With commercial real estate values and rents down 30% to 40% nationwide, across most sectors and metro markets alike, real estate investors — and the banks that lend to them — have already been hit by commercial real estate market's tsunami. But many believe the worst is yet to come.
The approaching wave of $1.5 trillion in overleveraged commercial real estate debt maturities over the next few years continues to threaten the commercial real estate markets and our fragile economic recovery.
With or without major efforts to tackle the problem, we could see further declines in values and rental rates, with vacancies creeping up even higher.
As commercial real estate loan defaults continue to increase, they will inevitably result in more foreclosures and distressed properties that will impact the broader market.
While plenty of capital remains available in the marketplace, most investors are more interested in buying distressed debt for pennies on the dollar than equity in real property (unless the property is discounted to match distressed conditions of the marketplace).
Today, there is very little left of the traditional commercial real estate investment, sales and leasing market.
Activity remains relatively stagnant, with most of the markets tangled up in a deleveraging quagmire that few, especially the banks, really know how to cope with. Call it what you will — extend and pretend, delay and pray, slow bleed, tsunami or just staying high on hopium — many lenders and investors continue to drift, waiting for the market to hit bottom.
While politicians and media outlets express enthusiasm at any sign of a recovery, we are also met daily with equally bad news involving critical areas of the economy. There is no magic wand here, no quick fix.
However, some ideas and potential solutions to the challenges the commercial real estate and banking industries are facing are being considered.
Associated Press real estate writer Alan Zibel wrote a June 23 article, headlined "New-home sales plunge 33 percent with tax credits gone," that focused mostly on the historic drop in sales.
I thought the headline could have been "Tax Credits temporarily worked to stabilize residential real estate market."
Tax credits are a time-tested way to stimulate business and consumers. It is possible tax credits could be crafted to deal with the commercial real estate crisis and the overleveraged debt.
However, this may simply postpone inevitable losses by both investors and lenders.
Delaying the day of reckoning may discourage investments that could spur job growth as well. Either way, lacking significant growth in jobs and business profitability nationwide we shall have a long wait for any true and lasting recovery.
The overleveraged debt must be addressed.
Regulatory measures that give banks a way out of their losses without signing their own death warrants and expediting more commercial loan workouts may be part of the answer.
Maura O'Connor, a partner at Seyfarth Shaw LLP in Los Angeles, said on GlobeSt.com: "Many distressed commercial loans that result in foreclosures could have been worked out, if certain simple, seemingly obvious steps were taken by both lender and borrower to cooperatively work out a consensual resolution. … Additionally, borrowers need to accept that times have changed and they may be required to bring in new equity if they want to keep their properties."
There remains the bigger systemic question: How will the CRE debt crisis impact the overall economy?
In February, the Congressional Oversight Panel issued its report "Commercial Real Estate Losses and the Risk to Financial Stability."
The panel concluded 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," the report said, "it creates a downward spiral of economic contraction: job losses; deteriorating storefronts, 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."
In the June 21 issue of Clain Brant's Real Estate and Banking Briefs, Clain reminds us that political factors cannot be ignored: "The forthcoming November 2010 elections are stymieing some of the current administration's decision to not encourage more enforcement actions by regulatory agencies toward troubled banks. With so much other bad news being faced by the current administration, the issue of numerous failing banks would probably not help incumbent politicians seeking reelection."
Today's commercial real estate market is full of contradictions, new directions and opportunities, but few have the experience to find their way.
If you are going to come out alive from this tsunami, learn to surf the big waves.