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Commercial Real Estate: How Bad Is It?
Created 08/10/2009 - 21:20

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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. (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, .  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?

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