The Looming Crisis in Commercial Real Estate

The Looming Crisis in Commercial Real Estate

The bailout may be coming to your local mall.

The credit crunch has thus far focused on the residential mortgage mess. But with $1.3 trillion in loans to shopping centers and other commercial properties coming due between now and 2013, another time bomb is ticking. In a report scheduled for release on Wednesday, Deutsche Bank estimates that at least half the loans — and two-thirds of those packaged and resold as securities — will not qualify for refinancing. As a result, many borrowers will likely default, leading to losses on securitized mortgages of $50 billion or more and losses of at least $200 billion on commercial real estate loans overall, according to Deutsche analyst Richard Parkus, who authored the report. “People are only now beginning to realize there is a looming crisis,” Parkus told TIME.

Financial analysts believe government incentives to banks to extend existing commercial real estate loans will be necessary to limit the damage. The Federal Reserve and Treasury Department are considering a number of options. The alternative is last week’s bankruptcy of General Growth Properties, the nation’s second largest shopping-center group, which could not refinance, even though many of its properties have positive cash flow.

Most mortgages for commercial real estate — office and apartment buildings, hotels, industrial warehouses and shopping malls — are structured as 5-to-10-year loans. After that, the loan is normally refinanced. But the recession has eroded the fundamentals of even good refinancing candidates. Property values have plummeted, with sale prices down as much as 45% from the peak in 2007, Deutsche Bank reports. And vacancies are up — expected by year’s end to reach 13.5% for retail and 17% for office buildings — cutting potential income that commercial properties need to make their mortgage payments. Some areas will be even worse. Vacancy rates in midtown Manhattan, already at 12.7%, are expected to reach 19% by year’s end, real estate experts say.

“I doubt too many banks will want to own a lot of commercial properties that are empty,” said George Raitu, an economist for the National Association of Realtors.

At the same time, underwriting standards have significantly tightened since the boom years of 2005 and 2006, when banks granted loans of up to 95% of a property’s appraised value. Today loan-to-value ratios have dropped as low as 60%, so a “very large percentage of outstanding loans simply will not qualify to refinance,” said Parkus.

The Fed is considering a plan to back new securitized commercial-property loans for five years, which could help enliven the market and create new opportunities for refinancing. But real estate executives are pressing for more direct government rewards to lenders, like an extra point on the refinancing or a bump in interest rates, to encourage them to continue loans as they mature. “Let’s provide a way for [the banks] to roll over those loans, not just say that no one wants to refinance them,” said Blaine Walker, a commercial real estate broker in Utah.

Although relatively few troubled loans will come due before the end of this year, the implications for banks are already being felt. The delinquency rate for commercial real estate loans hit 1.8% in March, triple that of a year ago, according to Scott Talbott, a lobbyist for the Financial Roundtable, which represents the largest lenders. “Losses from commercial real estate are the next economic shoe to drop,” he said. “This issue has moved to the forefront.”

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