Today's Wall Street Journal reports significant increases in commercial real estate loan defaults and delinquencies. Here's data through the fourth quarter on bank loans:
It paints a useful picture, but keep in mind that many commercial real estate loans are not from banks, and thus not reported here.
Two items for perspective. First, we did not overbuild non-residential properties as we did residential. This chart shows the share of GDP devoted to the two types of construction, with long-run averages in thin lines:
Not having overbuilt is not the same thing as being healthy. The recession has been hard on vacancy rates and rental rates, so the sector is hurting. However, note the difference from residential real estate: it was overbuilt even before the recession.
The second issue to get perspective is the role of "maturity defaults" in commercial real estate loan problems. Here's what that means. A typical real estate mortgage has a 5-year term. The loan may amortize over 30 years, or may be interest-only (common a few years ago, but rare now). Five years after the commercial mortgage was originated, the loan must be repaid and a new loan found. (I'm describing typical terms, but there's variation from these.)
Suppose you bought an office building five years ago with 20% down, for an 80% loan-to-value ratio. You have not missed a payment, the building's value has been stable, your amortization has paid down the loan balance by four percent of the building's original value. A new loan will have a 76% loan-to-value ratio.
Here's the problem: nobody will make a commercial mortgage loan with a 76% loan-to-value ratio today. You haven't missed a mortgage payment, your building is fully leased, you've been working down your principal, but the lenders are all scared. Bank regulators are scared. Secondary markets are scared. So you have to pony up additional cash to bring the loan-to-value ratio down to at least 70%, and maybe even 65 or 60%.
What if you don't have the cash sitting around to do that? You have a maturity default. Your problem is that credit standards tightened faster than you were paying off your loan.
What does this mean for the larger economy? If reflects a financial problem, not a real problem. A real problem is real estate that isn't wanted. A financial problem is useful real estate that doesn't fit lenders' risk profiles. The lender will face the facts and let the loan ride. The lender may be unhappy, and a regulator may be unhappy, but nothing bad is going to happen to the property. Even if the lender forecloses, the building is still occupied. There's no big impact on the economy. In other words, the real situation is not as bad as it may appear.
How much of the total commercial real estate loan problem is due to maturity defaults? A Deutsche Bank analysis suggest a whole boatload of loans won't qualify for refinancing in the coming years. As I read their estimates, some 66% of loan values coming due in 2009-2012 won't qualify for refinancing. The biggest problem areas are multi-family and office.
A loan to value of 76% may be just fine for refinancing. One other factor to consider in conjunction with LTV is the debt coverage ratio. If the property is generating sufficient cash flow to cover the debt, then I don't think there would be any difficulty in getting a new loan.
Posted by: Luther Anthony | April 10, 2009 at 08:27 AM
Good post.With the development of private property ownership, real estate has become a major area of business. Purchasing real estate requires a significant investment, and each parcel of land has unique characteristics...
Posted by: san diego real estate | April 16, 2009 at 12:14 AM
I would be very interested in seeing 2008 and 2009 data in your Commercial Real Estate loans chart. How has the trend been reacting the last two years?
Posted by: Brainerd Lakes Area | May 27, 2009 at 09:03 PM
More proof of the 100% accuracy of the May 15th Prophecy read What is Now and you will see what will happen next!
Posted by: Leondavis3 | June 08, 2009 at 02:14 PM
Hi,
I am going to start real estate business.What are mortgage loan situation today.
Posted by: Mortgage Loan | June 09, 2009 at 04:41 AM
Global recession has created many problems in real estate business worldwide.Property sale purchase is badly affected due to terrorism attacks in Lahore and current law enforcing agencies operation in Swat and adjacent areas.
Posted by: Pakistan real estate property | June 09, 2009 at 06:49 AM
Commercial real estate will get a lot worse yet. The fundamentals are off. The recession will not give them pricing power or even hold rental pricing. The lack of the ability to roll the mortgages is even a bigger problem. Not to say many markets are over built.
Posted by: Richard Stabile Bergen County Real Estate | June 14, 2009 at 09:21 AM