The Ugly Commercial Real Estate Picture

The commercial real estate market is a mess. I've mentioned this in the past, but a Bloomberg piece today presents some analysis worth highlighting. It includes a fascinating chart, but mostly focuses on a report by Randall Zisler, chief executive officer of Zisler Capital Partners LLC. He says, "A crisis of unprecedented proportions is approaching." If his analysis is correct, then it could happen.

First, here's that chart, compiled with data from National Council on Real Estate Investment Fiduciaries. It shows quarterly returns on commercial property:

The good news is that for 2009 the trend has been positive. The bad news is that returns are still negative, and are likely to stay that way through most or all of 2010, if the current trajectory remains unchanged.

And here's what Zisler has to say:

Property prices have fallen by 30 percent to 50 percent from their peaks, Zisler estimated yesterday in a report. The plunge has wiped out the equity in most real-estate deals that relied on debt financing since 2005, he wrote.

Zisler, whose firm focuses on real-estate investment, estimated that building owners will default on $500 billion to $750 billion of mortgage debt. This equals as much as 54 percent of the $1.4 trillion in loans that will come due in four years, by his count.

"Much of the debt is likely worth about 50 percent of par, or less," the report said. Many banks will end up insolvent as they reduce the value of their holdings, he wrote, adding that regional and community lenders are especially vulnerable.

Credit Crisis II? If Zisler's right, I'm not sure how some banks will be able to sustain these losses with still fragile capital cushions. He's talking about at least $250 billion to $375 billion in losses, potentially. Some of that is held by investors as commercial mortgage-backed securities (CMBS), but banks still have plenty of exposure through their mortgage and CMBS portfolios.