Just When You Thought It Was Safe To Go Back In The Water

Over the next few years, a wave of commercial real estate loan failures could threaten America’s already-weakened financial system. The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy.

Commercial real estate loans are taken out by developers to purchase, build, and maintain properties such as shopping centers, offices, hotels, and apartments. These loans have terms of three to ten years, but the monthly payments are not scheduled to repay the loan in that period. At the end of the initial term, the entire remaining balance of the loan comes due, and the borrower must take out a new loan to finance its continued ownership of the property. There are no easy solutions to these problems. Although it endorses no specific proposals, the Panel identifies a number of possible interventions to contain the problem until the commercial real estate market can return to health. The Panel is clear that government cannot and should not keep every bank afloat. But neither should it turn a blind eye to the dangers of unnecessary bank failures and their impact on communities. 

The Panel believes that Treasury and bank supervisors must address forthrightly and transparently the threats facing the commercial real estate markets. The coming trouble in commercial real estate could pose painful problems for the communities, small businesses, and American families already struggling to make ends meet in today’s exceptionally difficult economy.

According to the Congressional Oversight Panel's February oversight report, Commercial Real Estate Losses and the Risk to Financial Stability, there is genuine concern that “commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy”. Commercial real estate loans (office, retail, hotel, industrial, and multifamily properties) made in the go-go days of 2002 - 2007 total some $1.4 trillion will mature in 2010 through 2014 and require refinancing.

In almost half of these cases, the amount of the maturing loan is greater than the value of the real property securing it.

The Panel found that "a significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American." When commercial properties fail, it creates a downward spiral of economic contraction: job losses; deteriorating store fronts, office buildings and apartments; and the failure of the banks serving those communities. Because community banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery and extend an already painful recession.

A few of the important statements in the Report are excerpted below: 

· Banks and other commercial property lenders bear two primary risks:

1. A borrower may not be able to pay interest and principal during the loan’s term, and
2. A borrower may not be able to get refinancing when the loan term ends. In either case, the loan will default and the property will face foreclosure.

· While some loans never should have been made, other loans were potentially sound when made but the severe recession has translated into an increased the likelihood of default on commercial real estate loans.

· Commercial property values have fallen more than 40* percent since the beginning of 2007. Increased vacancy rates, which now range from eight percent for multifamily housing to 18 percent for office buildings, and falling rents, which have declined 40 percent for office space and 33 percent for retail space, have exerted a powerful downward pressure on the value of commercial properties.

· A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American including more lost jobs. Foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment. Banks that suffer, or are afraid of suffering, commercial mortgage losses could grow even more reluctant to lend, which could in turn further reduce access to credit for more businesses and families and accelerate a negative economic cycle.

· In the worst-case scenario, hundreds more community and mid-sized banks could face insolvency. Because these banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery, and extend an already painful recession.

*44% according to latest ULI Real Estate Business Barometer

There are no coincidences!
Copyright 2010 The Falbey Institute for the Development of Real Estate