by Dan Krell © 2009
www.DanKrell.com
If Wall Street is considered by some to be the “life blood” of the United States economy, then commercial real estate can be described as the economy’s lungs. If you can take a pulse of the economy by looking at Wall Street’s progress, then you can measure how well the economy “breathes” and thrives by looking at the state of commercial real estate. Even though Wall Street’s markets have somewhat rebounded from last fall’s correction, a bust in commercial real estate can correct Wall Street’s correction with another dip into the recession bin.
Owners of commercial real estate depend on cash flow to service their debt; this means that they depend on their business to pay their mortgages. For owners of retail and office centers, this means that the key to paying their mortgages is to collect the rents from businesses leasing space. When the economy is strong, vacancies are low and lessees pay their rents. As the economy slipped into a recession, vacancies increased and owners of retail and office centers found it more difficult to service their debt.
Commercial real estate financing is much different than residential real estate financing. Unlike residential mortgages, where typical terms are 30 years and underwriting guidelines are standardized for many programs; the terms and conditions of commercial real estate mortgages are often tailored to the risk level of the individual project or property.
Because commercial real estate mortgages are due in shorter periods (usually a balloon note), owners of commercial property are always looking for better rates and terms to improve their cash flow. As liquidity dried up in the last year due to bank fall outs and shake ups, some commercial real estate owners are finding it more difficult to refinance their notes that are coming due.
This double whammy is the reason for many real estate analysts’ predictions of a bursting commercial real estate market. As Lingling Wei and Peter Grant pointed out in their August 31st Wall Street Journal commentary (Commercial Real Estate Lurks as Next Potential Mortgage Crisis), delinquencies in commercial mortgage backed securities (bundled loans sold to investors such as hedge funds and pension plans) rose 600% to a delinquency rate of 3.14% in July 2009 as compared to the same time the previous year.
Wei and Grant also point out that an additional $1.7 trillion worth of commercial mortgage notes are being held by banks. As notes become due, bank losses are also expected to increase because of the inability to re-finance mortgages. Many commercial real estate owners and their lenders are finding that commercial properties are increasingly burdened by vacancies, making it more difficult to service the debt, while commercial real estate values are being driven down due to increasing defaults and foreclosures.
The good news is that like residential real estate, commercial real estate data is regional (depending on local market activity). Local commercial Realtor, Cory Hoffman (of Thur and Associates located in Mclean, VA) was optimistic when he said that “the commercial real estate market will get worse before it gets better…but the Washington D.C. commercial market will not be as hard hit as the rest of the country…” because of the strong government job market and stronger local economy.
This column is not intended to provide nor should it be relied upon for legal and financial advice. This article was originally published in the Montgomery County Sentinel the week of September 28, 2009. Copyright © 2009 Dan Krell