By Ted Schmidt

Commercial real estate is financed primarily through three channels, portfolio lending, commercial mortgage backed securities (CMBS) and direct cash purchases.

Portfolio lenders are regional banks, insurance companies, pension funds and others that lend money directly to property owners. These loans stay on the lenders books for the life of the loans. Portfolio lenders have pulled out of the market and are actively trying to reduce their exposure to real estate.

CMBS loans are made by mortgage banks that fund the initial transaction and then sell the income stream that the loan produces as investment vehicles on the stock market. The CMBS market seized up in 2008 following the sub-prime crisis and even with efforts from the Federal Reserve with the Term Asset Lending Facility (TALF) program to "prime the pump" the market is still effectively locked down. The TALF program allows institutional owners of CMBS to use the securities as collateral for extraordinarily low interest rates loans. This was designed to grease the wheels of the CMBS market but does not address the nearly $270 bn. capital deficiency on the exiting $800 bn. in maturing loans in the next 2 years.

Effectively there is nowhere to go. The options for both lender and borrower are few.

Fed Chairman Ben Bernake says that these loans "ought to" be modified. Portfolio loans have some chance of being worked out and restructured since it is easy to identify and contact the owner. The major obstacle for regional banks who own these loans is that if they modify the loan or accept a short sale, they have to recognize the loss on their books. At a time when they are already hurting for capital they are reluctant to acknowledge the loss and would rather keep it on their books at full value.

CMBS's cannot be modified because no one even knows who owns them and there is no clear legal path to contact the owners. Furthermore they all have divergent interests and there is no way to get them all to agree.

Commercial property buyers remain on the sidelines as values plummet. Property owners and portfolio lenders are in still in denial about the true market value and can only sell at distressed prices. Right now, only seller financing and all cash deals are being accomplished in the commercial real estate space.

We need an entirely new way to fund commercial real estate transactions. Will the government step in with a commercial real estate bailout? Who will they bail out? Will congress pass new laws that will circumvent servicing agreements and force investors to accept renegotiated terms? These questions need to be answered.

We need a new paradigm in commercial lending. Comments please.