Fears of a Looming Commercial Real Estate Crisis

Are we headed for another 2007?

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In 2006 and 2007, the U.S. residential real estate market began the long decline that was one of the top factors contributing to the global economic recession from which the world has not yet reemerged. Now some financial journalists are wondering if the U.S. commercial real estate market could be headed for disaster. No one is suggesting that an implosion in the market could repeat the darkest days of the recession, which had many triggers such as over-leveraged mortgages and a tinderbox of credit default swaps, but commentators' concerns offer an important reminder of the major role real estate plays in the health of the economy.

Some banks have a special technique for dealing with business borrowers who can't repay loans coming due: Give them more time, hoping things improve and they can repay later. Banks call it a wise strategy. Skeptics call it "extend and pretend."

Banks are applying it, in particular, to commercial real-estate lending, where, during the boom, optimistic borrowers got in over their heads to the tune of tens of billions of dollars. ... the practice is creating uncertainties about the health of both the commercial-property market and some banks. The concern is that rampant modification of souring loans masks the true scope of the commercial property market weakness, as well as the damage ultimately in store for bank balance sheets.
  • How This Could Cause Disaster The Business Insider's Henry Blodget sounds the alarm bell. "When banks 'extend and pretend' just to avoid write-offs and protect their capital, they're just delaying the inevitable. ... The value of commercial real estate has fallen 42% from the peak, and it hasn't recovered much," he writes. Banks are betting big money that real estate values will return to their peak value. But if they don't? "If this is a 'new normal' where we just don't need as much commercial real-estate as we did when we were fueling spending by borrowing more and more every month" then the entire market could collapse, possibly taking some banks with them.
  • Regulators Sleeping on 'Time Bombs' EconoBlogger Yves Smith laments that "regulators unwittingly enabled this practice." Smith writes, "Banking experts like Chris Whalen and Josh Rosner have been talking for some time about the time bombs sitting on the books of medium sized and smaller banks (well big banks too, but [commercial real estate] is is usually a bigger % of equity at smaller banks). ... projects that go bad often deliver loss severities in excess of 100%. Not only does the lender lose his principal, but he usually has to pay to demolish the project in order to sell the land."

  • High Vacancy Rate Saps Recovery The Atlantic's Daniel Indiviglio points out, "Why is commercial real estate struggling to recover? Because so much of it is vacant, of course. In fact, a new report by Reis Inc. says that office vacancies have hit a 17-year high. Rents are also falling."
  • Why We're OK...For Now Bloomberg's David Levitt explains, "Record-low interest rates make it easier for owners to hold a distressed property, said Tom August, president and chief executive officer of Equity Office Properties, a unit of Blackstone Group LP. Equity Office owns more than 60 million square feet (5.6 million meters) of so-called Class A office properties in cities including Boston, New York and Los Angeles."
This article is from the archive of our partner The Wire.