Behind all the good news about the economy, one thing is keeping bankers awake at night: commercial real estate is looming as the next asset bubble to pop. This comes just as residential real estate appears to have hit bottom and is rebounding. According to the National Association of Realtors, pending home sales have increased for seven straight months.
While residential real estate also has problems such as foreclosures, it is commercial real estate that has officials worried. Commercial real estate was identified by the Federal Reserve as “one of the weakest sectors” in its Beige Book report on economic health.
“Each district indicated that demand for private commercial real estate was weak,” the Beige Book said. “An inability to obtain credit was often cited as a problem for businesses that wanted to purchase or build space.”
Fed Chairman Ben Bernanke also raised the problem when he testified to the House Financial Services Committee earlier this month. “We are concerned, both because the fundamentals are weakening and because the financing situation is bad and could provide a lot of stress, particularly for small and regional banks that have a very heavy concentration in commercial real estate.”
Just how bad is it? According to Bloomberg, defaults on commercial real estate loans have soared to $110 billion in the second quarter, about 6 percent of all loans. That was 11 times the level in the fourth quarter of 2006 and may rise to $170 billion by the fourth quarter of next year.
The problem became clear as banks reported their third quarter results in the last week. At Citigroup, for example, commercial real estate losses were written off by $594 million in the quarter, compared to $354 million in the second quarter.
Similarly, General Electric, which has $84 billion in real estate holdings on its books in its GE Capital division, recorded a $538 million loss in the third quarter, 100 percent more than the loss in the second quarter. Last year, GE Real Estate made a profit.
Even at KeyCorp, Ohio’s second largest bank, commercial real estate weighed down the banks results. It raised loan loss reserves by $146 million to $2.5 billion. Losses on commercial real estate mortgages and construction loans have risen by 300 percent in the last year.
Just as some homeowners ended up with the homes being under water - their mortgages were higher than the worth of the property — a huge amount of commercial real estate notes — $1.4 trillion by some estimates — are coming due in the next three years and landlords such as shopping center owners faced with empty shops will have difficulty in paying for them.
“Most of that (debt) - a least a good slug of that - is under water,” Jed Smith, head of quantitative research with the National Association of Realtors told a conference in Charleston.
As the Wall Street Journal noted last week, commercial real estate tends to lag behind the overall market by one to two years as leases run out and businesses then renegotiate the terms of their agreements by getting a lower rent or taking smaller space. “Brace yourself for more bad news,” the Journal said.
