Saturday , 19 August 2017


Major Commercial Real Estate Losses to Rekindle Financial Crisis

Over the next few years, a wave of commercial real estate loan failures could threaten America’s already-weakened financial system. Commercial loan losses could jeopardize the stability of many banks, particularly the nation’s 2,988 mid-sized banks that have these dangerous concentrations in commercial real estate lending and, as such, as the damage spreads beyond individual banks, contribute to prolonged weakness throughout the economy. In fact, between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms – and nearly half are “underwater” already. Words: 987

In further edited excerpts the TARP Congressional Oversight Panel Report Executive Summary* goes on to say:

Mortgage Refinancing Problems
Commercial real estate loans are taken out by developers to purchase, build, and maintain properties such as shopping centers, offices, hotels, and apartments. These loans have terms of three to ten years, but the monthly payments are not scheduled to repay the loan in that period. At the end of the initial term, the entire remaining balance of the loan comes due, and the borrower must take out a new loan to finance its continued ownership of the property. Banks and other commercial property lenders bear two primary risks: 1) a borrower may not be able to pay interest and principal during the loan’s term and 2) a borrower may not be able to get refinancing when the loan term ends. In either case, the loan will default and the property will face foreclosure.

The problems facing commercial real estate have no single cause. The loans most likely to fail were made at the height of the real estate bubble when commercial real estate values had been driven above sustainable levels. Many loans were made carelessly in a rush for profit. Other loans were potentially sound when made but the severe recession has translated into fewer retail customers, less frequent vacations, decreased demand for office space, and a weaker apartment market, all increasing the likelihood of default on commercial real estate loans. Even borrowers who own profitable properties may be unable to refinance their loans as they face tightened underwriting standards, increased demands for additional investment by borrowers,and restricted credit.

Declining Property Values and Revenue
Commercial property values have fallen more than 40 percent since the beginning of 2007. Increased vacancy rates, which now range from 8 percent for multi-family housing to 18 percent for office buildings, and falling rents, which have declined 40 percent for office space and 33 percent for retail space, have exerted a powerful downward pressure on the value of commercial properties.

Major Losses Projected for 2011 and Beyond
The largest commercial real estate loan losses are projected for 2011 and beyond. Losses at banks alone could range as high as $200-$300 billion. The stress tests conducted last year for 319 major financial institutions examined their capital reserves only through the end of 2010 and, even more significantly, small and mid-sized banks were never subjected to any exercise comparable to the stress tests, despite the fact that small and mid-sized banks are proportionately even more exposed than their larger counterparts to commercial real estate loan losses.

Diverse Economic Damage
A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American:
1. Empty office complexes, hotels, and retail stores could lead directly to lost jobs.
2. Foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment.
3. Banks that suffer, or are afraid of suffering, commercial mortgage losses could grow even more reluctant to lend, which could in turn further reduce access to credit for more businesses and families and accelerate a negative economic cycle.

Number of Banks Facing Insolvency Could Increase
It is difficult to predict either the number of foreclosures to come or who will be most immediately affected. In the worst case scenario, hundreds more community and mid-sized banks could face insolvency. Because these banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery, and extend an already painful recession.

Conclusion
There is a commercial real estate crisis on the horizon, and there are no easy solutions to the risks commercial real estate may pose to the financial system and the public. An extended severe recession and continuing high levels of unemployment can drive up the LTVs, and add to the difficulties of refinancing for even solidly underwritten properties. Delaying write-downs in advance of a hoped-for recovery in mid- and longer-term property valuations, however, also runs the risk of postponing recognition of the costs that must ultimately be absorbed by the financial system to eliminate the commercial real estate overhang.

There appears to be a consensus, strongly supported by current data, that commercial real estate markets will suffer substantial difficulties for a number of years. Those difficulties can weigh heavily on depository institutions, particularly mid-size and community banks that hold a greater amount of commercial real estate mortgages relative to total size than larger institutions, and have – especially in the case of community banks – far less margin for error.

Until Treasury and bank supervisors take coordinated action to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small businesses, and individuals – the financial crisis will not end.

*http://cop.senate.gov/documents/cop-021110-report.pdf

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
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