More Real Estate Distress Looms

While the residential real estate market continues to languish and there is little activity outside of lower priced first time buyer homes, a new disaster is in the offing: the collapse of the commercial real estate market. This next round of economic pain arises from a combination of overbuilding in some areas and the failure of banks to make loans even to credit worthy borrowers. As I have been arguing for over two years, unless and until real estate recovers, there will be no overall recovery of the economy. And a key to a recover is that the banks who have been bailed out, dolled out bonuses for themselves, and ceased lending start making loans again. Businesses cannot expand or take on new facilities when they are forced to operate solely out of cash flow and cannot secure financing for capital improvements - something I've had to do for years now. Otherwise, the downward spiral of values and foreclosures will continue. The Washington Post has a story that looks at this coming disaster. Here are some highlights:

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A mortgage crisis like the one that has devastated homeowners is enveloping the nation's office and retail buildings, and few places are likely to be hit as hard as Washington. The foreclosure wave is likely to swamp many smaller community banks across the country, and many well-known properties, including Washington's Mayflower Hotel and the Boulevard at the Capital Centre in Largo, are at risk, industry analysts say.
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The new round of financial pain, which some had anticipated but hoped to avoid, now seems all but certain. "There's been an enormous bubble in commercial real estate, and it has to come down," said Elizabeth Warren, chairman of the Congressional Oversight Panel, the watchdog created by Congress to monitor the financial bailout. "There will be significant bankruptcies among developers and significant failures among community banks."
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Unlike the largest banks, such as Citigroup and Wachovia, that got into so much trouble early on, the community banks in general fared better in the residential mortgage crisis. But their turn is coming: Not only did community banks issue a higher proportion of commercial loans, but they also have held on to them rather than sell them to other investors.

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Nearly 3,000 community banks -- 40 percent of the banking system -- have a high proportion of commercial real estate loans relative to their capital, said Warren, whose committee issued a report on commercial real estate last week. "Every dollar they lose in commercial real estate is a dollar they can't use for small businesses," she said.
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The threat is especially acute in the District, the firm said, where the catalogue of troubled commercial real estate properties has grown tenfold since April. Moreover, the region has $7.3 billion in commercial properties that are underwater -- worth less than the mortgages on them -- according to CoStar.
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Nationwide, at least $1.4 trillion in commercial real estate debt is expected to roll over during the next three years. Warren said that half of commercial real estate mortgages will be underwater by the beginning of 2011. A fifth of residential mortgages are underwater now, she said.
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Things do not bode well and meanwhile we have a Congress that cannot get anything done. The GOP obstructs everything and the Democrats lack the spine to act. It's not a cheerful picture.

Commercial Real Estate Teetering on the Edge?

So far there has been a great deal of news coverage of the residential real estate meltdown that began the current severe recession. However, little focus to date has been on the commercial real estate sector which is likewise teetering on the edge of a meltdown due to the huge drop in business expansion plus businesses suffering major reductions in cash flow and overall business revenues. Around the Hampton Roads area for instance, much office and retail space remains empty after months and months on the market just as quantities of new space are about to become available as construction of projects begun before the economic collapse near completion. It could become a very nasty situation if the economy continues to languish or get worse with banks being only some of the parties about to suffer major problems. Here are some highlights from MSNBC:

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Even as banks grapple with rising foreclosures, many lenders have something else to worry about: A rising tide of potential losses from commercial real estate loans that could reach into the billions. Delinquency rates and defaults on office and retail buildings and hotels have more than doubled in just six months. For apartments and industrial buildings, the rates have increased more than 80 percent, according to Reis Inc.

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While homeowners are defaulting at almost four times the rate of commercial landlords, the sudden spike in late payments has many industry insiders worried about the collateral threat to the economy and financial system. Nearly $73 billion worth of commercial real estate loans are in some level of financial distress, according to Real Capital Analytics.

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"Because of the severity of the economic downturn, now the pressure ... for commercial real estate, is much higher," said Hessam Nadji, managing director at Marcus & Millichap Real Estate Investment Services. The economy has forced many businesses to downsize and others like Linens 'N Things and Circuit City to go out of business. That's left behind empty storefronts, office buildings and warehouse space.

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Landlords are finding it hard to attract new tenants. Increasingly, they are slashing rents or offering incentives like money for tenant renovation. Tenants, likewise, have also become more aggressive about demanding concessions from landlords. Starbucks, for example, recently pressed its landlords to renegotiate the rents for leases at company operated stores.

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Overall, some $270.5 billion commercial property loans are expected to come due this year alone, said McLaughlin, a financial analyst for Reis. And it's likely many borrowers won't be able to refinance.

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[S]ales of foreclosures and other distressed properties can create a downward spiral for similar properties in the neighborhood. Vacant commercial buildings, like vacant homes, also invite vandals and vagrants.

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And through all of this, my former wife - and judges who have never been in private practice - can't understand why my income is down significantly.

Worried Banks Sharply Reduce Business Loans

I have seen this cycle of reduced commercial lending in the past when even sound companies are turned away by banks if not unceremoniously thrown out the door so to speak. What scares me so much this time is that it is coinciding with a semi-virtual shut down of residential lending. Typically, commercial lending or residential lending have tended to cycle in the opposite direction so that when one segment is weak, the other is at least somewhat sound and helps cushion the economic downside. Now, both sectors seem headed sharply downward at the same time. This is NOT a good economic sign. Does McCain even know it's happening and what it might foretell? I doubt it. Married to an heiress and raised as a privileged son of a famous admiral, McCain has never lived in the real world where most of us find ourselves. Here are some highlights from the New York Times:

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Banks struggling to recover from multibillion-dollar losses on real estate are curtailing loans to American businesses, depriving even healthy companies of money for expansion and hiring. The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt.

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“The second half of the year is shot,” said Michael T. Darda, chief economist at the trading firm MKM Partners in Greenwich, Conn., who was until recently optimistic that the economy would continue expanding. “Access to capital and credit is essential to growth. If that access is restrained or blocked, the economic system takes a hit.” Companies that rely on credit are now delaying and canceling expansion plans as they struggle to secure finance.

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Earlier this year, credit extended by banks to companies and consumers was still growing at double-digit rates compared with three months earlier, according to an analysis of Federal Reserve data by Goldman Sachs. By mid-June, bank credit was declining at an annualized pace of more than 6 percent. That is a drop of nearly $150 billion, an amount much larger than the value of the tax rebates the government has sent to households this year in an effort to spur economic activity.

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But if the newfound caution of American banks is prudent in the long run, the immediate impact is amplifying the troubles with the economy. The Federal Reserve has been lowering interest rates aggressively to make money flow more loosely and to spur economic activity. The financial system is not going along: As banks hold on to their dollars, mortgage rates are climbing. So are borrowing costs for corporations.

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But recent signs suggest that tight lending is spilling from housing into other areas of the business world. Companies with solid credit and profitable businesses can generally still get loans, but rates are higher and wait times are longer. According to a survey of senior loan officers conducted by the Federal Reserve in April, 55 percent of American banks tightened lending requirements for commercial and industrial loans to large and midsize companies — up from about 30 percent in the previous survey, in January. About 70 percent of the respondents said they have made such loans more expensive.

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“It’s the small business guy who creates most of the jobs,” said Mr. Kiefer, the First Capital chief executive. “If they can’t borrow to employ people, then we’ve got a mess on our hands.”