By Kevin D. Williamson
Remember 2007? Glory days, right? Everything was booming, and nothing was booming quite as much as real estate — especially commercial real estate. Malls,
hotels, warehouses, industrial parks: Everything was being built, and
everything was being financed on ridiculously generous terms. Remember
interest-only loans? Good times.
But commercial real estate is different from residential
in one important way: Your standard residential mortgage goes 20 to 30
years. Your standard commercial loan goes for five years, at the end of
which you either make a big balloon payment (what it is that balloons
remind me of?) or you refinance, the idea being that five years is long
enough to get your project built or developed, to secure tenants and
leases, get your cash flow flowing, etc. Five years: Seems like it was
only yesterday. By my always-suspect English-major math, that means that
a whole bunch of commercial mortgages written at that poisonous sweet
spot when prices were highest but lending standards were lowest are
coming due . . . oh, any minute now.
In New York City alone, there’s about $70 billion worth
of commercial mortgages — some of which have been sold off as
mortgage-backed securities, naturally — coming due this year. The
national total is more than $150 billion, or a bit more than 1 percent
of U.S. GDP. That’s going to be a little awkward: The value of U.S.
commercial properties has declined by an average of 45.7 percent since
their all-time high in 2007, according to Real Capital Analytics. Those
2007 vintage loans weren’t exactly bulletproof: Typical terms included a
20 percent down payment and a five-year payment schedule that required
little more than interest payments. An $80 million mortgage on a $100
million property is not so bad, but an $80 million mortgage on what is
now a $60 million property is a problem. More than half of the
2007-vintage loans are expected to have trouble refinancing, and maybe
well more than half.
This is true even for borrowers who have never missed a
payment. Banks are required to take into account a number of factors
when rating commercial mortgages. One of the most important is the
loan-to-value ratio, which has a lot of borrowers over a particularly
uncomfortable barrel: They may have the cash to make their payments, and
they may have the cash flow to continue making payments on a refinanced
loan, but their properties still are worth less than their mortgages,
so nobody wants to refinance. And those are the lucky ones: Just as
those loans were mostly for five years, most commercial leases are for
about the same length of time. With retail and office-space rentals
down, lots of commercial borrowers are sitting on largely vacant
properties that are not producing much in the way of cash flow. Among
the more high-profile cases, the WTC 3 tower at the World Trade Center
still has not located an anchor tenant, which could put the much of the
project on ice. Thousands of strip malls across the fruited plains have
empty storefronts, and thousands of office buildings have floor upon
vacant floor.
Standard & Poor’s advises: “One-third of maturing
loans are for office properties, for which five-year lease terms are
fairly common — and if tenants don’t renew these leases, securing new,
long-term lease commitments may be more difficult in the current
environment. Those leases [were] signed in 2007, at peak rents will
likely reset to lower levels as five-year leases roll.” S&P’s bottom
line: “50%-60% of the 2007 vintage five-year-term loans maturing next
year may fail to refinance, and retail loans are at the greatest risk.”
Translation: Armageddon at the strip mall.
To address the forthcoming Armageddon at the strip malls, some would refer to von Mises; others to Galbraith. Obama has evidently consulted trannie-stripper, RuPaul, as to what to do about strip malls.
Strip Clubs In Strip Malls Across Amber Waves Of Grain, Purple Mountain Majesties, And Fruited Plains And From Sea To Shining Sea, Perchance?
And it’s not just a problem for New York City and other
big, coastal cities. Richmond, Va., has it worse than Manhattan,
Washington, or Los Angeles, according to the local Times-Dispatch,
which reports that a dozen large commercial properties have gone into
foreclosure recently and that 12 percent of the commercial properties in
the Richmond-Norfolk market are “distressed.” In Bergen County, N.J.,
commercial foreclosures
are up 7 percent this year over last year. In the first year of the
recession, there were 373 foreclosure actions filed in Bergen County,
while in 2011 there were 1,586. Commercial foreclosures are up 10
percent for the state as a whole.
In hard-hit Phoenix, about half of the commercial
mortgages backing securities are at risk of default, and a couple of
hundred, mostly strip malls and other retail, office buildings, and
apartments, already are in default.
Taking a look at the commercial MBS (CMBS) market, Standard & Poor’s issued this advice: “Buckle Up.”
Trepp, a CMBS-analysis firm, in its most recent report
(data as of October 2011) finds that the delinquency rate for
multifamily-property mortgages is 16.73 percent; for hotels, 14.12
percent and rising; for offices, 8.95 percent and rising; for industrial
properties, 11.59 percent and rising; and for retail, a steady 7.61
percent. Trepp managing director Matt Anderson does not sound like a ray
of sunshine: “Overall, we do not expect 2012 to be a repeat of 2008,
but there will be more disappointments than pleasant surprises in the
New Year. The banking sector has not yet returned to ‘normal’ despite
two years of earnings growth. With increased regulation and the
temptation for banks to take additional risks in order to preserve
margins, 2012 should be a very interesting year.”
Not as bad as 2008 — is there a better example of damning with faint praise?
Trepp gets to the real concern here, which is that these
mortgages and mortgage-backed securities are sitting on the balance
sheets of a bunch of still-wobbly banks. How wobbly? About 100 banks
went under last year, and about 250 are expected to go under this year.
Trepp finds that, of the banks that went toes-up in 2011, bad commercial
real estate accounted for two-thirds of their failing loans.
This is a textbook case for the Austrian business-cycle
theory: Artificially low interest rates and loose money produce
overinvestment, by both bankers and builders, in a bubble — this time,
offices, apartment buildings, and retail space — that can’t be sustained
once the artificial stimulation comes to an end, as it must. In this
case, that malinvestment has to be worked out at two levels: At the
financial level, among the lenders and borrowers, but also at the physical level: There’s going to be a lot of dark storefronts out there,
with serious long-term consequences for nearby neighbors and for local
real-estate markets: Foreclosures will put more property onto the
market, driving down rents and subsequently making existing loans less
tenable as the cashflow of commercial properties is diminished. They
called the Depression-era tent cities “Hoovervilles.” The next time you
see a mile of half-abandoned strip malls, think “Obamaville.”
Not as bad as 2008? Probably not — and let’s hope it is
not even close. But there’s a $3 trillion commercial-mortgage market
lurking out there, and a lot of CMBS investors — banks and insurance
companies in particular — that Washington thinks are “too big to fail,” a
problem we persistently refuse to address.
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