Commercial Property Crash May Threaten Economic Recovery

With commercial property prices falling the most in 25 years in the second quarter, fears are rising that a commercial property crash will cause significant damage to the …

With commercial property prices falling the most in 25 years in the second quarter, fears are rising that a commercial property crash will cause significant damage to the recovering economy. Falling prices can put pressure on commercial mortgage-backed securities, which can lead to massive losses at large financial institutions. To learn more, see the following article from Money Morning

Having last month addressed concerns about inflation by outlining a stimulus “exit strategy,” U.S. Federal Reserve Chairman Ben S. Bernanke may turn his attention to the growing threat posed by commercial real estate at the Federal Open Market Committee’s (FOMC) two-day meeting taking place tomorrow (Tuesday) and Wednesday.

As Money Morning warned in an investigative report that ran in early April, the stumbling U.S. commercial real estate sector was developing into a financial black hole that was threatening to blot out the resurgence of the U.S. economy. Commercial real estate prices have been in sharp decline for the past two years, making it tough for owners to refinance and pressuring companies to sell buildings at steep discounts.

The plummeting prices not only jeopardize a possible recovery, but they put pricing pressure on commercial mortgage-backed securities (CMBS) that are held by institutional investors.

Commercial property is “certainly going to be a significant drag” on growth, Dean Maki, a former Fed researcher who is now chief U.S. economist at Barclays Capital Inc. (NYSE ADR: BCS), told Bloomberg. “The bigger risk from it would be if it causes unexpected losses to financial firms that lead to another financial crisis.”

Property values for commercial real estate such as hotels, apartments, shopping malls, and office buildings fell by more than 18% on a year-over-year basis during the second quarter, according to an index published by the Massachusetts Institute of Technology’s Center for Real Estate. That’s the biggest decline in the 25 years since the index was first published. It’s also the fifth consecutive quarterly drop and the seventh quarterly decline in the past eight quarters.

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The index is down 39% from its mid-2007 peak, surpassing even the 30% decline in housing prices.

That means companies that earlier in the decade borrowed heavily and expanded as property values soared have been left with buildings that are worth far less than their mortgages and aren’t generating enough cash from rental fees to pay off financing expenses.

Maguire Properties Inc. (NYSE: MPG), one of the largest office-building owners in Southern California – including in the downtown Los Angeles market, for instance – is making preparations to turn seven properties with about $1.06 million in debt over to creditors.

But even with those sales, Maguire still has $3.5 billion in debt and many analysts believe that exceeds the value of the properties in its portfolio.

“Almost everything in Maguire’s portfolio is underwater,” Michael Knott, an analyst with Green Street Advisors Inc., told The Wall Street Journal. “I don’t envy some of the choices that they are having to make.”

Maguire reported a second-quarter net loss of $380.5 million, more than triple the loss of $110 million reported a year earlier.

If the slump in commercial real estate continues to test these depths, the Federal Reserve may be forced to keep emergency-lending programs in place and leave its benchmark interest rate close to zero for longer than some investors expect.

The Fed expanded the Term Asset-Backed Securities Loan Facility (TALF) in June to cover as much as $100 billion in loans to support commercial mortgage-backed securities.

More than 40 members of Congress, led by Rep. Paul E. Kanjorski, D-PA, on July 31 sent a letter to Bernanke and U.S. Treasury Secretary Timothy Geithner, asking them to extend the program through 2010.

“The $6 trillion commercial real estate market has recently experienced a massive credit shortfall, which the TALF program has only just begun to help stabilize,” the petition read. ”While I would like to wind down the government’s emergency support for the private sector as quickly as possible, we need to provide more time for the TALF program to work in this industry, especially with $1 trillion in commercial real estate debt maturing in the near future.”

Fed Chairman Bernanke – in his testimony before the Senate Banking Committee on July 22 – assured lawmakers that he is ready to counter the threat posed by the ailing commercial real estate market, and said he would consider the policymakers’ petition for an extension of the Term Asset-Backed Securities Loan Facility.

“We will certainly be monitoring the situation, and if markets continue to need support, we will be extending the final date of that program,” Bernanke said. “We are somewhat concerned about that sector and are paying very close attention to it. We’re taking the steps that we can through the banking system and through the securitization markets to try to address it.”

This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.

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