding that the documents it obtained do not represent the Fed's formal position. The point is ratified by a review of regulatory filings by the Journal, which found that banks with heavy exposure to commercial property loans set aside only 38 cents in reserves for every $1 in bad loans in the second quarter.

I don't know what's worse, the banks skimping on reserves and holding off on reporting losses in hope of a revival or the Fed for knowing about the problem and trying to keep it a secret. Someone at the Fed must feel the same way because the report somehow found its way to the media.

To illustrate the risk, Capmark Financial is singled out by the Journal as having only 11 cents in reserves for every $1 in bad loans in the second quarter. Capmark, you may recall, was previously part of General Motors' GMAC lending arm before being taken over by an investor group that includes Kohlberg Kravis Roberts and Goldman Sachs (GS Quote).

Last month, Capmark acknowledged that it is teetering on bankruptcy and accepted a rescue deal from a group led by Warren Buffett. Capmark is a pretty good a barometer of the commercial property mortgage industry since it is among the top servicers of U.S. commercial real estate loans and the biggest for property in the rest of the world, according to the Mortgage Bankers Association.

The top servicer of commercial mortgages in the U.S. is Wells Fargo (WFC Quote), which was already in the top 5 before buying Wachovia, which is the biggest master and primary servicer of commercial bank and savings institution loans, according to the MBA. Wachovia also ranks at the top for warehouse facility mortgages.

GEMSA is the top credit company, pension funds, REITs, and investment funds servicer, PNC (PNC Quote) is the leading FHA and Ginnie Mae servicer and Capmark is first for other investor type loans, according to the MBA..

If you're concerned about international exposure to commercial property loans, the leaders are Hatfield Philips, Deutsche Bank (DB Quote) and GEMSA, according to the MBA.

And those are just the servicers. Banks and thrifts hold roughly half of outstanding commercial property loans, representing $1.6 trillion of debt, according to Commercial Property Executive, which concluded that the highest default risk is for loans originated in 2006-2007 boom , when "commercial properties were valued far too highly in those days, and are now underwater."

In case you're wondering whether the commercial real estate sector is really at risk, consider that defaults on loans to the sector rose to 2.88% in the third quarter from 2.25% in the second quarter, which was already the highest level since 1994, according to an analysis of FDIC data by Real Estate Econometrics.

Real Estate Econometrics projects that the default rate will swell to 4.2% by the end of this year and peak in 2011 and the group warns that the largest losses will occur at regional and community banks.

All things considered, it seems like something the Fed should be talking about more openly and that banks should be addressing more quickly.

Nobody wants a rerun of the mortgage meltdown.

This post has been republished from The Street.

The Impending Commercial Real Estate Crisis

Commercial real estate may be a ticking time bomb that could create a whole new set of problems for the struggling economy. The commercial real estate market, which is half the size of the residential real estate market, is nearing a breaking point as more tenants leave and refinancing becomes impossible for more landlords. See the following post from Tom Dyson from Daily Wealth for more on this.

This weekend, I had pizza and beer with an executive at a commercial real estate company...

My friend's company is one of the largest office landlords in America, with big investments up and down the East Coast. My friend manages the debt-finance division.

"So is there a commercial real estate crisis coming?" I asked.

"Yes. Absolutely," he said. "It's definitely coming."

"How do you know?"

"Nobody can refinance their loans. You have to be able to roll your debt. But if the property isn't worth as much as the debt, you can't roll it over. And there's a lot of debt coming due soon. We were fine... But we've slowly lost tenants. Now we've got a couple of buildings where rent doesn't cover the mortgage. We're giving these buildings up soon..."

He said his company is sending the keys back to the bank.

"It'll damage our reputation," he said. "We've never given up property before. But we don't have a choice."

Over the last decade, commercial real estate boomed. All over the country, players took on trillions of dollars in debt to buy malls, warehouses, office towers, and industrial parks, believing prices and rents would rise forever.

The recession caused consumers to stop shopping and retailers to stop hiring. Occupancy levels and rents started falling. Commercial real estate prices should have collapsed...

Here's the thing: So far, the commercial real estate market has held up better than the residential market. According to my friend, this is for two reasons. First, commercial real estate is mostly leased to tenants. In the residential market, you walk away as soon as you get underwater. But in the commercial market, you don't mail the keys back to the bank until your tenant leaves. Because occupancy erodes slowly, there's a delay in defaults.

Secondly, the new mark-to-market accounting rules kept the game going. These rules free banks from reporting loan losses until their loans mature. And they free commercial real estate owners from reporting investment losses until they sell the property. In other words, they give banks a huge incentive to extend bad loans and companies a huge incentive to keep holding properties.

Investors and banks hoped if they could hold on for long enough, the turnaround in the economy would rescue them. But it hasn't happened. Now, according to my friend, the reckoning is here for commercial real estate.

One way to play the coming crisis is to short the stock prices of commercial property REITs, like Boston Properties, Simon Properties, Prologis, and Vornado. These companies hold billions of dollars in investment property that needs marking down, and their stock prices have soared in the last six months.

Shorting regional banks is another way. Many regional banks have huge exposure to commercial property.

Finally, you could just short the stock market. When the residential real estate market collapsed, it brought America's financial system to its knees. The commercial real estate market is half the size of the residential market. Its collapse may not cause another credit crunch, but it'll definitely knock a few points off the S&P...

One word of warning: Standing in front of a freight train is never a good idea. These investment ideas are all rising in a powerful uptrend right now. I’d wait for a 10% decline in the S&P before you start placing these short trades.

This post has been republished from Steve Sjuggerud's blog, Daily Wealth.

Prime 40-Story Commercial Building In New York City Sells For $100,000

Imagine buying a commercial property for $500 million and later having to walk away with virtually nothing. That is what happened to Harry Maclowe who defaulted on a loan on a prime commercial skyscraper in the heart of New York City. Values of commercial real estate are plummeting and buildings are being sold at unbelievable discounts (the John Hancock Tower in Boston was recently sold for just over $20 million). For more on this story see the following article by HousingWire.

As we all know by know, times are tough. Signs of it are found everywhere we look - from flagging real estate prices to job losses and everything else in between. However, when a 40 story skyscraper in the middle of New York sells for a measly $100,000 we can’t help but wonder what in the world is going on.

The tower is positioned right on a prime corner of real estate, close to the Museum of Modern Art and close to the Rockefeller Center and Central Park.

The building or tower mentioned here is the 1330 Avenue of the Americas building. The tower sold for nearly $500 million three years ago. When owner Harry Maclowe defaulted on his $130 million loan last year the tower was auctioned off last month for the ridiculously low price of $100,000 to a Canadian pension fund.

Distressed properties are an investors dream come true since they are to be had for bargains. In these economic down-times we see billions of dollars worth of distressed real estate auctioned off for next to nothing. Many developers are left in the leach as they fall behind in their mortgage payments and their tenants leave. With banks and lending institutions being very cautious in granting loans these days, people find it hard to finance their shortcomings.

However, despite the great price buyers are getting for these distressed properties there is usually a condition attached to them. Buyers will have to take on the existing debt connected to theses properties.

Dan Fasulo, a managing director at Real Capital Analytics said: “Just imagine in a residential market, if there weren’t 80 percent loans available for everyone. If everyone had to buy their houses in cash, the values of houses would plummet everywhere. That’s happening on a massive scale on the commercial side.”

Analysts expect many more of these auctions as more foreclosures will hit the shores in the U.S. This will dramatically reduce the worth of prime real estate all around and some even speculate it will level many office tower markets. Talk is that many of these properties in danger of foreclosure have actually been marketed at over-inflated prices and now that the market has crashed they will “feel” the full brunt of it first hand.

Real Capital Analytics, which tracks commercial real estate transactions, counted over $86 billion worth of distressed properties in the country as of April, over $6 billion in Manhattan.

Source: Boston Times

This post can also be viewed on overseaspropertymall.com.