Commercial Real Estate Free Fall

Sometimes it pays to be late to a story. In this case, the decline in commercial property values probably has a lot to do with the problems community banks appear to be facing which I discussed in the post below.

First, the facts. According to the WSJ, Moody’s Investors Services reported today that their index of commercial real estate property prices fell 8.6% in April (see graph for the trend, click for larger view). With the April fall-off, prices are now down about 25% from last year at this time. The Moody’s survey covers multi-family, office, retail and industrial properties so it’s pretty comprehensive. For the wonkish among you, here is a link that describes their methodology.

That’s bad enough, but now let me share a few comments from Deutsche Bank today on the subject of the commercial real estate market. It comes from Reuters:

The U.S. urban commercial real estate markets probably will not recover until 2017, the head analyst of commercial mortgages for Deutsche Bank Securities (

“The froth is still working itself out,” Richard Parkus, Deutsche Bank head of Commercial Mortgage-backed Securities and Asset-Backed Securities Synthetics Research said at the Reuters Global Real Estate Summit in New York. “We are currently in something which is comparable to what we saw in the 1990s and potentially worse.”

U.S. commercial real estate values could fall by more than 50 percent from the peak in 2007, he said.

Although asking rents are down about 28 percent in New York, factoring in free rent and other perks by landlords, rents are down about 50 percent, Parkus said.

“Rents will be back to where they were in 2017,” Parkus said. Building prices also will take six to eight years to recover, he said.

The U.S. commercial markets are deteriorating at an increasing pace as rent dries up and demand plummets. That is leaving borrowers struggling to make their monthly mortgage payments.

“The number of new loans that are becoming delinquent each month are defaulting at rates between 5 percent and 8 percent per year, with the most loosely underwritten loans of 2007 defaults at 8 percent per year, Parkus said. That puts accumulated losses at about 4 percent this year, and 12 percent over the next four years.

Loans loses ranged between 7 and 11 percent a year during the commercial real estate crash of the early 1990s.

“We are not only not approaching stability, we are at a period of maximum deterioration,” Parkus said.

I usually don’t excerpt an entire column but this one was so short and, at least to me so startling, that I didn’t want to grab pieces or put my own spin on the facts.

This wasn’t supposed to happen. Time and again we’ve heard from government officials, banks and so-called experts that the one fairly bright spot was commercial real estate. It wasn’t supposed to be over built as it was in the 90′s and, yes it would take its lumps, it wouldn’t be one of the real problems in recovery. I guess you throw that one out the window!

For my money, Deutsche Bank has some of the best research and on the ground intelligence to be found in the CRE sector, so I take them pretty much at their word. A lot can happen but they don’t even have to be half right for this to turn into one spectacular crash. In that case, recovery is going to be even slower and more difficult than many have forecast. If residential and commercial construction do not rebound in any significant manner in the next year or two, this country is in for a prolonged period of anemic growth.

I started by referring to the community banks that are having problems paying their TARP funds. Those banks are stuffed to the gills with commercial property loans. I don’t think it’s overstatement to say that if the losses approximate Deutsche Bank’s projections that thousands of banks are going to be compromised to the point of failure.

If memory serves me correctly, I think the S&L bailout cost a bit over $100 billion. I may be low on that number. This one might well be many multiples of that number and could dwarf what we’ve paid out for the big banks. Maybe we need to take a look at what we’re facing before we go all in on health care, more fiscal stimulus, “green” investments and whatever else strikes the fancy of the Washington establishment. I get the feeling we might have to dig deep for some more fundamental problems.

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