naked capitalism

A story in the New York Times warns, “Some Fear Commercial Property Loans Will Be Next Stage in Downturn.”

This is news? I’m in a lazy mood, so I will merely search old posts.

Fitch warned in April 2007 (yes, the year is no typo) of the lousy quality of commercial real estate loans and predicted higher defaults. We noted:

The same overly aggressive lending practices in operation in the subprime market, such as 0% down, overly optimistic forecasts, and loan structures that make sense only if one assumes a refinancing in the not-too-distant future, are also prevalent in commercial real estate. But because most commercial real estate markets are still strong and occupancy rates are high, the risks have not yet come home to roost

Fitch issued another warning in July 2007.
CMBS spreads widened markedly in July 2007 and August 2007

In September, investors start anticipating a 15% fall in commercial real estate prices for 2008 and get leery of completing deals

In November, Nouriel Robini describes the commercial real estate market as “totally frozen,” point to rising delinquency rates, and predicts a “coming meltdown.” Imagery a bit mixed, but the message is clear.

A couple of weeks later, the MIT Center for Real Estate reports that commercial real estate prices are falling

Showing that the often colorful Roubini wasn’t exaggerating, a Bloomberg story at the end of November said:

In the bond market, commercial property investors are about as creditworthy as U.S. homeowners with subprime mortgages…“The commercial real estate market is imploding,” said James Ortega, who manages $150 million at Saenz Hofmann Fund Advisory in Sao Paulo. Ortega has set trades to profit from a decline in property companies’ shares. “We’re about to experience a very significant correction.”

That should prove the point, particularly since this blog isn’t real estate focused. No doubt you’d find at least five times as many posts along those lines at Calculated Risk.

Now, kvetching over, the New York Times article can more accurately be read as an update on worsening conditions in a market that has already taken some knocks. This development was foretold at a panel sponsored by RGE Monitor in New York in May. One theme (Chris Whalen of Institutional Risk Analytics and Roubini in particular made much of this one) was that the next leg of the banking crisis would hit when regional and local banks started taking writedowns. That would create a feedback loop, since those banks have a much higher proportion of their balance sheets in real estate (not just residential but also commercial, particularly construction lending).

And we have so far neglected to mention the most obvious reason for flagging conditions in commercial real estate: a weak, probably deteriorating economy. Office space rentals are a function of employment. Weakening consumer spending hurts retailers; the number of shuttered stores and restaurants rises in a downturn. And as the Times implies, those overly-optimistic, end of cycle deals are coming apart.

From the New York Times;

A default by the complex, the rent-regulated Riverton Apartments, a 12-building residential development constructed after World War II, would be New York’s largest in the current housing crisis. For Wall Street banks, which hold about $100 billion of commercial mortgage-backed securities, the prospect has fanned new worries that a deterioration of the overall commercial property market could prompt more write-downs in the coming quarter, on top of losses already expected from their distressed mortgage securities holdings….

At the end of the second quarter, Deutsche Bank held $25.1 billion worth of commercial loans. Morgan Stanley held $22.1 billion and Citigroup had $19.1 billion.

Lehman Brothers, which has the largest exposure to this type of security, is shopping about $40 billion worth of commercial real estate assets, as well as its entire commercial real estate business. A large part of its portfolio is a high-risk loan known as bridge equity made with Archstone, a metropolitan apartment developer, and most of the rest are floating-rate loans, which are riskier, according to a person who reviewed the offering.

Banks are scrambling to dispose of these loans, typically made to hotels, office developers and retail strips, before problems arrive.

Yves here. A little late, no?

Broader real estate indexes are already showing signs of trouble. Moody’s/REAL Commercial Property Price Index has dropped nearly 12 percent since its peak last October. A more conservative index by the National Council of Real Estate Investment Fiduciaries shows growth slowing to one-half of a percent in the second quarter, from upward of 4 percent a quarter….

Now, the prospect of an immense default on a commercial residential property in New York — which has not suffered as much as troubled markets like Florida — has lent new momentum to concerns over the stability of commercial real estate loans….

A recent report by Lehman Brothers showed that aggressive underwriting is what probably has brought Riverton to the brink of default, not a fundamental deterioration in the overall market. But that report noted that there are other commercial properties that received similar optimistic underwriting, known as a pro forma loan.

Ratings agencies have only downgraded a few commercial real estate securities. At Moody’s, the list includes loans given to the Ritz-Carlton in New Orleans, a casino in Atlantic City and a land development deal in Miami.

Still, many analysts say a lengthy downturn in the economy would probably lead many commercial property owners to struggle with their mortgage bills. And pricing in commercial real estate is starting to reflect a tightening in commercial lending, they said.