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Mar 11 2010

The forecast for commercial real estate remains cloudy

Signs of rebound, but few and far

It’s a story all too common in commercial real estate throughout the U.S. A company experiences unprecedented success after years of aggressive expansion. Several months later, that same company files for bankruptcy. With tanking real estate values, dismal occupancy rates, and a severely reduced credit market with stringent refinancing terms, the scale of this problem is unprecedented.

The commercial real estate market has miles to go before even small steps toward recovery.

“The current commercial real estate market (in the Chicagoland area) still is experiencing stress,” said Heidi Smithson, vice president of First Midwest Bank. “There are signs certain property types are rebounding slightly, like multifamily and medical properties, but retail, office, and condo projects are suffering.”

The coming storm

A report issued by the Congressional Oversight Panel on Feb. 10, 2010, concedes nearly $1.4 trillion in commercial real estate loans will reach the end of their terms between 2010 and 2014. Of those, nearly half are under water, where the borrower owes more than the property is worth. Total losses from these loans could hit $200 billon or even as high as $300 billion in 2011. Because of this, banks that feel the effects of these losses or are shaken by the economic outlook might become less willing to lend, which could decrease access to credit across the board – for businesses and families alike.

The default tsunami that might result could be crushing for more than those involved in just commercial real estate. As noted in a recent ABA Journal article entitled, “The Pain Spreads,” many hotels, restaurants, stores and other commercial tenants might be forced to shutter their doors as landlords default or properties they occupy fall into foreclosure, creating a surplus of empty buildings and contributing to unemployment, which has been dismal at best for months.

More trouble for banks?

Additionally, the failure to refinance commercial real estate loans could force more banks to flounder, in particular, the small- and mid-sized banks with a multitude of commercial real estate loans in their portfolio. To make matters worse, numerous commercial real estate loans were sold to mutual, pension, and hedge funds that also will suffer the adverse effects of default. Experts fear the possibility that this refinancing catastrophe could be the catalyst for yet another recession especially in light of the fact that commercial real estate is more reliant on credit than residential real estate, which has not recovered from its own collapse.

Billions in default brings some opportunity

As the months progress, the default rate is anticipated to increase as billions of commercial real estate mortgages come due. Because banks and financial institutions are being tasked with cleaning up their balance sheets to dispose of commercial real estate loans and financially distressed real estate assets, investors could see numerous purchase options. “There are some great opportunities out there for those individuals who are well capitalized,” Smithson conceded. What remains to be seen is who is willing to take on risks and the impact they might have on an otherwise bleak market picture in the near future.

Buying time to soften the blow

In an attempt to slow the default avalanche, the Treasury Department handed down rules in September 2009 that encourage lenders to adopt “extend and pretend” strategies. Extending the maturity on troubled loans buys at least a little time, delaying an assessment of the full damage until the following quarter or calendar year.

Although each extension is being handled on a case-by-case basis, lenders aren’t eager to grant extensions to troubled loans. But there is some small hope that a stronger economic climate or healthier balance sheet down the road will decrease the pain of a write-down, foreclosure, or other issue that may arise. Buying time is only a Band-Aid, though, and only time will tell how much trouble has been averted by such desperate measures.

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