Are flood of commercial real estate loan defaults coming?
December 31st, 2009
Are flood of commercial real estate loan defaults coming?
Submitted by SHNS on Thu, 12/24/2009 - 14:54
Fears of a commercial real estate mortgage meltdown are bolstered by persistent unemployment, which has led to office and retail vacancies, rising commercial loan default rates and hundreds of bank failures.
A wave of commercial mortgage foreclosures would probably translate to more empty storefronts and offices, decreased municipal property tax revenue and fewer bank loans available to start and expand businesses.
But while most commercial real estate experts agree that in 2010 there will more loan defaults, scores more bank closures and limited construction lending, many observers do not believe that commercial mortgage defaults will derail the recovery.
"Things are not rosy, but the outlook for commercial real estate as the next shoe to drop after the residential mortgages just really isn't what we see," said Steven Buster, president and chief executive officer of Mechanics Bank in San Francisco.
Buster said that while there is a perception that the commercial real estate market will soon collapse in the way the residential market did, the two markets are fundamentally different.
In recent years, many home mortgages were extended to buyers who never had enough income to cover their debt. In contrast, commercial real estate fundamentals did not change, Buster said.
In general, lenders did not issue loans to businesses without adequate income to cover their mortgage payments.
While many residential properties that fell into foreclosure were deeply underwater (meaning their loans were much larger than the value of the property), fewer distressed commercial properties have such a large imbalance.
Buster and others said that troubled borrowers will get significant relief from recent efforts by the Federal Deposit Insurance Corp. to help banks modify commercial loans in a way that extends the terms and does not cut into the lenders' capital.
If borrowers can hold on to their properties in the coming months, the strengthening economy should bolster their prospects, experts say. Rebounding businesses eventually will need to hire workers and need more office space, pushing up rents, the theory goes.
Matthew Anderson, a partner with Foresight Analytics, a real estate research and forecasting firm in Oakland, Calif., said predictions of a commercial loan default deluge may be overstated.
"The scenario in which banks work with borrowers to tread water is looking more likely," Anderson said. "The economic recovery is real and starting to take hold, and late next year we may see more demand for commercial space."
Still, the numbers do not look good. More than half of the $1.4 trillion in commercial mortgages coming due nationwide in the next five years are underwater.
Anderson predicted that 600 of the nation's approximately 8,000 banks will fail between the third quarter of 2009 and the end of 2011. He noted that about 130 banks closed in 2009.
The new FDIC guidelines are similar to those on home mortgage restructurings. They are intended to keep commercial properties from spiraling into a foreclosure cycle that could suck in local and regional banks.
"Part of the intent of these rules is to allow banks to push off taking action on bad loans so that property owners can continue to stay in the property with the hope that as time goes by the values will recover," said Marc Young, a partner with the Morrison & Foerster law firm in Los Angeles who focuses on real estate. "It's kind of a kick-the-can-down-the-street mentality."
Buster said pessimism about commercial real estate is coming from property owners who have seen their values disappear on paper, but that the values will inch up as the economy regenerates.
"The economy is turning and we are out of the recession," Buster said. "We'll have to grin and bear it for a time, but the fundamentals of the economy are reflected through real estate."
Chronicle staff writer Carolyn Said contributed to this report. E-mail Robert Selna at rselna(at)sfchronicle.com.
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