Commercial Real Estate REALLY Is the Next Big Crisis
On August 10, 2009 I posted an article asking readers if commercial real estate was the next big crisis. I spent a lot of time writing that article because there wasn’t a lot of reliable information on the commercial real estate situation available.
Interestingly, it turns out that we were ahead of most of the major media with this blog post. And, tooting my own horn, the video on my YouTube channel is the most-watched video, and the blog post has received the most comments of any blog post on the site.
Furthermore, I have it on pretty good authority from a source inside the Treasury (who will remain anonymous because they didn’t want to get into trouble. Makes us sound important, doesn’t it?) that the Treasury is more worried about commercial real estate than most people, even so-called real estate experts, realize. I suspect that there isn’t much information out there because the recession is supposedly over (or we’re all tired of hearing all the bad news!)
The Fed probably learned a lot from the residential mortgage crisis and it won’t be caught unawares this go round, which explains Plan C and the easing of the rules for restructuring commercial mortgage backed securities.
This week, the Wall Street Journal reported that the Fed has released new rules that make it easier for distressed property owners to restructure loans that were packaged by Wall Street firms and sold as securities. The WSJ says that most people in the industry were happy with the new rules, but others warned it would be problematic, especially for the servicers of the securities who will be under pressure from borrowers and competing classes of investors.
The IRS also helped this week by issuing new rules that will give servicers some wiggle room in negotiating with borrowers on performing loans that may not be due for some time. The new rule applies to all loan modifications that were made after Jan. 1, 2008.
Finally, for a more personal spin on the commercial real estate crisis, check out this story from Slate.com about a guy names Scott Lawlor and his company, Broadway Partners’ acquisition of Boston’s Hancock Tower and subsequent default on the loan in January 2009.
The article’s author says that Lawlor has become the whipping boy for the commercial real estate crisis, despite the fact that he was doing the same thing many other commercial real estate players were doing before the credit markets dried up.
I wonder how many more Scott Lawlors are out there.
It’s interesting to me that commercial real estate is a lagging indicator of economic problems in the country – it was still going strong when the problems with residential mortgage began. I don’t think anyone (except maybe Josh) thought that the recent economic problems were going to be as bad and last for as long as they did. Until jobs are created, commercial office space demand will remain low, creating a drag on the economy.
Clearly, we have a big problem on our hands. My bet is on another round of bailout money for the coming crisis in commercial real estate. The Treasury’s Plan C, a pre-emptive program, won’t be enough to stop a big wave of loan defaults, bankruptcies and foreclosures.
If you need help renegotiating a commercial loan modification, please contact me. We have attorneys in our network who can help you out. As I mentioned before, I just did a commercial loan audit and found some problems with the paperwork. As it turns out, residential and commercial lending guidelines have more in common than you might think.
If you offer commercial loan modification services, we’d love to hear from you – I’m open to a guest blogger who wants to explain how it works to our audience. Please comment or send us an e-mail.
Plan C: The Treasury is Preparing for a Commercial Real Estate Crisis
In the recent past, I’ve seen a lot of buzz on the internet about how a commercial real estate crisis is our next big economic problem. There has not been much in the way of commentary from reputable sources in the last several weeks, so I decided to dig a bit deeper.
Interestingly, there seems to be a wave of positive economic news coming from the media these days and discussion about the problems in the residential mortgage industry have, at least for now, died down. Whether the positive economic news is accurate is another issue. Thus, the shift of attention from the residential mortgage problems to commercial real estate makes sense.
Also, as I researched the information for this post, I concluded that commercial real estate is complex and I think the average consumer isn’t really interested in figuring out what’s wrong with commercial lending. Many of these people are still trying to save their homes.
Commercial real estate loans are structured differently from residential mortgage loans. Most commercial real estate loans have a shorter term, say, ten years. At the end of the loan term, the loan is not paid in full as a result of making monthly payments over the loan term. Instead, a percentage of the loan is due and payable as a lump sum or balloon payment.
The basic problem is that many of the commercial real estate loans that were made over the last decade will be coming due over the next couple of years. Many borrowers planned to refinance the loan, but with the commercial lending markets drying up, many borrowers face foreclosure if they cannot obtain financing.
Similar to residential mortgages, many of these commercial loans were made without regard for acceptable underwriting standards so that they could feed the demand for commercial mortgage backed securities (“CMBS’”).
I’m already seeing commercial property owners asking for help with commercial loan audits to help them get a commercial loan modification. I’m also currently auditing a loan on behalf of a commercial investor being sued by the second position lender for a deficiency after a foreclosure.
In an article published in early July, the Washington Post discussed the Treasury’s “Plan C”, of which commercial real estate is seen as one of several problems that could derail economic recovery. The Post reported:
“The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.
Banks and other firms that provided such loans in the past have sharply curtailed lending.
That has left many developers and construction companies out in the cold. Over the next few years, these groups face a tidal wave of commercial real estate debt — some estimates peg the total at more than $3 trillion — that they will need to refinance. These loans were issued during this decade’s construction boom with the mistaken expectation that they would be refinanced on the same generous terms after a few years.
The credit crisis changed all of that. Now few developers can find anyone to refinance their debt, endangering healthy and distressed properties.”
Or, as explained by Jon Greenlee, the Fed’s Associate Director, Division of Banking Supervision and Regulation, in his testimony before the Federal Reserve on July 9, 2009:
“The decline in the CRE market has been aggravated by two additional factors. First, the values of commercial real estate increased significantly between 2005 and 2007, driven by many of the same factors behind the residential housing bubble, resulting in many properties either purchased or refinanced at inflated values. Prices have declined about 24 percent since their peak in the fall of 2007 and market participants expect significant further declines. Second, the market for securitized commercial mortgages (CMBS), which accounts for roughly one-fourth of outstanding commercial mortgages, has been largely dormant since early 2008 while many banks have substantially tightened credit. The decline in property values and higher underwriting standards in place at banks will increase the potential that borrowers will find it difficult to refinance their maturing outstanding debt, which often includes substantial balloon payments.
The higher vacancy levels and significant decline in value of existing properties has also placed pressure on new construction projects. As a result, the construction market has experienced sharp declines in both the demand for and the supply of new construction loans since peaking in 2007.
The negative fundamentals in the commercial real estate property markets have broadly affected the credit performance of loans in banks’ portfolios and loans in commercial mortgage backed securities. At the end of the first quarter of 2009, there was approximately $3.5 trillion of outstanding debt associated with commercial real estate. Of this, $1.8 trillion was held on the books of banks, and an additional $900 billion represented collateral for CMBS. At the end of the first quarter, about seven percent of commercial real estate loans on banks’ books were considered delinquent. This was almost double from the level a year earlier. The loan performance problems were the most striking for construction and land development loans, especially for those that finance residential development. Notably, a high proportion of small and medium-sized institutions continue to have sizable exposure to commercial real estate, including land development and construction loans, built up earlier this decade, with some having concentrations equal to several multiples of their capital.”
In May 2009, the Federal Reserve’s Term Asset-Backed Securities Loan Facility (“TALF”) opened up to commercial mortgage-backed securities that were issued in 2009. This bailout might sound good, but these securities aren’t the ones with the problems. It’s the securities that were sold in before the economic crisis and based on the old economic model that’s troubled, and the government isn’t buying those.
Given all of this information, there’s no question in my mind that commercial loan defaults are going to be a problem for economic recovery. The question is, how bad will it be? Some estimates range in trillions of dollars and others say that real estate has bottomed out. I think the government is facing pressure from Main Street for a recovery, so much that they’re not going to let commercial real estate fail and further hamper the economic recovery.
What do you think? Please post your comments!
