Commercial Real Estate Heading for the Mat
If you thought the housing market bust felt like a haymaker, wait until you experience the punch to the solar plexus that commercial real estate is about to land. With the economy already gasping for air, this next big blow threatens to knock the economy off its feet for long after the 10-count.
Just when popular media suggests that the economy is back off the ropes, the Congressional Oversight Panel, which is charged with monitoring the banking system bailout, is warning that the economy could be headed into round two of the worst downturn since the Great Depression.
“There’s been an enormous bubble in commercial real estate, and it has to come down,” Elizabeth Warren, chairman of the oversight panel, told the Washington Post on February 19. “There will be significant bankruptcies among developers and significant failures among community banks.”
So far this year, America is on track to see well over 100 banks fail—and this despite unprecedented government action to prop up the sector. During 2009, 140 banks failed—most of them related to the residential mortgage market.
But if Warren is right, America is just experiencing the opening jabs and the main event is yet to come.
“[O]ver the next few years, a wave of commercial real-estate loan failures could threaten America’s already weakened financial system,” revealed the Congressional Oversight Panel’s report, titled “Commercial Real-Estate Losses and the Risk to Financial Stability.”
“Between 2010 and 2014, about $1.4 trillion in commercial real-estate loans will reach the end of their terms.”
Unlike residential mortgages, which can be locked in for 30 years, almost all commercial loans come due in periods between three to five years. Typically, when a loan comes due, the commercial property owner will simply roll over the loan—that is, pay back the original loan with a new loan—provided that his property collateral has not depreciated.
That is the problem facing commercial property owners. Commercial loans that were issued during 2005, 2006 and 2007—at the very height of the property bubble—are now up for renewal. But according to Warren, by next year half of all commercial property owners with mortgages will be “underwater” and owe more than their properties are worth. This means that it may be impossible for them to roll over their loans, and their properties will be forced into foreclosure.
This means that property owners are not the only ones in trouble. Foreclosing on real estate when the property market is declining is like asking for a beating. Losses could range between $200 to $300 billion, according to the report.
“There is a strong potential to see a thousand commercial real-estate bank failures in the next couple of years unless Congress acts to bail them out,” predicts economic analyst Mike Shedlock. “Of course no banks should be bailed out. [T]he correct decision is to let failed banks fail. The last thing we need is further bank zombification.”
And when the banks go down you can be sure they will not go down alone.
A second banking crisis would trigger economic damage that could touch the lives of nearly every American. Think empty office complexes, hotels, retail stores. Think job losses. Think families being forced out of their apartments even though they never missed a rent payment. Think social unrest.
And when the losses start hitting the banks as we head into next year, expect further reductions in lending as financial institutions scramble to shore up bottom lines. For a borrow-to-spend debt-based economy, a reduction in credit supply is like slipping a boxer enough tranquilizer to euthanize an elephant.
As the Trumpet has warned in the past, the current stock market and economic rally will eventually come to an end—and probably an abrupt one. If the economy was a prize fighter, you can picture it bouncing off the ropes, with legs wobbling, a loose jaw and a glazed look in the eye—with a freight-train-size fist labeled commercial real estate barreling straight toward it.