Thank you for sharing!

Your article was successfully shared with the contacts you provided.

NEW YORK CITY-Last week, Federal Reserve chairman Ben Bernanke presented his agency’s semi-annual Monetary Policy Report to both houses of Congress. In response to Senate questions, Bernanke admitted that the rising tide of problems in the commercial mortgage market could pose “serious and major challenges to the banking system.” But, when asked by New Jersey Sen. Robert Menendez if the Fed had the tools to “stem” any approaching crisis, Bernanke replied that he did not know.

Experts agree that the sea of maturing commercial real estate mortgages is the next shoe to drop in the nation’s recession. But the size of that shoe remains to be seen, and just how far it falls is anyone’s guess. And there’s no consensus, on whether greater government intervention will jump-start the sleeping industry and perhaps soften any blows the crisis throws at the nation’s banking system.

“We’re in for some tough times,” says Robert Dobilas, CEO/president at Realpoint LLC, the credit rating agency based in Horsham, PA. He adds, “we’re midstream in the fall.”

Undoubtedly, the commercial sector’s nose-dive at least has the potential to further destabilize the nation’s financial markets. The Fed says US banks hold around $1.8 trillion in commercial real estate loans. Data from Real Capital Analytics’ mid-year report show that during the first half of 2009, the number of distressed commercial properties rose by $67 billion to $115 billion, an increase of 122%.

Commercial real estate defaults on mortgages held by depository institutions rose from 1.62% in the fourth quarter of 2008 to 2.25% in the first quarter of 2009, according to Real Estate Econometrics. REEcon projects that number to increase to 4.1% by the fourth quarter of ’09. REEcon also says the balance of delinquent commercial mortgages has increased 84.3% over last year.

Added to that, data from Realpoint shows that delinquent unpaid balances for CMBS loans increased by $9.87 billion to a 12-month high of $28.65 billion. By June of this year, the total unpaid balance for all CMBS pools under its review was $817.4 billion and clearly trending upward, Realpoint says.

“Government is well aware this crisis is happening,” says Dobilas. “We’ve been in DC for the past year and a half, letting them know what’s going on in the commercial industry. So far, the TALF program has been somewhat ineffective; it’s not going to be enough to address the sheer volume of delinquencies and re-financings that are going to need to take place.”

Dobilas calls the current climate “a perfect storm,” compounded by uncertainty and a lack of confidence in overall markets. Of increased commercial defaults, Dobilas says a “lot of that has been driven by borrowers that took advantage of very aggressive lending and underwriting from 2005 through mid-2008.”

Of the loans coming due for refinancing, he says, “we are not ready for what’s coming,” adding there are “no lenders to take them out.” Dobilas explains “you have special servicers who instead of foreclosing and liquidating assets, they hold on in hopes the market will recover” and they can recover more money, and that presents another set of problems.

“Properties that are close to, if not already, struggling with cash flows are just concerned with their ability to meet debt service payments going forward,” says Realpoint’s director of analytical services, Frank Innaurato. He says that’s led to an increasingly prevalent term in the commercial industry: “imminent default.”

Both say this is partly the result of “limited special servicer bandwidth and capital that can be put out for advances,” which they say is “quickly leading to a situation where government is going need to get involved.” Adds Dobilas, “At all costs, we should be trying to jump-start the lending market, and make sure people are willing to make loans, bringing confidence back to the process.”

Innuerato points out that as the markets have crumbled, amidst everything else going on in the economy, property values “are coming down at least 30% to as high as 50% off their peak values.”

Dr. Sam Chandan, president of REEcon, adds “I think we can see, in some of the office properties that have transacted, or are under conditions of extreme distress, the decline in price from where these assets were acquired is very large.” Case in point: Boston’s John Hancock Tower, which Broadway Partners bought for $1.3 billion in 2006 and sold for $660 million earlier this year.

Thus far, public policy motivation for government intervention in commercial real estate’s crisis appears limited. “With residential, you have individual families in danger of losing their homes to foreclosure, as compared to a situation where you have private market participants that made investments in assets like office buildings and retail properties,” Chandan tells GlobeSt.com. He adds. “residential is naturally going to elicit a different type of response from the policy-maker.”

Still, he does see policy-makers encouraging banks to modify loans. “The most recent data we have from the Treasury, from May, show modifications and renewals for existing loans on their balance sheets outnumber new mortgage commitments two to one.”

For example, Birmingham, AL-based Regions Financial Corp. recently said its focus is on “renewing and restructuring real estate loans with existing clients verses active pursuit of new real estate loans,” with the bank adding “our underwriting criteria continues to reflect the declining property prices and stressed cash flows.”

Chandan says we’re seeing banks work aggressively to avoid foreclosures, because the market is currently very thin. Still, he acknowledges that in some cases, banks might be concerned that they will work out a loan, only to see it fall into delinquency or further default in the future.”

Innaurato says that considering the volume, it wouldn’t make sense for lenders to foreclose on all the loans now being transferred to asset managers. He says that in many cases, especially if they have a borrower who has shown commitment to a property, it makes more sense to “work with the borrower who has cash on hand, and equity in the property verses foreclosing and trying to liquidate in a severely distressed market.”

Dobilas says the current situation is putting large amounts of stress on the valuation of properties, so that as more special servicers are forced to liquidate assets at distressed prices, it’s not going to be good for values across the nation.

While he agrees that commercial real estate is the next shoe to drop, Christopher N. Macke, CEO of General Equity Real Estate in Çhicago takes a slightly different view and approach, saying a growing economy and normally functioning credit market will not make the problem in the industry go away.

Macke pulls no punches, blaming “the irrational exuberance of lenders and borrowers that preceded the current downturn” for most of the industry’s current problems. He argues that “even in a good economy, with normally functioning credit markets, other financial institutions will not offer the same loan terms that were being offered before the downturn.”

“The problem isn’t that buyers won’t pay enough, the problem is that sellers paid too much and nobody wants to be substituted into their shoes,” says Macke.

Contrary to the macro-view, Macke says government should not intervene in the commercial crisis if it wants to get the economy moving again. He says “until borrowers and lenders acknowledge that the assets they bought and lent aren’t worth as much as they were, banks won’t have the capacity to lend and borrowers won’t have the capacity to buy and we will all be asking why nobody is doing deals.”

Comparing government intervention to propping up a currency, Macke adds, “the government can not prop up commercial real estate values when the market knows the values on the banks’ books are above even normal market prices, and if the market doesn’t believe in a value that the government is trying to sustain.” Instead, he says, private money should pick up balance sheets of lenders, adding they’ve been in the game throughout the current crisis. However, “they just aren’t willing to overpay like the current owners did.”

“Trying to forestall this by the government pumping money to the banks would only delay dealing with the reality,” says Macke.

Relating back to Menendez’s question for Bernanke, Chandan finds the absence of a systemic program for addressing the problem “worrisome.” As for what the plan should be, Chandan says what’s ideal on paper may not be practical from an implementation perspective. “There are a lot of things that are ideal from the perspective of textbook economics that will be infeasible or unpalatable given the more complex environments we’re working in,” Chandan says. Regardless, he says, “we have to identify additional sources of credit, over and above banks’ own capacity to modify loans and a marginal contribution from securitization activity.”

Chandan says, in addition to “normalization” there has to be a healthy market for new transactions. He says there has to be an attempt at refinancing all the loans out there. And, as has become increasingly clear, with the symptoms of the recession in full swing, fundamentals have weakened and therefore there’s little demand for new loans.

“Why would you build right now when vacancy rates are going up?” Chandan asks. He then cautions, “when banks say there is weak loan demand, we need to put that in context.”

Want to continue reading?
Become a Free ALM Digital Reader.

Once you are an ALM digital member, you’ll receive:

  • Unlimited access to GlobeSt and other free ALM publications
  • Access to 15 years of GlobeSt archives
  • Your choice of GlobeSt digital newsletters and over 70 others from popular sister publications
  • 1 free article* every 30 days across the ALM subscription network
  • Exclusive discounts on ALM events and publications

*May exclude premium content
Already have an account?


Join 1000+ of the industry's top owners, investors, developers, brokers & financiers at THE MULTIFAMILY EVENT OF THE YEAR!

Get More Information


Join GlobeSt

Don't miss crucial news and insights you need to make informed commercial real estate decisions. Join GlobeSt.com now!

  • Free unlimited access to GlobeSt.com's trusted and independent team of experts who provide commercial real estate owners, investors, developers, brokers and finance professionals with comprehensive coverage, analysis and best practices necessary to innovate and build business.
  • Exclusive discounts on ALM and GlobeSt events.
  • Access to other award-winning ALM websites including ThinkAdvisor.com and Law.com.

Already have an account? Sign In Now
Join GlobeSt

Copyright © 2021 ALM Media Properties, LLC. All Rights Reserved.