Attempts to slow the mounting number of bad debts in the U.S. commercial real estate market have been unsuccessful. On top of continuously declining rents at office buildings and shopping malls, the problem is a lack of new sources of capital. Over the next three years, more than $1.4 trillion in commercial real estate loans will come due. In an environment where banks and investors are taking a conservative position in regards to investments, will real estate developers be able to raise the capital they need to refinance the loans? Among market insiders, fears that this is a hidden time bomb in the American market are on the rise.
In the several years leading up to the peak of real estate prices in 2007, large loans were made under fairly lax lending standards. This is the main cause for the rising numbers of bad loans. Supported by the increasing values of collateral and the expanding securities market, banks and investment funds were actively pursuing real estate companies for investment.
From 2005 to 2008, the peak of the real estate market, many loans were made which were either highly leveraged compared to the value of the collateral, or which used estimated values for the collateral which were artificially high. Loans made in that environment are now starting to come due.
According to the FRB, during the 4th quarter of 2009, the percentage of commercial real estate debt held by banks which is more than 30 days in arrears grew 3.28 points, to 8.81%, over the same quarter of the previous year. In the fall of 2007 the number was in the 1% range but the continued economic slump has taken its toll on rents, which remain sluggish. Since 2008, when the financing for real estate companies became more difficult, the trend has continued to accelerate.
The percentage of overdue loans among commercial mortgages that were bundled into commercial mortgage-backed securities is also on the rise. According to ratings agency Fitch Ratings, by the end of 2009 the percentage of overdue securitized loans rose 3.3 points over the previous year, to 6.59%. Fitch predicts that by the end of 2010, the figure will be over 11%.
Looking at the statistics compiled by U.S. ratings firm Moody’s, the value of the commercial real estate index continued to rise from 2003 until the second half of 2007. In the five years leading up to the peak, in October of 2007, prices increased by 70%. But over the two years and four months since prices began to fall, values have dropped to only 42% of what they were at the height. As a result of this, an ever greater number of loans exceed the value of their collateral. As borrowers were pressed to come up with additional collateral, or tried and failed to secure new sources of capital, loans were pushed into default.
According to real estate investment firm Blumberg Capital Partners, the value of loans that will come due in the four year period from 2010 – 2013 is more than $1.4 trillion. It’s possible that if the trend of extending payback periods for borrowers who are unable to raise sufficient capital continues, that number will grow even more in the future.
On the other hand, the volume of new loans issued in the fourth quarter of 2009 decreased by 80% over the fourth quarter of 2007. Local banks, the largest issuers of commercial real estate loans, do not have the leeway to increase financing while recovering from their lagging performance. Massey Knakal Realty Services President Robert Knakal says that more than half of the investment funds and investors who were in commercial mortgage-backed securities withdrew from the market and have not come back.
President Philip Blumberg of Blumberg Capital Partners explains that although the demand for funds in the market is large, the supply is extremely limited. He predicts that new flows of capital into the market will remain limited, giving funds with ready capital continuing opportunities to buy seized properties from the banks.
After a brief lull at the end of last year, real estate prices began to fall again in February this year. Moody’s sees a risk that real estate prices will fall still further if property trading doesn’t become more active, and this sense of caution is deeply rooted in the market. Mr. Knackal sees a bright spot in some areas, such as New York and Boston, where there’s a movement among foreign investors and some funds to buy desirable properties at a relatively cheap price. But for the U.S. market as a whole, it seems that it’ll take some time for a true recovery or a return of capital into the marketplace.
Keywords: Blumberg Capital Partners, capital, CRE, debt, Fitch Ratings, FRB, investing, loans, Moody's, Philip Blumberg
