Commercial Real Estate Crisis:
27 May 2009
For those thinking that the real estate bust is all but over with, think again. The residential market has nose dived and continues to sink lower, but now it looks like commercial real estate may crash harder than a lot of people thought possible.
And this will drive a wave of foreclosures through out the global economy, killing off any chance of economic recovery in the near term.
The sizeable Commercial component of real estate securitization on bank balance sheets is on the verge of being the next domino to fall. While residential real estate’s impact on the global financial and economic crisis still retains the spotlight, indications are growing that a global commercial real estate implosion is on the verge of becoming the next asset bubble to pop, and with devastating consequences.
The delinquency rate on securitized commercial real estate loans has doubled since September 2008 and now stands at about 1.8%. While that number indicates the problems that owners are encountering in servicing their debt, it is only a small part of the larger issue.
According to Deutsche Bank there is about $6.5 trillion of commercial real estate in the USA which is financed with $3.1 trillion of debt. Deutsche Bank estimates that commercial property of all types have declined in value by about 35% to 45% from their peak 2007 highs, and with a 35% decline in value you end up with $4.2 trillion of assets and $3.1 trillion of debt.
Between 2009 and 2012 $154 billion of securitized loans will need to be refinanced and $524 billion of whole loans held by the banks will have to be rolled over. And estimates are that two thirds of the securitized loans and half the whole loans will not qualify for refinancing without extremely large infusions of borrower equity.
Compounding the problem is that commercial real estate exposure is spread over a wide swath of the commercial banking sector and the evidence is that most banks are under reserved. Estimates are that the banks are carrying their holdings at somewhere in the range of 90% to 95% of the original value.
Deutsche Bank predicts that the income generated by commercial properties, which will be eroded as tenants either go out of business or downsize, won’t rebound from its current decline until 2013 and will not reach levels seen before the economic problems until 2018.
The problem then becomes one of rolling over existing debt on a severely depleted asset base.
Deutsche Bank’s outlook dismisses a notion widely held in the real estate industry that lenders will simply extend expiring loans that can’t presently be refinanced in order to dodge a period of depressed real estate values.
Given the unlikelihood that lenders will simply be able to wait out the problems, it is clear that the real estate industry will be awash in foreclosures and distressed property sales for the next decade.
The Global Economic Crisis has unleashed a wave of demand destruction, the likes of which have not been seen since the Great Depression of the 1930s. In major cities and shopping complexes across the globe, retail outlets are bereft of customers, in the process halting essential cash flow for these enterprises.
This means even where credit might be available, such as through government funded injections of capital into the banking system, enterprises lack the capacity to service loans that otherwise might be accessible. The result is a self perpetuating meltdown in which commercial real estate increasingly becomes vacant, with few potential buyers or tenants available, further distressing their economic value.
With fewer tenants and constricted income, property owners unable to service their outstanding loans are deleveraging. Keep in mind that this is not just an American phenomenon. England, Hungary, Germany and Japan are already seeing this torrent of economic destruction at work.
As the implosion in commercial real estate accelerates, the already fragile global banking and credit system will be hammered again. In a worst case scenario, the blow about to be delivered by this next bursting asset bubble may prove to be mortal for the global economy.
