Tuesday, November 10, 2009

California Controller: Overview of the Commercial Property Markets

by Bill McBride on 11/10/2009 10:23:00 PM

Buried in the California Controller's November analysis is a guest article: Overview of the Commercial Property and Capital Markets with Implications for the State of California by Dr. Randall Zisler. (ht picosec)

Here are some excerpts:

Whereas excessive and imprudent leverage fed the bubble, deleveraging not only popped the bubble, but, in the process, destroyed record amounts of equity and debt. Most deals financed with high leverage from 2005 to the present are under water. The equity is gone and the debt, if it trades at all, trades at a deep discount to face value. Most leveraged equity invested in real estate has evaporated since property prices, if marked to market, have fallen 30% to 50%.
Property Returns Click on graph for larger image in new window.

The chart [right] shows overall U.S. property total returns, quarterly (at annual rates) and lagging four quarters. This appraisal-based, lagging index shows sharp negative returns exceeding the deterioration of the RTC (Resolution Trust Corp.)
period of the early 1990s. (See Chart 1.) Second quarter 2009 returns indicate the possibility that total returns, while still negative, may have hit a point of inflection. We expect that property values in many sectors, especially office, retail, and industrial, will likely deteriorate further in 2010 with improvement beginning sometime in 2011.
A crisis of unprecedented proportions is approaching. Of the $3 trillion of outstanding mortgage debt, $1.4 trillion is scheduled to mature in four years. We estimate another $500 billion to $750 billion of unscheduled maturities (i.e., defaults). Unfortunately, traditional lenders of consequence are practically out of the market and massive amounts of maturing debt will not easily find refinancing. Marking-to-market outstanding debt will render many banks, especially regional and community banks, insolvent, especially as much of the debt is likely worth about 50% of par, or less.

The inability of many banks and other capital sources to lend not just to real estate firms but to other businesses in the State as well presents a real challenge to the private sector and state and local governments.
The author points out that many local and regional banks will fail because of CRE loans.

FDIC Chairwoman Sheila Bair said today: "We do obviously have a lot more banks that will close this year and next," Bair said, adding the failures "will peak next year and then subside."

These bad loans are also limiting lending to small businesses. Atlanta Fed President Dennis Lockhart made the same argument this morning:
I am concerned about the potential impact of CRE on the broader economy ... there could be an impact resulting from small banks' impaired ability to support the small business sector—a sector I expect will be critically important to job creation.
Many small businesses rely on these smaller banks for credit. Small banks account for almost half of all small business loans (loans under $1 million). Moreover, small firms' reliance on banks with heavy CRE exposure is substantial. Banks with the highest CRE exposure (CRE loan books that are more than three times their tier 1 capital) account for almost 40 percent of all small business loans.