Brace for Impact!

I didn't write the article below but was so impressed with the details and how factual this report is that I felt it worth posting here. It does not paint a pretty picture but does give us due warning to be ready for what is 99% likely in our near future. If you're a praying man or woman this would be the time to turn up the volume....

Source: Copyright 2009, The Dilenschneider Group, Inc.

Even though many prognosticators are optimistic
that we could be at the end of what has become
known as the “Great Recession,” there are disturbing
signs that suggest America is about to
confront the possible collapse of the commercial
real estate market—represented by $6 trillion
plus in total asset value, and supported by $3.5
trillion in debt. Be prepared!

Owners and developers of office and residential
buildings, stores, hotels and other commercial
real estate are coming under greatly increased
pressure to meet their debt obligations. Sharply
falling rents, mounting vacancies, and unfinished,
abandoned projects across the country have
raised genuine concern among banks, other lenders
and regulators that any hoped-for recovery
may be derailed before it really gets started.

Some $83 billion in office, retail, industrial and
apartment properties have fallen into default,
foreclosure or bankruptcy thus far this year, according
to research firm Real Capital Analytics.

Some see the commercial default rate hitting 4.1
percent by year’s end. Meanwhile, with property
values down an estimated 40% from their
2007 peak, most lenders still remain reluctant to
foreclose on devalued properties in such a deadly
market.

Commercial real estate now accounts for 13% of
the Gross Domestic Product and plays an integral
role in the U.S. economy. It is a linchpin in the
nation’s financial system.

Key Concerns:

• Private commercial construction will continue
to contract sharply, impacting GDP growth.
• Nearly $1 trillion in short-term commercial
mortgages are slated to mature by the end of
2010.
• Lenders’ losses may total $250-500 billion,
especially hurting regional and local banks.
• Banks’ commercial real estate losses will keep
them cautious on lending through 2010.

All this is happening at the same time that residential
mortgage foreclosures are continuing to
rise sharply, triggered by the nation’s high unemployment
rate. Estimates suggest a staggering
1.8 million borrowers will lose their homes this
year, up from 1.4 million in 2008.
The Arrival of the Commercial Real Estate

Crisis

According to Richard Parkus, a Deutsche Bank
analyst who wrote a commercial real estate report
in late April 2009, an estimated $1.3 trillion in
loans to commercial property owners will be
coming due between now and 2013. Parkus estimated
that at least half the loans—and two-thirds
of those loans packaged and resold as securities—
will not qualify for refinancing.

“People are only now beginning to realize there
is a looming crisis,” he said.

The Achilles’ heel of commercial real estate is
vacancy rates. Not surprisingly, vacancies nationwide
are up and expected to reach 13.5% for
retail and 17% for office buildings. This, in turn,
decreases the potential income that commercial
properties need in order to make mortgage payments.

“I doubt too many banks will want to own a lot of
commercial properties that are empty,” comments
George Raitu, an economist for the National Association
of Realtors.

The current extraordinary weakness in the U.S.
commercial real estate market is poised to plunge
the economy under water for a very long time.

Some 9 million jobs are generated or supported
by real estate. These jobs touch all areas of the
economy and are in construction, planning, architecture,
environmental consultation and remediation, engineering, building,
maintenance and security, management, leasing, brokerage,
investment and mortgage lending, accounting and legal
services, interior design, landscaping, cleaning services and more.

The repercussions go further than the workforce,
however. The implosion of the commercial real
estate market could significantly reduce the value
of Americans’ pension funds invested in commercial
real estate equity. Construction, hotel and
retail workers will lose jobs. Moreover, state and
local governments will confront the prospect of
reduced tax revenue and the loss of recording and
transaction fees.

In testimony before Congress in early July, Jeffrey
Deboer, CEO of the Real Estate Roundtable,
said: “The current credit system in America
simply does not have the capacity to meet the legitimate
demand for commercial real estate debt.

As demands for debt remain unmet, stress to the
financial services system overall, individual financial
institutions, and those who have invested
in real estate directly or indirectly will increase.”

Assessing the situation, he added, “This is a market
failure of catastrophic proportions.”

The Crisis is Pervasive

These are the dimensions of the potential crisis:

• The number of transactions is down 80%.
• Asset values are estimated to have fallen an
average of 35% from their peak.
• Capitalization rates have climbed 250 basis
points while rents have declined up to 20% depending
on property type.
• With so few transactions, there is no effective
price discovery.
• Without sufficient price discovery, it is almost
impossible to determine loan-to-value, the
linchpin metric in lending.

Federal Reserve Chairman Ben Bernanke told
Congress in July that he is encouraging banks
to work out troubled real estate loans. Yet Bernanke
believes that anything more substantial in
the form of intervention would require Congress
to decide. “I think, really, Congress has to make
those trade-offs between the fiscal cost, the fiscal
risk and …a very real risk on the side of foreclosures
and the problems in commercial real
estate,” he said.

Averting a Crash Landing

What can be done to avert a second economic
disaster?
Deboer of the Real Estate Roundtable recommended
to Congress that the following federal
policy actions be enacted as soon as possible:

1. Extend the Term Asset-Backed Securities Loan
Facility (TALF) beyond its current December 31,
2009 sunset date, through the end of 2010.

2. Establish a federally backed credit facility,
possibly created from the PPIP structure or a
privately-funded guarantee program for originating
new commercial real estate loans.

3. Encourage foreign capital investment in U.S.
real estate by amending or repealing the outdated

Foreign Investment in Real Property Tax Act

(FIRPTA).

4. Encourage banks and loan servicers to extend
performing loans, based on cash flow analysis;
and temporarily amend real estate mortgage
investment conduit (REMIC) regulations to
facilitate early review and possible modifications
to the terms of commercial mortgage loans that
have been securitized in CMBS.

5. Reject new anti-real estate investment taxes,
such as the carried interest proposal, and provide
a five-year carry-back for the net operating losses
of all businesses.
© Copyright 2009, The Dilenschneider Group, Inc.

4 Implications For Business
• Understand your immediate commercial real
estate situation. What is the financial health of
your landlord? What is the vacancy rate in your
building? Are building services being cut back to
save money? How is all this affecting your own
business, its brand, its image?
• With the possible collapse of the commercial
real estate market, unemployment will persist in
all job sectors.
• Be prepared for an increase in crime as unemployment
benefits end for America’s jobless.
• The financial future of companies with large
real estate holdings will be suspect.
• If your building’s ownership defaults, how is
the lender going to remediate and how does this
affect your work environment? What circumstances
in your lease allow you to terminate the
lease? Will you be forced to move your business
to another location? Does this have business
interruption insurance implications?
• Each business will need to engage its elected
officials at the local, state and federal level on its
behalf.

• If a building or neighborhood is in a downward
vacancy spiral, is your business taking steps to
provide a safe work environment for your employees
(e.g., dealing with empty parking lots,
too much empty space for security guards to
adequately monitor, etc.)?

• Your company’s pension committee needs to determine
the nature of its investment in commercial
real estate securities in both equity and fixed
income portfolios. The committee will need to
be in close communication with its investment
advisers and managers on this question.

Conclusion

The day of reckoning is approaching in the commercial
real estate market. The vital question is
whether the shoe will drop softly. As we await
its landing, it’s worth remembering the words of

U.S. Airways hero pilot of Flight 1549, Captain
Chesley “Sully” Sullenberger, moments before
landing in the Hudson River, “Brace for impact.”

The commercial real estate market—and, therefore,
many of us who will be impacted if the
economy takes another major hit—need to brace
for impact and hope for the best.

© Copyright 2009, The Dilenschneider Group, Inc