A vacant grocery store in Fairfax, Calif.Justin Sullivan
A looming crisis in commercial real estate looks like the next big headache for recession-weary Americans.
Real estate insiders, experts and regulators warned a U.S. congressional committee Thursday that commercial real estate is headed for a crash that could eclipse even the devastating slump of the early 1990s, saddling already hobbled banks with a new wave of bad loans.
The picture isn't pretty. Property values have already collapsed more than home prices, vacancy rates are soaring as the recession wears on and once-buoyant loan and credit markets have virtually dried up. Now, even the owners of good properties are facing foreclosure.
"Commercial real estate is the next shoe to drop," James Helsel, a Pennsylvania realtor and treasurer of the U.S. National Association of Realtors, told the joint economic committee.
The hearing comes as the Obama administration is investigating what to do about emerging risks facing the U.S. economy - a process ominously dubbed "Plan C" to signify a last line of defence. And the plight of commercial real estate is near the top of its concerns.
The dilemma for the U.S. Federal Reserve and the Treasury Department is that they do not want to expose the banking system to any new risks. But unless banks resume steady lending to commercial real estate, the industry says the job market and local tax revenues could take another big hit. There aren't any easy answers.
But industry officials told the committee that better tax treatment of foreign investors would go a long way to help.
They also called for a degree of mortgage relief from banks, and improved government efforts to revive the lifeless mortgage-backed securities market.
"We need to turn the page and get the market working again," said Jeffrey DeBoer, president and chief executive of the Real Estate Roundtable, which represents large developers and property managers.
The epicentre of the commercial real estate crisis is New York, where nearly $8-billion (U.S.) worth of commercial properties - mainly office towers - are in various stages of financial distress.
But Manhattan isn't the only problem market. A growing number of properties are in trouble in several other major cities, including Las Vegas, Los Angeles, Detroit, Phoenix, Chicago, Dallas and Boston, real estate agents said.
And the crisis is only just beginning. A wave of loans made during the boom years of the past decade are now coming due, including roughly $400-billion (U.S.) worth this year and more than $1.8-trillion by 2012, according to the Washington-based Real Estate Roundtable.
With prices falling rapidly, banks are balking at refinancing all that debt. And the mortgage-backed securities market has ground to a halt.
"The severity of the current downturn is likely to exceed, possibly by a large magnitude, [the crash]of the early 1990s," Deutsche Bank real estate analyst Richard Parkus told the committee.
In April, the refinancing impasse forced Chicago-based General Growth Properties, the second-largest U.S. shopping mall owner, into Chapter 11 bankruptcy protection. With rental revenue falling and vacancies rising, General Growth's lenders refused to refinance its $27-billion in debts.
Prices for office towers and shopping centres are already down 35 to 45 per cent from their peak in 2007, and further declines are likely, Mr. Parkus said. That compares with a 32 per cent peak-to-trough decline for house prices, according to the Case-Shiller home price index.
Many office towers with significant vacancies, in Manhattan and elsewhere, are being unloaded at "fire sale" discounts of up to 70 per cent.
In an environment of rapidly falling prices, banks are leery about renewing loans because they don't know what properties are really worth, noted Mr. DeBoer of the Real Estate Roundtable. "It's like asking the banks to catch a falling knife."
The industry is pushing the Fed to help out by loosening up the terms of its $1-trillion Term Asset-Backed Securities Loan Facility (TALF), which was recently extended to cover commercial mortgage-backed securities.
But Mr. DeBoer said there are few takers because the rates are too expensive and the program is set to expire at the end of the year.
This all spells looming trouble for banks. The banking industry, which has a $1.8-trillion exposure to commercial real estate, could face losses of nearly $200-billion, according to Mr. Parkus.
And unlike the housing meltdown, this crisis is likely to hit smaller banks the hardest. Mr. Parkus pointed out that the four largest U.S. banks have an average exposure of 2 per cent to commercial real estate. The 30 to 100 largest banks have an average 12-per-cent exposure.
"We see [commercial real estate]as a very significant risk," acknowledged Jon Greenlee, the Fed's associate director of bank supervision and regulation.
He pointed out that the 19 large financial institutions that recently underwent stress tests had roughly $600-billion in commercial real estate loans. The total market is worth $3.5-trillion.
There were 5,315 U.S. commercial properties in default, foreclosure or bankruptcy at the end of June, more than twice the number at the end of 2008, with hotels and retail among the most "problematic," Real Capital Analytics Inc. said in a report Thursday.