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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

June 11, 2010 at 10:05 AM

Did we dodge a bullet on commercial real estate? Maybe or no way…

Good-news seekers can take some comfort in the fact that, so far, we’ve avoided a major commercial real-estate crash. This is no small thing when measured against economists’ fears of the past two years and a dire warning from bailout watchdog Elizabeth Warren. True, Seattle, like many cities, faces very high vacancy rates and CRE has taken down several smaller Washington state banks. But things could have been far worse.

In Fortune magazine, Heidi N. Moore reports that the economy is outrunning the worst, at least for now. “The only question now is how long it can keep up the sprint while the ghosts of boom-time leverage haunt the sector, and $1.4 trillion in loan maturities loom three years over the horizon.”

Government help for the financial markets has played a big role in maintaining confidence. Here’s the argument of the bulls:

…investors in commercial properties and buyers of commercial mortgage-backed securities believe that the commercial real estate market will continue to suffer until it hits a bottom, but it will never crash in the way that the residential market collapsed. They believe that commercial real estate will be an example of how a market can take the hits and keep on ticking, that not every spot of trouble results in a crisis, that an industry can actually, somehow, stop a crisis if it acts early enough and has enough support.

A big unknown remains with commercial mortgage-backed securities (CMBS). A total of $602 billion were written between 2005 and 2007 — 49 percent of all such securities issued over the past 20 years. Moore reports:

CMBS, however, accounts for only about 20 percent of the total loan market, according to Jones Lang LaSalle’s (Peter) Roberts. The bigger danger to the capital markets — and to banks — are speculative commercial loans, like those in construction and land loans. Those aren’t backed by firm assets and are a key part of the reason that many smaller banks have failed in recent years. It is these loans, in particular, that worry Warren and others, and could yet bring a reckoning to CRE.

Much of the outcome depends on no further major shocks to economy. And the hope that, unlike the much larger housing bubble, we really have a handle on the interconnected risks associated with commercial real estate.

UPDATE: A couple of in-the-know locals weigh in. One writes:

Unfortunately, there are few indications that we have dodged a bullet; it is still headed our way and seems to be gaining speed.

Banks are working as hard as they possibly can to avoid recognizing their ever-growing mountains of ‘troubled’ commercial real estate debt and the FDIC seems to be actively encouraging this denial of reality. You’ve undoubtedly heard of ‘extend and pretend’ or ‘delay and pray’; these practices are rampant in the CRE world.

For perhaps a third of our local and regional banks, dealing with their existing non-performing CRE loans (never mind those that are headed for trouble) would result in overnight insolvency — thus their desperate measures to prolong their lives are understandable. For the remainder, such actions are unforgivable. The longer banks delay taking back, then selling, commercial collateral, the larger the backlog of CRE becomes and the worse the repercussions will be when the FDIC is finally forced to mandate the sale of these assets. It seems inevitable that when the dam does burst, we’ll see commercial listings skyrocket and prices will plummet…there is a terrible storm brewing and you will want to keep an extra-close eye on it.


If you were to call any leasing broker they would tell you that every tenant, even those with many years left on their existing leases, are all out pushing for new lease terms or they will vacate and relocate. In a market with high vacancies the landlords cannot let these tenants out of their buildings because they won’t be able to get anybody to fill the vacant space. This drives down NOI and therefore Indicated economic value. The lenders now have the right to “margin call” the loan as it does not meet minimum loan standards. The landlord tells the bank, “I don’t have the extra money to pay down the loan,” so the bank has to make a decision: Do we pretend/extend or do we go the legal route? It is a mess and will not be solved until a)debt in all markets is reduced; b)we have employment growth; c) we have wage growth; and d) we have reduced or at least stabilized vacancies.

Values of buildings are falling and therefore prop tax revenues will be falling. It is a bit of a death spiral and not easy to get out of.

Today’s Econ Haiku:

Once burned, twice not shy

TPG still finds reasons

To like Seattle

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