Commercial Real Estate: Credit Crisis #2?by Tim Manni
Towards the end of 2008, the meltdown in the financial and mortgage markets led to a credit crisis that froze lending nationwide. For a while now analysts have been forecasting another looming credit crisis — this time it has to do with the commercial real estate market. Finance and economic blogger Calculated Risk predicted declines back in December 2008.
However, what makes this “latest” threat to U.S. lending institutions particularly dangerous, is that several Federal entities — from the Federal Reserve, to the Treasury, to the FDIC — are financially stretched to their limits, and may be unable or unwilling to provide adequate support to lenders if or when the time arises.
With the nation’s banks still in recovery from the first credit crisis, are they stable enough to withstand another? If the commercial real estate market does collapse and banks begin to collapse at great speed, will the struggling FDIC even be able to support the banks’ customers?
The Cause for Concern
Remember back in June when we argued that, in terms of the residential real estate recovery, home prices were the statistic that mattered most? Well, the same could be said for commercial real estate. Furthermore, it seems as though many of the same factors that contributed to the first real estate collapse, are triggering the second — falling property prices, unemployment, vacancies, underwater loans, etc. What’s particularly disconcerting about these factors is that, just like residential mortgage loans, they can make refinancing impossible.
The losses sustained by big banks during the residential mortgage meltdown were so severe and far-reaching, Washington created a $700 billion “bailout” to save them. According to HSH VP Keith Gumbinger, this will affect small and mid-size banks disproportionally. While TARP has allowed those large banks to quickly bounce back to business (the top four residential mortgage originators in the second quarter of 2009 were TARP banks), there is no “bailout” or support system in place to save the smaller lenders that may go under because of commercial loans.
Structure of Commercial Loans
The way commercial loans are structured is very different from residential loans. The more you hear about commercial real estate and it’s potential threats to our economic recovery, the more you will hear the phrase “coming due”.
The makeup of a commercial loan is that after a given period of time (say 10 years), the loan is intended to be refinanced, or, they loan is “coming due”. Again, like residential, if the loan is underwater, if the property is vacant, if the owner is underemployed, or if the property has lost significant value, there’s a slim chance the lender will be willing to refinance the loan.
Currently, the commercial real estate market is valued at $3.5 trillion dollars. The industry has experienced a 39% decline from its peak reached just two years ago, according to the MIT Center for Real Estate. What’s keeping market observers up at night is that the decline far outweighs the 27% drop the industry experienced during the economically-devastating ’savings and loan crisis’ of the late 1980s, early 1990s.
The problem is that without immediate changes in bank regulations and laws governing Real Estate Mortgage Investment Conduits (REMICs), this next wave of the credit crisis will sabotage economic recovery — driving up bank failures and bailouts by the FDIC. The recession could become a depression.
It’s important to note that, unlike residential loan failures, the growing defaults of commercial loans are largely recession related and the defaults aren’t a result of subprime lending or exotic products, but the result of ongoing economic troubles.
Readers: Thanks to commercial failures, are small and mid-size banks next in line for a “bailout”? If so, do they deserve it?