Keeping An Eye On Commercial Real Estate

When Federal Reserve Chairman Ben Bernanke meets with his fellow governors Tuesday, the state of commercial real estate market is sure to be high on their agenda. While a deterioration in the residential real estate market kicked off the recession, the rapid decline of the commercial market could quickly undo all the recovery efforts taken so far.

While there are "green shoots" showing up throughout the U.S. economy, commercial real estate isn't one of them. Last month, Realpoint Research reported that June delinquencies in commercial mortgage-backed securities rose an "astounding" 585% to a 12-month high of nearly $29 billion. In June 2008, delinquencies totaled only $4 billion.

Other assessments of the commercial real estate market were even more alarming. In July Real Capital Analytics found 5,315 troubled commercial properties nationally, valued at more than $108 billion; and in June, Real Estate Econometrics LLC predicted that the default rate on commercial real estate is likely to reach 4.1% by year's end. That projection would imply defaults on about $44.3 billion of commercial mortgages, based on the $1.08 trillion of such loans held by U.S. banks in the first quarter, according to data in the report.

"In all, about $1.5 trillion in commercial real estate loans are coming due within two to three years, and every vacant property represents another lost source of money needed to pay off those obligations," Walter J. Mix, a managing director at LECG LLC, recently wrote in The Deal magazine.

Bernanke is likely to be especially wary of trouble in real estate markets after famously saying he expected the spillover of trouble in residential real estate not to have a huge effect on the overall economy.

According to Bloomberg:
The Fed is "paying very close attention," Bernanke told the Senate Banking Committee on July 22, the second of two days of semiannual monetary-policy testimony before the House and Senate. "As the recession's gotten worse in the last six months or so, we're seeing increased vacancy, declining rents, falling prices, and so, more pressure on commercial real estate."

Other Fed governors are worried about commercial real estate too as Janet Yellen, president of the San Francisco Federal Reserve Bank, called it a "particular danger zone," last month, while N.Y. Federal Reserve Bank chief William Dudley said he expects that marketplace to be "under stress for some considerable period of time," according to Bloomberg.

And as LECG's Mix notes in his column, "with about 60% of these assets on the books of commercial banks ... commercial lenders are beginning to see plenty to worry about on the horizon." And indeed there may be much to worry about: Considering the unpopularity of the current banking sector bailout and the sky-high deficit, another one to backstop commercial real estate losses would be a long-shot. - George White