Some people only associate the subprime lending meltdown with the residential real estate market. However, any loan to any borrower can be “subprime” if the debt to equity or income ratios are to high. This applies to the commercial real estate market as well.
Over the past several years, the market for commercial property has enjoyed the very best conditions. In fact, by early 2007, delinquencies on commercial loans fell to all-time record lows. However, commercial lenders were no less foolish than residential lenders making loans to home buyers with questionable credit and/or finances. Is there any reason to believe that commercial lenders will not suffer the same fate as residential lenders?
There are factors that may soften the blow to commercial lenders. Commercial real estate is a smaller market than residential real estate. Commercial landlords often have a diversified group of tenants with different income streams. A commercial landlord also has the advantage of being able to more easily reconfigure available space to meet the needs of new occupants. Also, the supply of commercial buildings has not increased dramatically over the past several years. Most owners of residential property do not have these advantages.
With all this being said, industry leaders have intimated that that lenders are set for a collision in the years to come. Banks have already recognized an estimated 60% of cumulative losses, or about $50 billion. Recent indicators suggest that the commercial real estate market may have hit rock bottom despite a cascading drop in the price of apartments, office buildings and industrial properties nationwide in 2009. According to Moody’s/REAL Commercial Property Price Index, commercial property values have increased 1% in 2010 after 13 months of consecutive declines. However, some commercial real estate industry experts believe that the problems will get worse before they get better. High-priced commercial spaces will soon feel the same pinch considering the nation’s unemployment rate remains at 10% with consumer spending levels continuing to slide.
Thousands of community and regional banks nationwide that hold approximately $860 billion in commercial mortgages and construction/development loans are bracing for implosion. Banks have been slow to recognize potential losses on these loans since many borrowers are still current on their payments despite being upside down on their loans; thus, foreclosures are not on the books. With a subtle nudge of industry regulators, many banks have extended the terms of a majority of their commercial loans in hopes that property values and occupancy levels will improve in 2011. Unfortunately, the consensus is that neither prices nor occupancy rates will improve anytime soon. And, borrowers will find it even more difficult to refinance their existing loans considering an approximate $1.4 trillion in outstanding commercial real estate paper is expected to come due over the next three years.
By Stuart Miller, Esq.
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