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Commercial Real Estate Lending

Commercial real estate time bomb still ticking

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Trends in commercial real estate usually follow those in residential housing. That's because shopping centers, office buildings and hotels are usually built to support expansion in residential real estate. It takes longer to get the financing, to build them, and to lease out the space.

Therefore, you can usually predict what will happen in commercial real estate by following the ups and downs of the housing market. Knowing this makes it easier to invest in Real Estate Investment Trusts (REITS). They are easily traded investments that focus on commercial real estate.

Commercial real estate lending is now recovering from the 2008 financial crisis. As of June 30, 2013, banks held $991.2 billion in commercial loans. This was a 3.3% increase over 2012, which rose 2.4%. This biggest driver to this growth is in apartment buildings. This could tail off as the single-family home market slows. (Source: WSJ, Commercial Loans Pick Up, October 15, 2013)

Nearly $300 billion of commercial-mortgage backed securities (CMBS) come due in 2015-2017. These were written in 2005-2007, when property values were at their highest. Analysts have been worried that these loans would default, just as the residential mortgage-backed securities did. However, real estate values for commercial properties have been rising, so the risk is lower than originally thought.

In 2014, $42.7 billion in loans will come due.That isn't a problem because $100 billion in new CMBS will be written. However, those amounts will rise, as follows:

  • $94.7 billion in 2015,
  • $126 billion in 2016,
  • $126.8 billion in 2017. 

As long as commercial real estate values remain healthy, it shouldn't be a problem. However, if values weaken, then the ticking time bomb may explode. (Source: WSJ, Fear Ebbs About Mortgage-Loan Reckoning, May 14, 2014)

Commercial Real Estate and the 2008 Financial Crisis

The first signs of decline in residential real estate occurred in 2006. Three years later, commercial real estate started feeling the effects. Commercial real estate defaults affected small banks more, because they had invested more in local shopping centers, apartment complexes and hotels.

1. Commercial Developers Ask Fed for Loans

The Plaza hotel in New York City.
Hotels are one component of commercial real estate. Credit: Don Kravitz / Getty Images

December 22, 2008 -- Commercial developers are facing between $160 - $400 billion in loan defaults next year if they can't find banks to refinance them. Unlike home loans, loans for shopping centers and office buildings have big payments at the end of the term. Instead of paying off the loan, developers typically refinance. If funding isn't available, the banks must foreclose. To avoid this, developers are asking the Fed to guarantee that they will buy the refinanced loans from banks on the secondary market. The Fed's purchase would be guaranteed by part of the $700 billion TARP fund to do this.

It seems like every business is asking the government for a handout. However, the commercial developers are simply looking for a loan guarantee, not a bailout of bad decisions. Since banks are not lending, the Federal Reserve and the Treasury are acting in their capacity as bank of last resort. However, the government cannot replace the entire banking sector forever. The government is hoping to keep lending going long enough until confidence is restored in the financial sector. Until then, the Fed will keep buying loans, and keep commercial real estate operating.

2. The Commercial Real Estate Ticking Time Bomb

Retail is another component of commercial real estate.

In July 2009, it became apparent that commercial real estate was the next blow to the economy. During the worst recession since the Great Depression, commercial property owners had to refinance or sell $165 billion in loans. Lower property values meant most loans had only 20-30% equity, while banks required 40-50% equity. Loan losses pummeled smaller, community banks, which had a larger exposure. Many were concerned it could be as bad as the 1989 Savings and Loan Crisis.

3. Hands Off Commercial Time Bomb

When home loans defaulted, commercial loans were soon to follow. Credit: David McNew/Getty Images
Many investors owned Real Estate Investment Trusts (REITs), which hold commercial real estate. These REIT values were depressed for years. Why? Owners of commercial real estate were upside-down in their mortgages, since their commercial property values had dropped 40-50% since 2008. They were scrambling to find cash to make the payments, since many tenants had either gone out of business or renegotiated lower payments. But, unlike banks, they did't have the FDIC to stand behind them. So, many of them went bankrupt and defaulted on their loans whether they wanted to or not.

4. Commercial Time Bomb Slowly Exploded

The financial crisis created huge vacancies in commercial real estate. Credit: Scott Olsen/Getty Images
By June 2010, the mortgage delinquency rate for commercial real estate worsened to $45.5 billion in bank-held loans, or 4.17%. This was higher than both the 3.83% rate in the fourth quarter of 2009 and the 2.25% rate a year ago.

5. Signs of Hope in Commercial Real Estate

By October 2010, it looked like rents for commercial real estate began stabilizing. For three months, rents for 4 billion square feet of office space fell by only a penny. The national office vacancy rate seemed to stabilize at 17.5%, lower than the 1992 record of 18.7%, according to real estate research firm REIS Inc.

6. What Exactly Is Commercial Real Estate?

Commercial real estate is any property owned to produce income. It typically refers to office complexes, shopping malls, and hotels. In its broadest definition, it includes apartment complexes and industrial real estate.  

7. The Savings and Loan Crisis

In the 1980s, banks invested in speculative real estate, including commercial loans. Between 1982 and 1985, these assets increased 56%. In Texas alone, 40 S&L's tripled in size, some growing 100% each year. Between 1986-1995, over 1,000 banks with total assets of over $500 billion failed. By 1999, the Crisis cost $153 billion, with taxpayers footing the bill for $124 billion, and the S&L industry paying the rest.

8. How Real Estate Affects the Economy

Real estate contributes 8%of the total U.S. economy's output. If real estate declines, so do construction jobs, increasing unemployment. It also leads to a decline in real estate prices, which reduces the value of everyone’s homes. This loss of equity eventually reduces consumer spending.
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